Tag: central banking

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Economics

[2638] The market will see through the undisclosed, differentiated Indonesian capital adequacy ratio

Bank Indonesia, the central bank of Indonesia, has been introducing several new institutional frameworks and rulings in the Indonesian economy. I suppose, that signifies that rate of reform in Indonesia.

One is the introduction of a trust fund. It is established to encourage Indonesian firms with earnings from abroad to keep it in Indonesia, at least for a bit longer than what typically happens now. The ultimate goal is to prevent the rupiah from depreciating further.[1] I do not understand how that will keep the money in. That is a polite way of saying, I do not think it will work too well.

Maybe the Indonesian central bankers know more than me about their economy and I am missing a piece of the jigsaw puzzle.

Another is the introduction of a new differentiated capital adequacy ratio ruling. Soon, different bank will face different ratio requirement based on their risks as determined by the central bank. But according to a report in the Jakarta Globe:

Under the new regulation, Bank Indonesia requires a minimum 8 percent capital adequacy ratio — which measures the lender’s financial strength — for banks with the soundest risk profile but it set a higher ratio for the riskiest. In the previous regulation, the ratio was set at 8 percent, regardless of the risk profile.

Bank Indonesia groups the country’s 120 commercial banks into five risk profiles. It usually updates a bank’s risk profile every 6 months but does not make the rankings or their specifications public to avoid a run on deposits at lower-ranked banks. [Dion Bisara. Bank Indonesia Sets New Rule to Strengthen System. Jakarta Globe. December 5 2012]

Bank Indonesia does not make the rankings or the specification public to avoid a run.

That is tough because as long as one can have access to the accounts of a particular bank, one can try to figure out the ratio faced (or really, ratio maintained) by the bank. From there on, the market can imply the imposed ratio.

In other words, the public can find out exactly what Bank Indonesia tries to not divulge. So, here is a ruling that I think is good but as far as risks, bank run and the differentiated capital adequacy ratio are concerned, I am quite certain that it cannot work. Bank Indonesia is revealing the very information it wants to hide.

To come to think of it, in times of banking crisis, it appears that banks with the highest ratio may face the highest likelihood of experiencing a run (ceteris paribus… and knock on wood).

The simplest and the most effective way to have a good ratio and not tell the market anything about individual banks is to impose a more or less uniform requirement across the board. There are issues with uniform requirement but it will address the problem of information superbly.

Mohd Hafiz Noor Shams. Some rights reserved Mohd Hafiz Noor Shams. Some rights reserved Mohd Hafiz Noor Shams. Some rights reserved
[1] — The central bank on Friday took another step to retain foreign earnings by setting up a trustee fund that will ensure steady and sustainable flow of overseas earnings that will be repatriated into the country. The move might also help to stem the rupiah’s depreciation against the dollar by holding income earned from abroad over a period of time rather than being withdrawn quickly. [Francezka Nangoy. Dion Bisara. Central Bank Sets Rule to Keep Foreign Earnings. Jakarta Globe. November 24 2012]

Categories
Economics

[2385] A case of MPs subverting the independence of the Bank Negara?

The importance of central bank independence has a lot to do with inflationary concerns. By independence, it typically means independence from political pressure. That entails strict separation between the central bank and the government. The central bank is not answerable to the government in general and the government does not represent the central bank. These two different entities are of two different minds. If they ever agree with each other, then it is necessarily a coincidence, or a conclusion achieved independently of each other. In its strong form, it is not achieved through any kind of discussion between the two parties.

It is feared that without independence and with exposure to political pressure, the central bank would embark on a populist policy, just as a democratic government that is susceptible to popular sentiment would. In times of crisis and without independence, the bank could run a loose monetary policy to appease the masses, eventually causing unacceptably high inflation simply by the operation of expectations.

The relationship between inflation and the independence of the central bank is widely known and is largely accepted within the field of economics: independence is correlated is an environment of low inflation. There are ample evidence for this.[1]

This is probably not subscribed by some Members of Parliament in Malaysia. Or they are unaware of it. Or that they define it very differently from what it is unusually understood. Whatever it is, three MPs are heading in the direction of subverting the idea.

