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