| Central banks are relatively new inventions. | | | | vigilance in the past. Let me explain this |
| An American President (Andrew Jackson) even | | | | statement:In most countries in the world, |
| cancelled its country's central bank in the | | | | bank supervision is a heavy-weight department |
| nineteenth century because he did not think | | | | within the central bank. It samples banks, on |
| that it was very important. But things have | | | | a periodic basis. Then, it analyses their |
| changed since. Central banks today are the | | | | books thoroughly and imposes rules of conduct |
| most important feature of the financial | | | | and sanctions where necessary. But the role |
| systems of most countries of the | | | | of central banks in determining the health, |
| world.Central banks are a bizarre hybrids. | | | | behaviour and operational modes of commercial |
| Some of their functions are identical to the | | | | banks is so paramount that it is highly |
| functions of regular, commercial banks. Other | | | | undesirable for a central bank to supervise |
| functions are unique to the central bank. On | | | | the banks. As I have said, supervision by a |
| certain functions it has an absolute legal | | | | central bank means that it has to criticize |
| monopoly.Central banks take deposits from | | | | itself, its own policies and the way that |
| other banks and, in certain cases, from | | | | they were enforced and also the results of |
| foreign governments which deposit their | | | | past supervision. Central banks are really |
| foreign exchange and gold reserves for | | | | asked to cast themselves in the unlikely role |
| safekeeping (for instance, with the Federal | | | | of impartial saints.A new trend is to put the |
| Reserve Bank of the USA). The Central Bank | | | | supervision of banks under a different |
| invests the foreign exchange reserves of the | | | | "sponsor" and to encourage a checks and |
| country while trying to maintain an | | | | balances system, wherein the central bank, |
| investment portfolio similar to the trade | | | | its policies and operations are indirectly |
| composition of its client - the state. The | | | | criticized by the bank supervision. This is |
| Central bank also holds onto the gold | | | | the way it is in Switzerland and - with the |
| reserves of the country. Most central banks | | | | exception of the Jewish money which was |
| have lately tried to get rid of their gold, | | | | deposited in Switzerland never to be returned |
| due to its ever declining prices. Since the | | | | to its owners - the Swiss banking system is |
| gold is registered in their books in | | | | extremely well regulated and well |
| historical values, central banks are showing | | | | supervised.We differentiate between two types |
| a handsome profit on this line of activity. | | | | of central bank: the autonomous and the |
| Central banks (especially the American one) | | | | semi-autonomous.The autonomous bank is |
| also participate in important, international | | | | politically and financially independent. Its |
| negotiations. If they do not do so directly - | | | | Governor is appointed for a period which is |
| they exert influence behind the scenes. The | | | | longer than the periods of the incumbent |
| German Bundesbank virtually dictated | | | | elected politicians, so that he will not be |
| Germany's position in the negotiations | | | | subject to political pressures. Its budget is |
| leading to the Maastricht treaty. It forced | | | | not provided by the legislature or by the |
| the hands of its co-signatories to agree to | | | | executive arm. It is self sustaining: it runs |
| strict terms of accession into the Euro | | | | itself as a corporation would. Its profits |
| single currency project. The Bunbdesbank | | | | are used in leaner years in which it loses |
| demanded that a country's economy be totally | | | | money (though for a central bank to lose |
| stable (low debt ratios, low inflation) | | | | money is a difficult task to achieve).In |
| before it is accepted as part of the Euro. It | | | | Macedonia, for instance, annual surpluses |
| is an irony of history that Germany itself is | | | | generated by the central bank are transferred |
| not eligible under these criteria and cannot | | | | to the national budget and cannot be utilized |
| be accepted as a member in the club whose | | | | by the bank for its own operations or for the |
| rules it has assisted to formulate.But all | | | | betterment of its staff through |
| these constitute a secondary and marginal | | | | education.Prime examples of autonomous |
| portion of a central banks activities.The | | | | central banks are Germany's Bundesbank and |
| main function of a modern central bank is the | | | | the American Federal Reserve Bank.The second |
| monitoring and regulation of interest rates | | | | type of central bank is the semi autonomous |
| in the economy. The central bank does this by | | | | one. This is a central bank that depends on |
| changing the interest rates that it charges | | | | the political echelons and, especially, on |
| on money that it lends to the banking system | | | | the Ministry of Finance. This dependence |
| through its "discount windows". Interest | | | | could be through its budget which is |
| rates is supposed to influence the level of | | | | allocated to it by the Ministry or by a |
