The Central Bank Vu Thanh Tu Anh

Lecture 4
THE CENTRAL BANK
The Central Bank Vu Thanh Tu Anh

The Prevalence of Central Banks
The number of central banks in the world has been
increasing rapidly in the 20th century
The number of central banks in the world
180
160
140
120
100
80
60
40
20
0
1800 1900 1930 1950 1990

The Necessity of the Central Bank
 Conducting monetary policy
 Monetary policy is closely related to
macroeconomic policies and objectives
• Macro policies: Fiscal, trade, exchange rate…
• Macro objectives: Inflation, growth, employment
 The necessity of the Central Bank is clearly and
fully reflected by exploring its functions

Functions of the Central Bank (1)
 Creating Money
• Issuing new currency
• Withdrawing damaged currency from circulation
 Conducting monetary policy (interest rates,
inflation)
• Directly managing the money supply: Controlling the
credit supply of commercial banks
• Indirectly managing the money supply: Utilizing the
discount rate, open-market operations, reserve
requirement ratio.

 Acting as the government’s banker
• Managing the government’s accounts
• Lending to the government
• Issuing the government securities
 Maintaining foreign-exchange reserves and
managing the balance of payment
• Managing foreign exchange reserves (incl. gold)
• Intervening into the foreign-exchange market to
regulate the exchange rates
• Managing the current account (import-export
payment) and capital account (FDI flows, portfolio
investment, commercial loans, and aids) in the
balance of payment
 Overseeing the banking system (acting as banks’
banker)
• Licensing the establishment, merging, and dissolution of
banks
• Promulgating protective regulations in banking activities
• Monitoring banking activities
• Establishing and managing the inter-bank settlement system
• Discount-lending
• Acting as the lender of the last resort to commercial banks
 Developing the information system and undertaking
research related to the conduct of monetary policy

The Central Bank’s Independence
and Organization

The Central Bank’s Degree of
Independence
 Financial independence
• Who owns the Central Bank
• The ability of government to fund its expenditure directly with loans
from the central bank
• The relationship between monetary policy and fiscal policy
 Personnel independence
• Representation of the government in the board of the central bank?
• The government’s influence in appointing/dismissing key personnels?
 Policy independence
• Goal independence
• Instrument independence
 Discussion:
• Arguments in favor of the high degree independence of the central
bank?
• Arguments against the high degree of independence of the central
bank?

The Ownership of the Central Bank
State ownership Private ownership State and private ownership combination
Argentina South Africa Austria (50% government share)
Australia Switzerland Belgium (50%)
Canada United States Chile (50%)
Denmark Greece (10%)
Finland Japan (55%)
France Mexico (51%)
Germany Turkey (25%)
India Italy (Public company)
Ireland
Netherlands
New Zealand
Norway
Spain
Sweden
United Kingdom

Why is the independence
of the central bank necessary?
 It is necessary to have a separation between
the creating money agency (the central bank)
and the spending money agency (the govt)
 If the central bank is under the government:
• Monetary policy may be used by the government to
support its economic policy, which is not always
optimal in terms of allocation of resources
• Example: Growth rate of money supply, directed
credit, inflation, fiscal deficit…

Why is the independence of CB necessary?
Evidence from empirical research
 The correlation between the Central Bank’s

degree of independence with:
• Inflation (negative)
• Budget deficit (negative)
• Economic growth (ambiguous)

The Central Bank’s degree of independence and
inflation rate in some countries (1955-1988)
Source: Alesina and Summers (1993), excerpts in Pollard (1993)

variation in inflation in some countries (1955-1988)

The Central Bank’s degree of independence
and growth rate in some countries (1955-
1987)

variation in growth in some countries (1955-1987)

The Central Bank’s degree of independence
and fiscal deficit in some countries (1973-89)
Source: Pollard (1993)

The CB’s degree of independence and variation in
fiscal deficit in some countries (1973-89)
Source: Pollard (1993)

The State Bank of Vietnam
&
The Federal Reserve System (FED)

Arguments against the independence
of the Central Bank
 Countries used to face difficulties and are adverse to
inflation tend to accept central bank’s independence
• What’s the implicit assumption in the above argument?
 Monetary policy is an organic part of the economic
policy system (incl. fiscal, trade, and employment)
 Politically, it is unacceptable that a powerful body (the
central bank) is not elected in a democratic manner
• Distinction between independence with accountability and
dialogue (such as, reporting to the legislative body)

