April 14, 2024

Finance financiers bank crises and the part played by central banks

  The concept of a central bank is somewhat recent. At the end of the nineteenth century, one American president (Andrew Jackson) even abolished the Federal Reserve System because he didn’t think it was all that necessary. However, it was then; times have shifted since. Today, central banks are the most crucial part of most countries’ monetary systems. Weird hybrids are central banks. It’s true that they share some capabilities with conventional banks. Aside from these common tasks, central banks do a number of special tasks. It has a de facto monopoly in several jurisdictions on those activities.

 A central bank accepts deposits from other banks and, in some situations, directly from foreign    governments, who deposit their gold and foreign currency reserves with the bank for protection (for instance, with the Federal Reserve Bank of the USA). The country’s foreign exchange reserves are invested by the Central Bank, which aims to mirror the state’s trade makeup in its investment portfolio. The country’s gold reserves are also stored at the Central Bank. As the price of gold continues to fall, many central banks have been trying to unload their holdings in recent years. Because central banks record gold at its historical worth, they are able to generate a tidy profit from this venture. Many countries’ central banks take part in international negotiations, but the United States’ is particularly active. They have an indirect impact if they don’t take the lead themselves. The German Federal Reserve Bank (Bundesbank) effectively controlled Germany’s negotiating posture during the Maastricht talks. The signatories were coerced into accepting stringent conditions for joining the Euro single currency project. For a country to join the Eurozone, its economy must be completely stable (low debt ratios, low inflation), as required by the Bunbdesbank. It’s a cruel twist of history that Germany doesn’t qualify for membership in the club it helped create. However, these only represent a small and tertiary part of a central bank’s overall operations.

  As a result, a central bank’s primary role in the modern economy is the control and management of interest rates. The Federal Reserve accomplishes this by adjusting the interest rate it charges financial institutions for borrowing money through its “discount windows.” The purpose of interest rates is to affect the degree of economic activity. To date, economic studies have failed to provide conclusive evidence of this purported connection. There is also a lag time between when interest rates are changed and when such changes are expected to affect the economy. This complicates the task of evaluating the central bank’s interest rate policy. However, interest rates are still a tool used by central banks to fine-tune the economy. If interest rates were raised, economic activity would fall and inflation would fall as a result. It’s also expected that the inverse will be correct. Changes of as little as a quarter of a percentage point can cause a domino effect in the stock and bond markets. Interest rates in the United States have been on an upward trend since 1994, when they doubled from 3% to 6%. In just one year, bond market investors lost $1 trillion (that’s $1,000,000,000). Even now, currency dealers all over the world fear the Bundesbank’s decisions and keep a fixed eye to the trading screen on days when statements are due.

  The focus on interest rates is just the latest passing trend. In the past, central banks would keep tabs on and occasionally adjust broad measures of the money supply, a practice influenced by the Chicago school of economics. They could either sell bonds to the public (and take in money) or acquire bonds from the public (and give themselves access to cash) (and, thus, inject liquidity). Otherwise, they would limit the government’s capacity to borrow and print money. Earlier than that trend, there was widespread faith in the efficacy of rigging currency markets. This was especially true in countries whose currency was not freely convertible due to ongoing implementation of exchange controls. It wasn’t until 1979 that Britain finally got rid of its exchange controls. Even as late as 1971, the USD remained tied to the gold standard and was not truly freely convertible. This long-held myth among central banks about the impossibility of free currency flows is a recent development. As a “soft” monetary instrument, exchange rates are rarely employed by central banks these days. However, the latter persist in trying to influence currency trading on international and domestic markets despite the fact that they have lost credibility as a result of their interventions. As a result of the embarrassing breakdown in enforcing the infamous Louvre deal in 1985, currency intervention has been viewed as a relic of the past.

  The commercial banking system relies substantially on the central bank’s lending practices. They provide the latter with essential services. Nearly all international monetary transactions are cleared by the central bank or a clearing agency that is subordinate to or reports to the central bank. In many nations, the central bank is still required to review and authorize all big transactions involving foreign currency. To ensure financial stability, central banks license bank owners, monitor bank operations, and keep a close eye on bank liquidity. If a company or individual is unable to pay its debts or needs emergency funds, the central bank will step in.

  This makes questionable the statements made by central banks around the world that they were caught off guard by the recent banking crisis. No central bank can say with a straight face that it had no early warning indicators or no access to all the data. There are always warning indications before a banking crisis happens. Any central bank that is even moderately well run should be able to spot these warnings. Only gross indifference on the part of the central bank could have produced such an unexpected result. The frequency with which a bank decides to borrow money through the discount windows is indicative of this. Another red flag is if its interest rates are significantly higher than those of competing lenders. Central banks should be experts at reading the many additional indicators  This extensive participation goes beyond merely gathering and analyzing information. By its very nature, a central bank must set the standard for all other financial institutions in the economy. By making adjustments to its policies (such lowering its reserve requirements), it can force banks into insolvency or produce bubble economies that are doomed to explode. The stock and real estate bubbles of the 1980s would not have been as large if not for the easy and cheap money provided by the Bank of Japan. The same bank (under a different Governor) then reined down lending, bursting both of these bubble markets. In 1992–1993, Israel made the same error again, with the same results.

This is why I think central banks shouldn’t be in charge of banking regulation.