| economic activity in the economy. This | | | | Parliament (ruled by one big party or by the |
| supposed link has not unequivocally proven by | | | | coalition parties). The upper levels of the |
| economic research. Also, there usually is a | | | | bank - the Governor and the Vice Governor - |
| delay between the alteration of interest | | | | could be deposed of through a political |
| rates and the foreseen impact on the economy. | | | | decision (albeit by Parliament, which makes |
| This makes assessment of the interest rate | | | | it somewhat more difficult). This is the case |
| policy difficult. Still, central banks use | | | | of the National Bank of Macedonia which has |
| interest rates to fine tune the economy. | | | | to report to Parliament. Such dependent banks |
| Higher interest rates - lower economic | | | | fulfil the function of an economic advisor to |
| activity and lower inflation. The reverse is | | | | the government. The Governor of the Bank of |
| also supposed to be true. Even shifts of a | | | | England advises the Minister of Finance (in |
| quarter of a percentage point are sufficient | | | | their famous weekly meetings, the minutes of |
| to send the stock exchanges tumbling together | | | | which are published) about the desirable |
| with the bond markets. In 1994 a long term | | | | level of interest rates. It cannot, however, |
| trend of increase in interest rate commenced | | | | determine these levels and, thus is devoid of |
| in the USA, doubling interest rates from 3 to | | | | arguably the most important policy tool. The |
| 6 percent. Investors in the bond markets lost | | | | situation is somewhat better with the Bank of |
| 1 trillion (=1000 billion!) USD in 1 year. | | | | Israel which can play around with interest |
| Even today, currency traders all around the | | | | rates and foreign exchange rates - but not |
| world dread the decisions of the Bundesbank | | | | entirely freely.The National Bank of |
| and sit with their eyes glued to the trading | | | | Macedonia (NBM) is highly autonomous under |
| screen on days in which announcements are | | | | the law regulating its structure and its |
| expected.Interest rates is only the latest | | | | activities. Its Governor is selected for a |
| fad. Prior to this - and under the influence | | | | period of seven years and can be removed from |
| of the Chicago school of economics - central | | | | office only in the case that he is charged |
| banks used to monitor and manipulate money | | | | with criminal deeds. Still, it is very much |
| supply aggregates. Simply put, they would | | | | subject to political pressures. High ranking |
| sell bonds to the public (and, thus absorb | | | | political figures freely admit to exerting |
| liquid means, money) - or buy from the public | | | | pressures on the central bank (at the same |
| (and, thus, inject liquidity). Otherwise, | | | | breath saying that it is completely |
| they would restrict the amount of printed | | | | independent).The NBM is young and most of its |
| money and limit the government's ability to | | | | staff - however bright - are inexperienced. |
| borrow. Even prior to that fashion there was | | | | With the kind of wages that it pays it cannot |
| a widespread belief in the effectiveness of | | | | attract the best available talents. The |
| manipulating exchange rates. This was | | | | budgetary surpluses that it generates could |
| especially true where exchange controls were | | | | have been used for this purpose and to higher |
| still being implemented and the currency was | | | | world renowned consultants (from Switzerland, |
| not fully convertible. Britain removed its | | | | for instance) to help the bank overcome the |
| exchange controls only as late as 1979. The | | | | experience gap. But the money is transferred |
| USD was pegged to a (gold) standard (and, | | | | to the budget, as we said. So, the bank had |
| thus not really freely tradable) as late as | | | | to do with charity received from USAID, the |
| 1971. Free flows of currencies are a | | | | KNOW-HOW FUND and so on. Some of the help |
| relatively new thing and their long absence | | | | thus provided was good and relevant - other |
| reflects this wide held superstition of | | | | advice was, in my view, wrong for the local |
| central banks. Nowadays, exchange rates are | | | | circumstances. Take supervision: it was |
| considered to be a "soft" monetary instrument | | | | modelled after the Americans and British. |
| and are rarely used by central banks. The | | | | Those are the worst supervisors in the West |
| latter continue, though, to intervene in the | | | | (if we do not consider the Japanese).And with |
| trading of currencies in the international | | | | all this, the bank had to cope with |
| and domestic markets usually to no avail and | | | | extraordinarily difficult circumstances since |
| while losing their credibility in the | | | | its very inception. The 1993 banking crisis, |
| process. Ever since the ignominious failure | | | | the frozen currency accounts, the collapse of |
| in implementing the infamous Louvre accord in | | | | the Stedilnicas (crowned by the TAT affair). |
| 1985 currency intervention is considered to | | | | Older, more experienced central banks would |