Controlling & balancing power in FED
 Why was FED established so late?
• The viewpoint against the over-centralization of power: 12 Fed
Reserve Banks, representative for 12 districts
 Each Federal Reserve Bank has 9 governors:
• Group A: 3 governors, who are experts in banking sector,
elected by private banks in the district
• Group B: 3 governors, who are excellent leaders, on behalf of
the industrial, agricultural sectors, labors, consumers, also
elected by private banks in the district
• Group C: 3 governors act on behalf of the community’s
interests, appointed by the Fed Board of Governors (they must
not be officials, employees, or shareholders of the bank)
• 9 governors elect president under the Fed Board of Governors’
approval

The Board of Governors
 Including 7 members appointed by the President of
the US and approved by the Senate
 Each member has a 14-year term, not extended de
facto
 Two members coming from the same district are not
allowed
 The Fed president has a 4-year term and can be
extended
 As a new president takes over, the former president
withdraws from the Board (even if his 14-year term is
not over)

Federal Open Market Commission
(FOMC)
 Including 12 members: 7 members of Board of
Governors, the president of New York Federal
Reserve Bank, and 4 presidents (rotating) of the
remaining 11 Federal Reserve Banks
 The president of Fed is also the president of FOMC
 FOMC meet 8 times every year to decide the activities
of the open market
 Although only 4 rotating presidents are allowed to
vote, all presidents have to be present
 In fact, all three important decisions (open market
operations, required reserves, discount rate) of Fed
are made in the FOMC meetings

Mechanism to ensure the Feed's
independence
 Financial independence
• Fed’s income from securities holdings and loans to
commercial banks is very huge
• Fed’s net income amounts to dozen billions of dollars
• This income then must be transferred to the Treasury
 Personnel independence
• The Board of Governors
• Federal Open Market Commission
 Policy independence
• Goals
• Instruments

Allocation of Federal Reserves Banks

Federal Reserve System Chart

Organization Chart of the SBV
The Governor
Deputy Governors
SB Offices, Representative Office Professional 64 Provincial

Departments of SB in HCMC Organizations Branches
Monetary Policy Dept. Banking Development Banking Times
International Collaboration Foreign Exchange Management Banking Journal
Banking Institute
Bank & Non-bank FI Dept.
Controlling Dept. Legislation Dept. Banking University of HCMC
Credit Department Financial Accounting Dept. Credit information Center
Personnel Dept.
Securities Exchange
Banking Inspection Commission
IT Office State Bank Office
Management Office

The State Bank of Vietnam’s degree of
independence
 The SBV vs. commercial banks
• May 6, 1951, the President Ho Chi Minh
promulgated the Ordinance no 15/SL establishing
the National Bank of Vietnam
• Circular no 20/VP–TH (21/1/1960) changes its
name to the State Bank of Vietnam
 Discussion:
• Financial independence
• Personnel independence
• Policy independence (goals and instruments)

The CB in Developing Countries
 Low degree of independence

 Dominant in the financial system
• Central bank’s assets/ total assets of the financial
system
• Reserve/M2
• Bank reserves/bank deposits
• M2/Total value of financial assets
 Often pursuing multiple goals besides
controlling the money supply and inflation
• Undertaking the responsibility to promote the
financial system’s development
Controlling and Monitoring the
Banking Activities

Controls of banking activities
 Insurance for the safety of the commercial

bank system
 Regulations on lending, investment
 Capital requirement
 Controlling, monitoring, and assessing the
risk-management system
 Other regulations:
• Information disclosure
• Consumer protection
• etc

1. Insurance for the safety of the
commercial bank system
 Commercial banks mobilize funds, part of which is used
as reserve, and the rest is loaned.
 Assumption: All depositors would not withdraw
simultaneously, and one withdraws as another
deposits.
 In the presence of AI w.r.t banks’ financial conditions,
depositors may not be able to distinguish b/w bad and
good banks → bank run.
 Even a good bank may not have enough reserves to
pay in case of bank runs.
 Two solutions:
• The central bank as the lender of the last resort.
• Deposit insurance (since 9/11/1999 in Vietnam)

Lender of Last Resort
 The central bank lends to banks when they fall short

of cash in a bank run
 Knowing that, depositors are more confident, and
bank run can be avoided
 Necessary condition: The distressed bank is only in a
temporary cash shortage and its assets are still
greater than its liabilities
 The problem is it’s not easy to distinguish a bankrupt
bank from a temporarily distressed bank. In this
situation, the lending policy of the central bank may
give way to moral hazard problems.