According to The Malaysian Insider, MP for Kuala Selangor, Dzulkefly Ahmad of PAS wanted the Prime Minister to justify the recent rate hike by the Bank Negara. MP for Lembah Pantai Nurul Izzah said in the same report, despite stating she “was not asking the government to intervene”, she effectively blamed the government for the rate hike.[2] In the Parliament today, MP for Rembau Khairy Jamaluddin asked the Finance Minister to explain whether the Bank Negara would change the base interest rate and the reserve requirement between now till the end of the year.[3]

Truly, the concern for the rate especially is not for the Prime Minister, the Finance Minister or any person of their choosing to explain. These questions should be directed to the Bank Negara itself.

If these elected officials do try to explain it, then it will create a perception that the government and the Bank Negara are in cahoot in managing monetary policy. A mere hint of relationship as far as monetary policy is concerned is damaging to the idea of independence. The relationship suggests that the central bank in some ways is responsive to popular demand; popular demand is a code word for loose monetary policy.

What will make it worse is the possibility of the government flip-flopping, which is not rare at all in Malaysia. For a central bank that is not independent, any u-turn is especially damaging to the the credibility of the bank. Without credibility, the bank can say goodbye to its ability to manage inflation expectations.

Because of the possible implications, the Prime Minister and his Cabinet members should be careful in answering any of such questions.

Mohd Hafiz Noor Shams. Some rights reserved Mohd Hafiz Noor Shams. Some rights reserved Mohd Hafiz Noor Shams. Some rights reserved

[1] — The degree of central bank independence varies considerably across countries. Several authors including Bade and Parkin (1982), Alesina (1988, 1989), and Grilli, Masciandaro, and Tabellini (1991) found that more independent central banks are associated with lower levels of inflation. This note investigates whether one can find a correlation between central bank independence and the level and variability of real economic variables such as growth, unemployment, and real interest rates. Our conclusion is that while central bank independence promotes price stability, it has no measureable impact on real economic performance. [Alberto Alesina. Lawrence H. Summers. Central Bank Independence and Macroeconomics Performance: Some Comparative Evidence. Journal of Money, Credit, and Banking. May 1993]

[2] — PAS MP for Kuala Selangor Dr Dzulkefly Ahmad said that the prime minister, who also holds the finance portfolio in cabinet, should explain the move, which surprised economists who were expecting Bank Negara to maintain the benchmark lending rate to preserve the country’s growth momentum in the face of dimming global economic prospects.

…

PKR MP Nurul Izzah Anwar also stressed that they are not asking the government to intervene in Bank Negara’s policies but said that it was important for the finance minister to clarify what she claimed were ”very inconsistent justifications.”

Nurul said that while the government could be trying to cool down the investment climate with an eye on keeping a lid on inflation, she was unconvinced that an interest rate hike could also drive the growth of the local domestic economy at the same time. [Melissa Chi. Justify May interest rate hike, PR MPs tell Najib. Journal of Money, Credit, and Banking. June 21 2001]

[3] — Tuan Khairy Jamaluddin [ Rembau ] minta MENTERI KEWANGAN menyatakan apakah Bank Negara Malaysia berhasrat untuk menyemak atau meminda Kadar Dasar Semalaman (Overnight Policy Rate) dan Keperluan Rizab Berkanun (Statutory Reserve Requirement) bagi bank-bank tempatan sehingga akhir tahun ini. Sila jelaskan sebab-sebabnya sekiranya ya mahupun tidak. [Order Paper. Dewan Rakyat. June 21 2001]

Categories
Economics

[2045] Of unemployment targeting? That is new…

Today in The Sydney Morning Herald:

THE dollar soared and financial markets began pricing in interest rate rises after the Reserve Bank governor declared that he will soon have to push up rates and that he might do so without waiting for unemployment to stop climbing.

The bank is thought to have never before lifted interest rates while unemployment was rising.

But yesterday the governor, Glenn Stevens, told a business audience in Sydney that he did not regard himself bound by such a convention.

”˜”˜I’ve never seen written down, or I have never heard in discussion in the institution, some rule of thumb that says we wait until unemployment has peaked before we lift the cash rate,’’ he said. ”˜”˜It depends what else is happening, and also depends how low we went. [Rate rise looming, warns top banker. Peter Martin. The Sydney Morning Herald. July 29 2009]

I am not quite sure if the reporter is right when he writes “[t]he bank is thought to have never before lifted interest rates while unemployment was rising”.

Maybe, I am just not familiar with Australian thinking but central banks — that is, independent central banks — typically target inflation and not unemployment rate.

Central banks may incorporate other factors like economic growth, for instance, but the primary factor, as I understand it through my pre-2008 crisis economics lesson, is always inflation.