| be a somewhat rusty relic of old ways of | | | | have folded under the pressure. Taking |
| thinking.Central banks are heavily enmeshed | | | | everything under consideration, the NBM has |
| in the very fabric of the commercial banking | | | | performed remarkably well.The proof is in the |
| system. They perform certain indispensable | | | | stability of the local currency, the Denar. |
| services for the latter. In most countries, | | | | This is the main function of a central bank. |
| interbank payments pass through the central | | | | After the TAT affair, there was a moment or |
| bank or through a clearing organ which is | | | | two of panic - and then the street voted |
| somehow linked or reports to the central | | | | confidence in the management of the central |
| bank. All major foreign exchange transactions | | | | bank, the Denar-DM rate went down to where it |
| pass through - and, in many countries, still | | | | was prior to the crisis.Now, the central bank |
| must be approved by - the central bank. | | | | is facing its most daunting task: facing the |
| Central banks regulate banks, licence their | | | | truth without fear and without prejudice. |
| owners, supervise their operations, keenly | | | | Bank supervision needs to be overhauled and |
| observes their liquidity. The central bank is | | | | lessons need to be learnt. The political |
| the lender of last resort in cases of | | | | independence of the bank needs to be |
| insolvency or illiquidity.The frequent claims | | | | increased greatly. The bank must decide what |
| of central banks all over the world that they | | | | to do with TAT and with the other failing |
| were surprised by a banking crisis looks, | | | | Stedilnicas?They could be sold to the banks |
| therefore, dubious at best. No central bank | | | | as portfolios of assets and liabilities. The |
| can say that it had no early warning signs, | | | | Bank of England sold Barings Bank in 1995 to |
| or no access to all the data - and keep a | | | | the ING Dutch Bank.The central bank could - |
| straight face while saying so. Impending | | | | and has to - force the owners of the failing |
| banking crises give out signs long before | | | | Stedilnicas to increase their equity capital |
| they erupt. These signs ought to be detected | | | | (by using their personal property, where |
| by a reasonably managed central bank. Only | | | | necessary). This was successfully done |
| major neglect could explain a surprise on | | | | (again, by the Bank of England) in the 1991 |
| behalf of a central bank.One sure sign is the | | | | case of the BCCI scandal.The State of |
| number of times that a bank chooses to borrow | | | | Macedonia could decide to take over the |
| using the discount windows. Another is if it | | | | obligations of the failed system and somehow |
| offers interest rates which are way above the | | | | pay back the depositors. Israel (1983), the |
| rates offered by other financing | | | | USA (1985/7) and a dozen other countries have |
| institutions. There are may more signs and | | | | done so recently.The central bank could |
| central banks should be adept at reading | | | | increase the reserve requirements and the |
| them.This heavy involvement is not limited to | | | | deposit insurance premiums.But these are all |
| the collection and analysis of data. A | | | | artificial, ad hoc, solutions. Something more |
| central bank - by the very definition of its | | | | radical needs to be done:A total |
| functions - sets the tone to all other banks | | | | restructuring of the banking system. The |
| in the economy. By altering its policies (for | | | | Stedilnicas have to be abolished. The capital |
| instance: by changing its reserve | | | | required to open a bank or a branch of a bank |
| requirements) it can push banks to insolvency | | | | has to be lowered to 4 million DM (to conform |
| or create bubble economies which are bound to | | | | with world standards and with the size of the |
| burst. If it were not for the easy and cheap | | | | economy of Macedonia). Banks should be |
| money provided by the Bank of Japan in the | | | | allowed to diversify their activities (as |
| eighties - the stock and real estate markets | | | | long as they are of a financial nature), to |
| would not have inflated to the extent that | | | | form joint venture with other providers of |
| they have. Subsequently, it was the same bank | | | | financial services (such as insurance |
| (under a different Governor) that tightened | | | | companies) and to open a thick network of |
| the reins of credit - and pierced both bubble | | | | branches.And bank supervision must be |
| markets.The same mistake was repeated in | | | | separated from the central bank and set to |
| 1992-3 in Israel - and with the same | | | | criticize the central bank and its policies, |
| consequences.This precisely is why central | | | | decisions and operations on a regular |
| banks, in my view, should not supervise the | | | | basis.There are no reasons why Macedonia |
| banking system.When asked to supervise the | | | | should not become a financial centre of the |
| banking system - central banks are really | | | | Balkans - and there are many reasons why it |
| asked to draw criticism on their past | | | | should. But, ultimately, it all depends on |
| performance, their policies and their | | | | the Macedonians themselves. |