 

 

  Central banks are required to oversee the banking sector, but they are more often than not criticized for their previous actions, policies, and levels of monitoring. Please allow me to elaborate on this claim: In the central banks of most countries, bank supervision is a significant division. On a regular basis, it takes a swath through various bank accounts. After that, it conducts a comprehensive financial audit and establishes guidelines for behavior, along with penalties if necessary. However, it is highly undesirable for a central bank to monitor the banks because central banks play such a pivotal role in defining the health, behavior, and operational modes of commercial banks. As I’ve mentioned, in order for a central bank to effectively supervise, it must be willing to critically examine its own policies, the methods it used to implement those policies, and the outcomes of previous supervisory efforts. Unlikely as it may seem, central banks are expected to play the role of unbiased saints.

  The trend now is to separate bank supervision from the central bank itself, so that the latter’s policies and activities might be indirectly challenged by the former. This is how things work in Switzerland, which has a highly controlled and closely monitored financial system (with the exception of the Jewish money that was placed there and never returned to its owners). We categorize central banks into two categories: fully autonomous and partially autonomous. The bank operates independently from both the government and the economy. Its Governor is appointed to a lengthier term than the elected officials now in office, shielding him from political interference. It receives no funding from either the legislative or executive branches. It’s self-sufficient; it operates autonomously, like a business. It reinvests its surplus in the business in years when it has a deficit (though for a central bank to lose money is a difficult task to achieve). In Macedonia, for example, the central bank’s annual surpluses are transferred to the national budget rather than being used to fund the bank’s own operations or the education of its employees The Bundesbank of Germany and the Federal Reserve System of the United States are excellent examples of independent central banks.

  The semi-autonomous central bank represents the second category. The Ministry of Finance, in particular, exerts a great deal of influence over this central bank. This reliance may take the form of an appropriation from the Ministry or a vote by Parliament on how to spend the agency’s money (ruled by one big party or by the coalition parties). Those at the top of the bank — the Governor and the Vice Governor — are subject to political removal (albeit by Parliament, which makes it somewhat more difficult). The National Bank of Macedonia falls under this category because it is required to account to the country’s legislature. Such banks serve the government in the role of economic adviser. There are well-known weekly meetings between the Bank of England’s governor and the Minister of Finance, when they discuss interest rates and the minutes are made public. However, without the ability to set these limits, it lacks what is likely the most useful policy instrument. The Bank of Israel is in a slightly better position, with some leeway in adjusting interest rates and currency rates, but still not complete freedom.

  By design, the law governing the National Bank of Macedonia (NBM) gives it considerable independence to conduct its operations. The Governor is elected to serve for seven years and can be removed from office only if he is found guilty of a felony. However, political pressures still play a significant role. It is common knowledge that powerful politicians have put pressure on the central bank (at the same breath saying that it is completely independent). The NBM is still in its infancy, and the majority of its employees, while brilliant, lack significant professional experience. Because of the low salaries it offers, it is unable to compete for top talent. This would have been possible if the bank had utilized some of the money it saved to hire internationally known experts (from Switzerland, for example) to fill up the knowledge gaps. But as we indicated, the funds are incorporated into the budget. Because of this, the bank had to figure out what to do with donations from USAID, the KNOW-HOW FUND, and other organizations. While some of the assistance provided was helpful and appropriate, some suggestions seemed inappropriate to the setting. Consider the example of supervision; it was modeled after the systems in use in the United States and the United Kingdom. Those Western managers are the absolute worst (if we do not consider the Japanese).

 Moreover, the bank has been facing extraordinary challenges ever since it was founded. The collapse of the Stedilnicas and the 1993 banking crisis (crowned by the TAT affair). Central banks with more years of expertise would have caved under the pressure far earlier. All things considered, the NBM has done exceptionally well. The Denar, the national currency, has shown consistent value. To stabilize the economy, this is a  central bank’s primary responsibility. The Denar-Deutsche Mark exchange rate returned to its pre-  crisis level shortly after the TAT incident as investors voted their faith in the central bank’management.The central bank must now confront its greatest challenge head-on, without bias or denial.  Reforming and improving bank oversight is essential. Bank’s political independence must be                strengthened significantly. TAT and the other failing Stedilnicas require a decision from the bank.The banks may buy them if packaged as asset-and-liability portfolios. In 1995,   Barings Bank was  acquired by ING from the Bank of England. he bank could and should require the Stedilnicas’s failed owners to raise equity    capital (by using their personal property, where necessary). In 1991, when the   BCCI affair occurred, the Bank of   England did this and succeeded. The Republic of Macedonia may choose to assume responsibility for the bank’s debts and reimburse depositors. Recent examples are the United States (1985–1987)   and Israel (1983).The FDIC insurance premium and reserve requirements might both go up if the   central bank decided  to do so. However, these are all fabricated, makeshift answers. There must be more radical action taken: The entire financial sector needs to be reorganized.  We must do away with the Stedilnicas. The minimum starting capital for a new bank or bank branch   must be reduced to 4 million DM (to conform with world standards and with the size of the economy of Macedonia). Banks should be allowed to open a large number of branches, develop joint    ventures with other financial service providers (such as insurance companies), and engage in other   forms of diversification (so long as they are of a financial nature). The bank regulators also need to be independent of the central bank and have the authority to regularly criticize the latter’s actions. Macedonia has all the potential in the world to become the economic hub of the Balkans, and    there are zero arguments against this. But in the end it’s up to the Macedonians themselves.

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