Blog: Banking on effective mandates -China Law.asia – Law.asia

THIS COLUMN DISCUSSES the role of central banks and why it is important for them to have clear mandates. It then identifies some of the key elements required to enable central banks to perform their mandates effectively. Finally, it outlines some of the common concerns that arise in relation to central banks and their mandates.

For the purposes of the discussion, the term “mandate” is used to refer to the functions entrusted to the central bank, and the term “objectives” refers to the purposes for which those functions are discharged.

MANDATES AND OBJECTIVES

Central banks have traditionally had three key objectives. The first is to maintain price (or monetary) stability. Central banks do this by formulating and implementing monetary policy, which primarily involves controlling official cash rates and the money supply. This is particularly important in an inflationary context, as the world is currently experiencing. Traditionally, price stability has been the dominant objective.

The second objective is to maintain financial stability, including through regulating and supervising banks, providing emergency liquidity assistance, and managing the payment system. In many jurisdictions, the function of regulating and supervising banks and other financial institutions has been taken out of the central bank and vested in separate regulators.

An important tool in achieving the second objective is the central bank’s role as the lender of last resort, under which it provides credit to banks and other financial institutions that are experiencing financial difficulties, to help them maintain customer confidence and prevent a collapse.

Financial stability also involves promoting stability of the payment system. Since the global financial crisis of 2007-2008, it has been recognised that financial stability requires a two-pronged approach that involves maintaining the financial soundness of individual financial institutions and managing related risks (microprudential regulation), and also managing risk to the financial system as a whole (macroprudential regulation).

The third objective is to issue the currency. A further objective that is sometimes included in legislation governing a central bank is the promotion of financial development and financial inclusion. This objective can, however, create conflicts of interest with other objectives, particular price stability and financial stability, and has often been a subject of concern expressed by the International Monetary Fund and the World Bank when assessing jurisdictions under the financial sector assessment programme (FSAP).

Typical central bank mandates (functions) and objectives are as follows:

Other functions often performed by central banks include the administration of deposit insurance and the management of foreign currency reserves.

It is widely accepted that all regulatory agencies, including central banks, should have clearly defined mandates, objectives and responsibilities. This maximises their effectiveness, efficiency and transparency. It also helps to ensure they enjoy operational independence.

In the case of banking supervisors, for example, the importance of having clear mandates is reflected in Principle 1 of the Basel Core Principles for Effective Banking Supervision, which is the international standard for banking supervision:

Principle 1 – Responsibilities, objectives and powers: An effective system of banking supervision has clear responsibilities and objectives for each authority involved in the supervision of banks and banking groups. A suitable legal framework for banking supervision is in place to provide each responsible authority with the necessary legal powers to authorise banks, conduct ongoing supervision, address compliance with laws and undertake timely corrective actions to address safety and soundness concerns.

As discussed in a previous column, there are different ways in which jurisdictions design their systems of financial regulation and the roles and functions of financial regulators, including the central bank (for a discussion about the different models, see China Business Law Journal ‘Twin Peaks’ financial regulation).

Mandate (function) Objective
Management of the exchange rate system To achieve stability in the general level of prices (price stability), sometimes supplemented with additional macroeconomic objectives, such as employment
Regulation and supervision of banks To achieve financial stability and protect depositors
Issuance and management
of currency
To achieve the security and availability of currency
Provision of interbank exchange settlement for the payment system To achieve a resilient and efficient payment and settlement system
Emergency liquidity assistance/lender of last resort To avoid financial system instability associated with illiquidity
Management of the exchange rate system To provide an efficient and reliable means of enabling the domestic currency to be exchanged with other currencies

KEYS TO PERFORMING EFFECTIVELY

Principle 2 of the Basel Core Principles provides as follows:

Principle 2 – Independence, accountability, resourcing and legal protection for supervisors: The supervisor possesses operational independence, transparent processes, sound governance, budgetary processes that do not undermine autonomy and adequate resources, and is accountable for the discharge of its duties and use of its resources. The legal framework for banking supervision includes legal protection for the supervisor.

Some of the key elements are examined below. It is important to note the close interrelationship between all of these elements.

(1) Operational independence. As stated in the commentary to Principle 2: “the operational independence, accountability and governance of the supervisor [should be] prescribed in legislation and publicly disclosed. Further, there should be no government or industry interference that compromises the operational independence of the supervisor.”

(2) Governance arrangements. A critical aspect of the operational independence of a central bank is the appointment process for officials, their terms of office, and the procedures for their dismissal. The operational independence of a central bank is strengthened when its officials have secure tenure and cannot be easily removed from their positions. Grounds for dismissal of the central bank’s governor, other officials and senior staff are usually prescribed by legislation.

(3) Legal protection. Principle 2 states that the legal framework for banking supervision should include legal protection for the supervisor. For example, legislation in Australia provides that the regulator, its members or commissioners and staff will not be liable to any person in the exercise or performance of the regulator’s powers, functions or duties, except where the act or omission is in bad faith.

(4) Accountability. It is recognised that, in return for enjoying operational independence, central banks must be accountable to ensure good governance. In addition, accountability must be supported by transparent processes and frameworks. A key issue is how to achieve an appropriate balance between protecting the central bank’s independence and preserving its accountability.

Principle 2 provides that the supervisor should be “accountable for the discharge of its duties and use of its resources”. Further commentary provides that the supervisor should publish its objectives and should be “accountable through a transparent framework for the discharge of its duties in relation to those objectives”.

Accountability mechanisms can be set out in formal arrangements such as the exchange of information and consultation between the central bank and the government, and publication of regular central bank reports. Informal accountability mechanisms include the disclosure of information and release of reports to financial markets and the general public.

(5) Transparency. Central bank transparency enhances accountability. Transparency is achieved through disclosure of information, including the publication of annual reports, financial information, monetary policy reports and minutes of central bank meetings.

COMMON CONCERNS

As noted, the International Monetary Fund and the World Bank regularly assess the financial regulatory systems of jurisdictions under the financial sector assessment programme (FSAP).

Common concerns include:

(1) Unclear mandates:

  • Unclear allocation of roles and powers between the regulators, including the central bank, and government/the responsible minister. This gives rise to concerns about whether the regulator has adequate powers to achieve the objectives of supervision.
  • Lack of clarity about which regulatory agencies have a macroprudential mandate.
  • Absence of an express macroprudential/financial stability mandate that has primacy over other mandates.

(2) Conflicting mandates and overlap between regulatory agencies:

  • Potential conflict between the prudential supervision or financial stability mandate and the development mandate. This gives rise to concern about whether the mandate for prudential supervision is compromised by the development mandate.
  • Potential duplication and overlapping responsibilities between regulatory agencies generally, and in specific areas such as crisis management.

There is a large body of international standards that apply to central banks. These standards serve as a benchmark against which central banks around the world can be assessed, and provide a basis on which reforms can be considered and implemented.

This column draws on an article by Zhang Yang and Andrew Godwin titled Administrative Enforcement of Insider Trading in China: An Empirical Study (2022), in Company and Securities Law Journal.

Andrew Godwin

Andrew Godwin previously practised as a foreign lawyer in Shanghai (1996-2006) before returning to his alma mater, Melbourne Law School in Australia, to teach and research law (2006-2021). Andrew is currently Principal Fellow (Honorary) at the Asian Law Centre, Melbourne Law School, and a consultant to various organisations, including Linklaters, the Australian Law Reform Commission and the World Bank.

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