Annals of “Dunarea de Jos” University of Galati Fascicle I. Economics and Applied Informatics
Years XXII – no2/2016 ISSN-L 1584-0409 ISSN-Online 2344-441X
www.eia.feaa.ugal.ro
Challenges of the Central Banks in the Post Crisis Period
when Needed to Ensure the Financial Stability
Anisoara Niculina APETRI
, Camelia Catalina MIHALCIUC
, Oana Iuliana MIHAI
A R T I C L E I N F O A B S T R A C T
Article history: Accepted June 2016
Available online September 2016
The concerns of the European and domestic monetary authorities to reform the current regulatory but also supervisory framework became our main reason to achieve this scientific approach. The international financial crisis has generated important dysfunctions at the level of the main activity of central banks but also at the level of the objectives that these banks should meet. Thereby, if most central banks have normally pursued the objective clearly stated in their mandate as "price stability", nowadays they are trying to achieve the "financial stability". Thus the main objective of this study particularly concerns: highlighting the role of central banks in ensuring the financial stability; and analyzing the challenges of the central banks after the financial crisis.
© 2016 EAI. All rights reserved.
JEL Classification
E58
Keywords:
Central Bank, Financial stability, Price stability
1. Introduction
The continuous adjustment of the central bank to the new economic environment involves also a reform process of the central bank. Most studies agree that the main reform within the central bank is on providing a level of independence of the central bank in relation to governmental authority. Another trend in the process of reforming the activity of the central monetary authorities is the permanent concern to ensure its transparency, by promoting some communication policies with some more efficient markets; and the permanent concern for maintaining credibility with the public regarding the fulfilment of its objectives. The biggest changes in the regulation and supervision field are taking place at the EU level, Member States being forced to adjust their domestic framework. Considering the above mentioned fact, we hereby tried to analyze how the Romanian banking system is regulated and supervised nowadays; emphasizing the role of the National Bank in this area and analyze its response to the challenges of the crisis, but also post-crisis.
2. General aspects of banking supervision
Financial Supervision involves, apart from choosing a supervision pattern, establishing the institution that will perform this task. Currently, this activity is an attribute of the national central banks in most countries of the world and they are directly involved and responsible for prudential supervision.
Central banks ensure to a certain extent the financial stability and we have two reasons to believe that. On the one hand, it is generally accepted that financial stability is a prerequisite for monetary stability. A financial crisis will lead to a contraction of money, which affects monetary stability. Conversely, too much liquidity generates inflation risk, usually followed by a recession. On the other hand, financial crises affect the real economy, leading to recession, unemployment, deteriorating the asset quality of the banking system; the central bank must not be indifferent to these consequences. The monetary instruments of the Central Bank are better suited to deal with the effects of a financial crisis than to prevent such a crisis. This is particularly evident in the emergence of financial bubbles. During the construction of a financial bubble, a central bank may issue warnings, can alleviate the credit expansion, but cannot totally limit the credit market. Once the bubble burst, the central bank can intervene by providing liquidity to banks facing temporary with liquidity problems, because the central bank acts as a lender of last resort to the banks (George, C., 2011, pp.3-4) .
However in literature there are arguments pro and against the supervising process by the Central Bank. The following presents a summary thereof.
Table no. 1. Arguments pro and against supervising process by the Central Bank
Pro arguments Against arguments
The informational synergy argument reveals the importance of confidential information collected for monitoring purposes, which may be essential for the conduct of monetary policy. Central banks access "prudential information" mostly in the process of macroeconomic monitoring.
The argument of conflict of interest between banking supervision and monetary policy is based on the possibility that the banking system supervision shall lead the Central Bank in a less restrictive monetary policy.
The systemic risk argument relies on the relationship between prudential controls over financial intermediaries and risk assessment for the entire financial system.
The moral hazard argument in favour of separation is linked to the role of central banks in crisis management with the source of supervisory responsibilities.
The independence and expertise argument highlights
the quality of the central banks participation to
achieving financial stability.
The independence of the supervisory authority of political interference is of great importance.