Deposit Insurance
 Objective:
• To secure the banking system’s stability and protect
depositors, especially small ones
 Mechanism:
• A deposit insurance institution is established,
usually with the government’s capital contribution
• Banks pay insurance premiums in proportion to
their deposits
• Insurance is provided for all or some particular
kinds of deposits
• Insurance claims are of full coverage or set with an
upper cap
Too big to fail?
 Moral hazard (too big to fail) is a down side of the role

as the lender of last resort,
 Big financial organizations know that if they fail, govt
would rescue
 Unsolved challenge: How to deal with the moral hazard
associated with big banks.

Deposit Insurance: Costs and Benefits
 Benefits: An increase in social benefits, since:
• It helps prevent bank runs induced by psychological factors,
and hence enhance the stability of the banking system;
• It protects depositors, thus increases deposits and promotes
financial development
 Costs: An increase in social costs, since:
• It causes moral hazard
• It causes adverse selection
⇒ Increasing risks in banking activities, and hence hindering
financial development
 Cost-benefit balance depends on the institutional
environment :
• A favorable institutional environment: Benefits > Costs
• A weak institutional environment: Benefits < Costs

Deposit Insurance and Moral Hazard
 Depositors know that their money is insured,
so they do not pay attention to the bank’s
operations
 The insured bank is not afraid of being drawn
down by depositors if it gets involved in risky
lending, since the insurance institution is
responsible for all claims
 The insured bank thus has incentives to lend
to risky projects for big profit if these projects
are successful

Deposit Insurance and Adverse Selection
 Without deposit insurance, depositors are more careful

in selecting good banks to deposit their money
 With the presence of deposit insurance, depositors
tend to deposit at banks that pay higher interest rates
though they may get involved in risky lending
 Banks that pay higher deposit rates and get involved in
risky lending can raise more funds
 Banks that pay lower deposit rates and make safe
loans find lower level of deposits. They are forced to
engage in risky lending so as to be able to increase
deposit or shut down otherwise.

Deposit Insurance
As a Bank Goes Bankrupt
 Liquidation
• The deposit insurance institution pays to insured depositors up
to the maximum prescribed amount
• The deposit insurance institution serves as an unsecured
creditor
 Restructuring
• The deposit insurance institution guarantees to repay all
deposits and takes over the distressed bank
• The distressed bank is merged with or sold to another bank
• The deposit insurance institution often purchases some bad
assets of the distressed bank, or loans to the merging/
acquiring bank at preferential lending rates

Lessons from Deposit Insurance
 Coverage:
• No full coverage
• Set a reasonable maximum coverage (example, equal to 1
or 2 times the average GDP per capita)
 Management:
• The private sector’s participation in managing and
controlling deposit insurance funds
 Limited liability:
• The deposit insurance institution has a limited liability: The
insurance premiums and capital are used to meet
insurance claims
• The government is not required to refinance the insurance
institution in case of its inability to pay all insurance claims

2. Regulations on lending/investment
 Restriction on investment in corporate

securities (especially risky securities such as
stocks)
 Restriction on participation in investment
banks’ activities (for example, underwriting)
 Requirement to diversify lending portfolios:
• Monitoring the maximum credit line to a single
borrower

3. Capital Requirement –
To Ensure Bank Capital Adequacy
 A bank’s capital must reach a minimum ratio of the
total assets
 Simple regulation: A bank has adequate capital when
its capital-to-assets ratio is above 5%. (A bank is put
under special surveillance if its capital-to-assets ratio
falls below 3%)
 The importance of the CAR requirement:
• Reducing risks for depositors
• Bank’s shareholders have incentives for a closer monitoring

Simple Regulation on CAR
 The regulation does not differentiate different types of
assets (assets of different exposures)
 It does not take into account the off-balance-sheet
items of the banks, such as endorsement of deferred
L/C
 A better CAR regulation should set a lower capital-to-
assets ratio for banks holding safe assets, and a
higher one for banks holding riskier assets
⇒ Basel Regulation on the minimum ratio of capital/risk-
adjusted-assets (CAR ≥ 8%)

Bank’s Tier-1 Capital
 Tier-1 capital (core capital):

• Equity contributed by shareholders: common stock
• Disclosed reserves (appropriated from retained
earnings and other surplus)
• Non-cumulative preferred stock (i.e., if a company
did not have enough income to pay dividends to
preferred shareholders last year, it does not have to
pay that amount this year)

Tier-2 capital
 Tier-2 capital (supplementary capital):
• Undisclosed reserves: those not officially
disclosed, but approved by regulatory bodies
(such as retained after-tax profits).
• Reserves from asset revaluation: reflecting the
adjustment of assets to their current market
value.
• General provisions/loan-loss reserves: created
against the possibility of future loss of loans
extended, provided that these reserves must not
be associated with any particular assets.

