Rethinking central banking

Atiur Rahman

Post-crisis initiatives on rethink/reforms of central banking have focused on financial stability, particularly on regulations found deficient in preventing and coping with the crisis.
These initiatives include interalia, risk appraisal and containment, capital adequacy and liquidity, principal-agent relationship issues like executive compensation, cross border co-ordination in supervision of globally active large financial institutions.
The ongoing revisions and refinements in macro-prudential regulations and related policy tools will hopefully lead to stronger, more resilient financial institutions and markets and supervision regimes better able to anticipate and withstand shocks from occasional destabilising events in the real or financial economy.
Smaller less advanced economies like Bangladesh have little scope of playing role in the global consultation processes; but with limited size and external exposure of their financial sectors they can opt for slower, more gradual implementation of regulatory changes, in which support and help from more advanced central banks and global forums are of course welcome.
The regulatory reform initiatives will hopefully be effective in strengthening resilience of financial institutions and markets in coping with future instabilities; but it is unclear whether enough is being done towards preventing the underlying macro-economic imbalances that cause the instabilities.
The recent global financial crisis was rooted in successive decades of cumulating global imbalances originating from spillovers of lax macroeconomic policies in some large economies; the international reserve role of their domestic currencies permitting them to run prolonged spells of external account deficits, causing global liquidity expansion well in excess of growth in real global output of goods and services.
The global community of central banks needs to spearhead the necessary preventive initiatives with appropriate reforms in the global monetary order; with effective deterrents against buildup of global imbalances from adverse spillovers of lax, unbalanced domestic policies in the larger economies. The IMF in its current mandate has not been effective or particularly active in preventing buildups of global imbalances from actions of its dominant quota holder members.
In the run up to the recent global financial crisis, no time series data on overall trends of global liquidity growth vis-à-vis growth trends in real global output were available in IMF publications, in apparent unconcern about consequences of the global imbalances.
For a reformed monetary order to maintain global balance and stability effectively, it will need some mechanism tethering global liquidity expansion with growth rate of real global output.
One option will be a reformed IMF mandated as the apex global monetary agency, issuing (or withdrawing) SDR allocations in line with actual or potential expansion (or contraction) in global output; with liquidity issues in national or regional currencies of members needing to be fully backed by SDR allocations. The mechanism will be in likeness of the erstwhile gold standard, with real global output growth substituting for gold.
The current basic quota (voting power) allocations in IMF are legacies of past dominance of North America and Europe; these need revision to reflect current realities, with reallocations for smaller developing economies taking into account the size of global population percentage they represent, beside their current minuscule shares in global output.
Besides attention to monetary and financial system stability, central banking needs also to promote fuller financial inclusion of all economic activities and all economic sectors, towards supporting global real output growth. Dereliction of traditional central banking orthodoxy in this direction has perpetuated market gaps and market failures in financial services (even in the developed economies), with forgone opportunities and suboptimal global performance in growth of output, income and welfare; slowing down eradication of global poverty.
It is opportune time now for the central banking community to redress the neglect of promotional role; effectiveness in this role will aid rather than hinder the stability preserving regulatory role.
As the central bank of a low-income developing country, Bangladesh Bank has of late been paying increased attention to fuller and deeper financial inclusion, with a view to redressing market failures and unleashing blocked advancement opportunities for the under served/ excluded economic sectors and population segments, promoting more inclusive economic and social growth.
The attention to growth promoting potentials of financial inclusion is of course not at the expense of any neglect of usual concerns and market based policy frameworks for monetary and financial stability; the approach is a pragmatic, heterodox blend aiming at optimising growth while maintaining and bolstering stability.

The paper was presented by the Bangladesh Bank governor at a meeting at the IMF headquarters at Washington DC recently.