The trend towards conglomerate and eliminate the distinctions between financial products and intermediaries.
The conglomerates argument emphasizes that there are closer ties gradually developing between banks, joint stock companies, insurance companies, to the detriment of the old contracts. Types of intermediaries compete in the same markets. Accordingly, the sector supervision may be less effective in monitoring overall risk exposure of the complex financial groups.
The need to avoid excessive concentration of the power at the Central Bank.
Source: prepared by the author after Nicolae Dardac, Moinescu, Bogdan, monetary policy and banking techniques, lecture notes, Bucharest, 2007, pp.7-9,, http://www.ase.ro/upcpr/profesori/756/PMTB_cig.pdf
3. The role of central banks in financial stability
The role of central banks in ensuring stability was a key objective since their establishment (Capi et al., 1994). We can say with conviction that central banks play the most important role in ensuring financial stability and price stability and that the financial stability is among their most important objectives. In order to achieve these objectives, the central banks use a set of tools such as the transparency of the system, the strengthening of the financial infrastructure, identifying the systemic risks, the cooperation with other institutions monitoring the financial markets.
Central banks have different methods for properly quantificate the financial stability such as, financial stability indicators, stress tests, modelling and network analysis, each of these methods showing both strengths and weaknesses. The lack of a generally accepted definition of financial stability implies the absence of a universal method for measuring the financial stability or the systemic risk. Aggregation of the financial stability indicators in an index of financial stability seems difficult because it requires expert judgment and creating a future indicator based on retrospective data (Smaga, P., 2014, p.33).
One of the prerequisites for achieving the main objective of central banks is their independence. According to some economists, central bank independence lies in its persistence to direct monetary policy
towards the goal of price stability as the sole objective or prime lens Căpraru , p. . A bank is
considered more independent, since the main objective is price stability and has full discretion in the use of specific instruments for achieving this goal. For measuring the degree of independence of the central bank the literature has developed a Central Bank Independence index (CBI). After developing the CBI indices published by Grilli, Masciandaro and Tabellini (1991), followed by Cukierman (1992), there has been proposed other various indicators such as those proposed by Berger, de Haan and Eijffinger (2001). Subsequent calculations are updated in Cukierman, Webb and Neyapti (1992), Cukierman, Miller and Neyapti (2002) and Jacome and Vasquez (2005), the Index Cukierman, and Arnone, Laurens and Segalotto (2007) for Grilli index, Masciandaro and Tabellini. Crowe and Meade (2008) developed a set of evaluation measures for central bank independence and transparency (Masciandaro, Quintyn, Taylor, 2008).
Central banks develop their own legal framework governing their activities but also the activity of other banking and financial institutions, and the legal framework can be changed whenever deemed
necessary. However, the legislative and the executive can directly influence the central bank s work whenever
is not satisfied by its results. In this context, we note, however, that the central bank cannot have full independence in decision making. To get the full independence of the central bank decisions, it should be exempted not only by the legislative but also by the executive.
them to impose duties, responsibilities and define directly or in a discrete way its operations. There is also a certain amount of skepticism, especially because of the potential political pressure. The latest crisis has shown that central banks under political pressure took a number of non-standard measures to mitigate and limit the crisis. The sovereign debt crisis in the European Union has had a major impact on central bank independence. Therefore, central banks should take measures to normalize their main activity in order to achieve their main goals. For a long term the monetary "hospitality" can undermine the credibility and independence of the central bank. Therefore, it should be independent of the legislative and executive
Momirović, Mirdita, .
In the last few years, the relationship between independence, responsibility and transparency has been a subject that has been given special attention. These three institutional features are increasingly recognized as important ingredients of central bank governance. The increasing interest in the governance of central banks represents the efforts of the policy makers, academics and practitioners to obtain appropriate institutional compatible with the needs of citizens.
At the same time, the scientists continued to research in order to verify the theoretical assumptions that underpinned the CBI, and to determine whether the degree of independence (legal and actual) of the central bank could be considered an independent variable in explaining important macroeconomic phenomena, such as inflation, public debt and interest rates, economic growth. In the research we found that CBI can be considered an independent variable.