Tier-2 capital
 Tier-2 capital:
• Hybrid capital: instruments that combine characteristics of
both equity and debt, e.g. cumulative preferred stock.
• Subordinated debt: Debt with fixed maturity, but having
lower seniority than the other debts and only more senior
than equity.
 Bank’s capital = Tier-1 capital + Tier-2 capital.
 Bank’s capital does not include:
• Deposits
• Short-term debt
• Other liabilities
• Goodwill

Weights of Assets by Their Risk Levels
(wi)
0%
 Cash
 Government securities and deposits at the
central bank (denominated in domestic
currency).
 Government securities and deposits at the
central banks of OECD countries.
 Securities, loans guaranteed by the
governments of OECD countries or
collateralized with OECD government
securities.

(wi)
20%
 Claims issued by multilateral development banks (IBRD,
IADB, ADB, AfDB, EIB); claims guaranteed by or
collateralized with securities issued by those institutions.
 Claims on banks in OECD countries or claims guaranteed
by banks in those countries.
 Claims on banks in non-OECD countries or claims
guaranteed by banks in those countries, provided that the
remaining time to maturity of those claims is less than or
equal to 01 year.
 Claims on government agencies in foreign OECD countries,
(excluding central governments), claims guaranteed by
those agencies.
 Cash being collected.

(wi)
50%
 Loans fully guaranteed by housing mortgage.
0, 10, 20 hay 50% (at each country’s discretion)
 Claims on domestic public-sector entities
(excluding the central government), and loans
guaranteed by those entities.

(wi)
100%
 Claims on the private sector.
 Claims on banks in non-OECD countries with remaining
time to maturity being greater than 01 year.
 Claims on non-OECD central governments.
 Premises, machinery, and equipment and other fixed
assets.
 Real estates and other investments.
 Financial instruments issued by other banks.
 Off-balance-sheet activities, e.g. deferred L/C’s.
 All other assets.

Risk-Adjusted Total Value of Assets
 Risk-Adjusted Total Value of Assets = 0%V1+
20%V2+ 50%V3+ 100%V4 = ΣwiVi

 Capital/Assets Ratio = Capital/ΣwiVi
 Basel Regulation on bank’s capital/assets ratio:
Adequate Good
Tier-I Capital 4% 6%
Total Capital 8% 10%

Weaknesses of Basel Regulation
 Risk weights do not fully reflect the risks inherent in a
bank’s investment activities:
• A loan to an A-rated firm is clearly safer than that to a B-rated firm,
but both of these loans are 100% weighted because they are loans
to the private sector.
 Basel Regulation ignores capital required to compensate:
• Operational risk
• Interest rate risk
• Market risk
 Basel Regulation does not catch up with financial
renovations, such as securitization and derivatives.

Basel II Proposal – Three Pillars
 Pillar I:
• Standard mechanism: minimum capital/assets ratio, similar to
that of Basel I. However, the number of risk weights
increases to reflect more closely the risk levels of various
assets. (For example, weights for the private sector are 20,
50, 100, and 150% rather than only 100% previously; bank
claims on the government, enterprises, and other banks have
weights according to their credit ratings).
• Alternative mechanism: Large banks are allowed to have
their internal regimes based on their own risk management
models.
 Pillar II: Enhancing the surveillance mechanism,
especially the evaluation of banks’ risk management.
 Pillar III: Improving market discipline by requiring
banks to disclose in more detail their risks, reserves,
capital…

The Central Bank Vu Thanh Tu Anh

Hochgeladen von

Dokumentinformationen

Originalbeschreibung:

Originaltitel

Copyright

Verfügbare Formate

Dieses Dokument teilen

Dokument teilen oder einbetten

Freigabeoptionen

Stufen Sie dieses Dokument als nützlich ein?

Sind diese Inhalte unangemessen?

Copyright:

Verfügbare Formate

The Central Bank Vu Thanh Tu Anh

Hochgeladen von

Copyright:

Verfügbare Formate

Lecture 4

THE CENTRAL BANK