However Donato Masciandaro, Marc Quintyn, Michael W. Taylor, (2008) conducted a study where they considered the degree of independence as a dependent variable and sought to identify potential factors that could alter the independence level from a certain period to another and to explain why after a period of several years of stability independence, politicians are implementing reforms to change the CBI degree. It is clear that studies of this type are of great importance, especially in times when there is a tendency for reform. If in the past it was emphasized the analysis and evaluation of CBI, nowadays the authorities in financial supervision become a debated subject. The authors of this study have applied the QRT model used by Quintyn, Ramirez and Taylor (2007), stating that they have applied to a sample of 55 countries, 27 countries where banking supervision is an attribute of the central bank and 29 countries where surveillance bank returns to a specialized agency. The empirical analysis of the determinants of the independence and responsibility agreements (based on indices of independence and responsibility), indicates that the quality of governance in the public sector plays a decisive role in establishing the responsibility agreements, rather than establishing the measures of independence. The results also show that the probability to establish appropriate governance measures for surveillance appears to be greater when the supervisory authority is outside the central bank.
While a number of studies show that financial stability is not one of the objectives set out in the mandates of central banks, which is more a macro-prudential policy objective, especially in the pre-crisis period, to ensure financial stability central banks already have lever action series such as open-market operations, deposit guarantying (even if it is not always among the responsibilities of central banks), monitoring payment and settlement systems to support and influence the financial stability.
In the post-crisis period, a key challenge for central banks is to maintain simultaneously monetary and financial stability (Granville and Mallick, 2009 cited in Tiberius Claudius Albulescu, p.54). The monetary and macroprudential policy seem to lie at the crossroads now. There is a consensus that monetary and macro-prudential policy should complement each other (Schoenmaker and Wierts 2011 cited in Tiberius Claudius Albulescu, p.54) and central banks have both a mandate for price stability and financial stability.
4. Challenges of the central banks in the post crisis period in the context of the need to ensure financial stability
The global financial crisis has highlighted the need to increase the involvement of the central bank's financial stability. Surely views on the role of central banks, made in the pre-crisis period, are no longer valid today because most of them have changed their mode of operation in terms of policy implementation, which should be adapted to the turbulent market environment. Thus, central banks were forced to work in a difficult economic context and to face all institutional challenges increasingly being involved in financial supervision (Smaga, P., 2014, p.30).
Undoubtedly, central banks have played during the crisis a key role through their measures in stabilizing financial. Meanwhile, despite the success in combating and limiting the effects of the intensification of the financial crisis, central banks have assumed another role such as the "manager" of the crisis. Specialists in the field (Caruana, 2011; Orphanides, 2011) wonder what will be roles of central banks in the future. Asmussen suggests multiple roles of central banks in the future and wonder which of them are relevant "as guardian of financial stability" and its role as a "crisis manager." (Asmussen, 2012).
There are the main challenges for central banks in the post crisis in the context of the need to ensure financial
stability, as formulated by Paweł Smagała in a recent paper Smaga, P., , p. :
The quantification of systemic risk;
The Development and implementation policies
The non-standard measures of monetary policy and counteract their potential effects generated by their application during the financial crisis;
Banking Union.
Studies in this area highlight the persistent divergences between the content of the financial stability and the objective to be pursued by central banks, beyond what creates difficulties in the exercise of central banks.
As the financial crisis has shown that preventing systemic risk may be less costly (in terms of loss of GDP and fiscal costs) than the costs of crisis management, it is clearly emphasized the application of macro prudential policies. Macro prudential policy is in an early stage of development, both theoretically and practically. Macro policy, the policy as opposed to micro, focuses on the stability of the system as a whole, as well as mitigating the systemic risk. Since the financial stability is more than the "sum" of stability of all financial institutions, it is important that macro prudential policy focus on risk of contagion. Compared to monetary policy instruments, prudential policy tools can be selectively applied, with an important impact only to a part of the implemented financial system. The implementation of macro prudential policy was based on the principle of "learning -by -doing" (Smaga, P., 2014, p.30) and on the experiences of developing countries, so that central banks in developed countries could learn example thereof
Some experts (Smaga, P., 2014) in the field believe that central banks are best to have the most important role in the application of macro prudential policy because:
Can effectively coordinate both macro pudential and micro prudential supervision;
Know very well the functioning of the economy so they can identify early potential sources of systemic risk;
It has a high degree of independence;
Have experience in the development of financial stability reports and other analyzes of the financial system.
At EU level it is recommended that the application of macro-prudential policy has to achieve national financial systems because EU countries have different financial structures and financial cycles are not synchronized. These issues will create problems for the ECB (European Central Bank) in terms of effective coordination of macro-prudential policy
During the financial crisis, monetary policy standard measures (such as lowering interest rates to near zero) were insufficient to counteract imbalances in the financial market, so that central banks have had to engage in "uncharted waters" and to introduce unconventional policy measures aimed at stabilizing markets and improving economic outlook. Loss of confidence in the financial markets and low level of liquidity influenced the mode of action of central banks, which had to "flood" the financial markets with liquidity as quantitative easing - QE. Central banks have injected liquidity in the form of purchase of assets from other banks, buying different securities, including sovereign bonds. Through these interventions central banks followed the revival markets and resuming lending that was hit hard. The effects of injection of
liquidity occurred on short term as markets stabilize, while the effect of economy s recovery and support
economic growth was limited. The implementation of QE programs led to a series of changes to the central bank:
Increase in inflation in the medium term and depreciation of the domestic currency;
The decrease in interest rates near zero has created a favorable environment for the search of other higher yields and increased risk-taking by financial institutions,
Reduce pressure on fiscal consolidation, when a central bank buys government bonds;
Excessive growth of public and private debt, due to the easy access to central bank s liquidity;
increasing dependency on financial institutions to the central bank (moral hazard); increased credit risk the central bank as a result of securities purchased;
High risk of loss of credibility when purchasing bonds or securities of poor quality;
Inclusion of unconventional policy measures in a non-standard monetary policy toolkit "standard". Another challenge is the participation of central banks or the banking union. Economic and financial crisis has demonstrated that the European banking system is vulnerable. A problem arising from a bank can quickly contaminate other financial institutions, affecting depositors, investment and the economy in general. Due to this situation, the European Union and its Member States have taken steps in terms of strengthening financial sector surveillance mechanisms. The idea to leave when the decision establishing the European Banking Union was to find the mechanism by which to avoid future drift or bankruptcy of large banks, systemic banks, which could trigger a chain reaction as was seen very often in recent years. Union of European Banking operates within the European Central Bank and its main objective is to break the vicious circle that exists between the state and banks (Delia David, 2013).
authorities oversees smaller banks. The European Central Bank supervises approximately 130 European banks that are considered significant holding approximately 85% of banking assets in the euro area. n the category of banks supervised by the European Central Bank are included and a number of subsidiaries of credit institutions outside the euro area, i.e. large banks in Romania considering that our country has committed to participate in Union Banking. The European Parliament and Member States in March 2014 reached an agreement on the winding mechanism, the second pillar of Union Bank project that 2016 will avoid situations in which taxpayers bear the costs of liquidation of banks. Winding mechanism came into force on 1 January 2015 will be operational in 2016. Liquidation of euro area banks will be financed by a fund of banks, according to criteria to be stable. The period of the Fund 55 billion is eight years. Shareholders and bondholders will be the first to pay for rescue or liquidation of banks, followed by depositors with deposits exceeding $ 100,000. National deposit guarantee funds, the third pillar of European Banking Union, might probably work best as a network of the Guarantee funds. The Directive in this respect reviewed and published in the coverage reconfirmed the EUR 100,000 per depositor per bank and gradual reduction from 20 days to 7 days refund deadlines in case of unavailability of deposits. Coverage of deposits should be e of 0.8% of covered deposits in a decade. From this perspective, Romania is better since the coverage of guaranteed deposits was 2.2% in March 2014 (http://www.bnr.ro/).
The Banking Union is "one of the fundamental pillars of the new economic governance framework at EU level. This construction is a pillar itself rather suboptimal alternative to the creation of fiscal union, and the unique solution and supervisory mechanisms, namely, the resolution will not only help solve the vicious circle between banks and national debt, but rather, will help develop a European banking sector safe, responsible and generator of economic progress "(Georgescu, F, 2014). Mugur Isarescu says in a speech at the conference The Economist 'The EU-Southeast Europe Summit - On the road to stability and growth' 'that all countries shall gain if banking union works - whether or not part of it - , given that it will lead to greater
financial stability in the euro area. " Isărescu, www.bnr.ro
There are views that argue that the European Central Bank will face a series of challenges regarding functioning of Single supervisory mechanism because it does not have sufficient experience in the field of micro-prudential supervision, but also because of the division of tasks between the European Central Bank macro, national authorities and the ESRB (European Council Systemic Risk).
5. Conclusions
Most experts say it is a good central banks to resume its role of ensuring financial stability by ensuring price stability and recommends that non-standard measures implemented during the crisis should be abandoned and be kept as a fallback when there is the possibility of financial shocks, and should not resort to these in post-crisis period. In addition, the central bank together with the government policy should take the necessary measures to strengthen defenses against external shocks and financial difficulties.
Acknowledgements
This paper has been financially supported within the project entitled „SOCERT. Knowledge society, dynamism
through research , contract number POSDRU/159/1.5/S/132406. This project is co-financed by European
Social Fund through Sectoral Operational Programme for Human Resources Development 2007-2013.
Investing in people!
References
1. Caruana J., (2011), Central banking between past and future: which way forward after the crisis?, speech at South African Reserve Bank 90th Anniversary Seminar, Pretoria, 1 July 2011.
2. Căpraru, B., , Banca centrală şi mediul economic –repere teoretice, evoluţii şi analize, Editura Universităţii Al. I. Cuza din Iaşi 3. David., D., , Tendinţe în evoluţia sectorului bancar din România, studiu publicat în volumul Studii post-doctorale în economie.
Disertaţii post doctorale, Ed. Academiei Române
4. Donato Masciandaro, Marc Quintyn, Michael W. Taylor, (2008), Inside and Outside of the Central Banks: Independence and Accountability in Financial Supervision -Trends and Determinants, Paolo Baffi Centre Research Paper No. 2008-15 , mai 2008, accesat http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1136146##
5. Dragan Momirović, Rajmund Mirdala, , Real Central Bank Independence in the Post-Crisis Period or Myth, Ekonomika, Vol 60, Issue 1, pp 1-9,
6. Georgescu, F., , Discurs susţinut la conferinţa 'Uniunea Bancară Europeană: evoluţii recente şi implicaţii la nivelul sectorului bancar românesc, 15 octombrie 2014, http://www.bnr.ro/Discurs-sus%C8%9Binut-la-conferin%C8%9Ba-'Uniunea-Bancara-Europeana-evolutii-recente-si-implicatii-la-nivelul-sectorului-bancar-romanesc'-11512.aspx
7. Georgescu, F., (2014), României la Uniunea Bancară şi ajustarea sectorului bancar, Constanţa, septembrie
8. Isărescu, M., , Discurs susţinut la conferinţa The Economist 'The EU-Southeast Europe Summit - On the road to stability and
growth , octombrie , www.bnr.ro, htt p://www.bnr.ro/Discurs-sus%C8%9Binut-la-conferin%C8%9Ba-The-Economist-'The-EU-Southeast-Europe-Summit---On-the-road-to-stability-and-growth'-11572.aspx
9. Isărescu, M., , România, adoptarea euro şi Uniunea Bancară, Conferinţa Ştiinţifică Anuală, ERMAS, Universitatea Babeş Bolyai, Cluj Napoca, 18 august, 2014
10. Nicolae Dardac, Moinescu, Bogdan, , Politici monetare şi tehnici bancare-note de curs, Bucureşti, , http://www.ase.ro/upcpr/profesori/756/PMTB_cig.pdf
