Central banks are powerful organizations. In addition to being endowed with significant statutory powers most are usually able to leverage these powers by applying what is referred to as “moral suasion”. This is politically correct talk for arm-twisting. Implicit threats or rewards may accompany the arm-twisting. Moral suasion is the ar t of getting banks to do things that the central bank wants but has no legal power to impose.
Their ability to influence domestic banks’ actions in the “national interest” is one of the reasons why most central banks act to ensure that locally controlled banks remain dominant in the domestic market. They usually seek to achieve this end by two means:
Foreign limits on control and ownership. They often impose limits on the proportion of shares in local banks (usually set at 40%, of issued shares) that can be held by foreign individuals or institutions. This usually results in two classes of shares and in many cases a “foreign premium” where shares on the “foreign board” trade at a premium to those on the local board. Individual holdings are also usually subject to a 5% limit. Central banks or regulators can also exercise their powers to approve senior management and board level appointments to ensure that management control remains in local hands whatever the ownership structure.
Restrictions on foreign banks’ operations. They also often try to restrict the market share of foreign banks. Measures include limits on the total number of banking licenses given to foreign banks. This often prevents the entr y of new foreign banks. Other restrictions that are often imposed concern the sor ts of businesses they are allowed to under take, limits on the number of branches and ATMs and being prohibited from being a member of the domestic clearing system (forcing them to clear all such transactions through a local bank). This heavy level of protection and regulatory requirements has had a significant influence on industry structures in many developing countries.
February 27, 2009
MORAL SUASION
December 27, 2008
THE RISK-FREE FALLACY OF GOVERNMENT BONDS
Bonds issued by governments are generally regarded as risk free in the sense that it is assumed that there is zero default risk. The implicit assumption is that if a government could not redeem its bonds it always has the option of printing more money. This assumption has always been flawed as holders of bonds issued by Napoleonic France, pre-revolution Russia and China would have found. Many of these bonds still exist but are traded as collector items for aesthetic reasons.
In more recent years experience with Argentina, Brazil and Mexico in the mid-1980s has also showed that this is a fallacy when the bonds are issued in a foreign currency and bought by foreign investors. In most OECD countries today, however, these government’s securities are generally regarded as providing a risk-free return. In the early part of this century Japanese governments ran significant deficits, funded by bond issues, to try to break out of their deflationary slump. Despite continuing current account sur pluses and massive foreign currency reserves they had to suffer the indignity of being warned by rating agencies that the status of their debt was under review.
October 27, 2008
Fed Action and the Yield Curve, November 1998–July 2003
The previous example occurred in the middle of what became known as “goldilocks” economics, not too hot and not too cold. It shows an example of a central bank taking early action to choke off inflationary pressures. While inflation remained in check through the 1990s the economy enjoyed one of its longest ever periods of sustained growth. The previous example demonstrated the success of the Fed’s monetary policy at that time. It had a much harder job in the period November 1998 through to July 2003 with the threat of a deflationary recession a real possibility:
November 1998–October 1999. The Fed left the discount rate unchanged through this period. Rates at the long-end star ted to drift up and despite their low nominal level they were relatively high in real terms and suggested rising inflationary expectations.
November 1999–January 2001. Over the course of a year the Fed increased the discount rate by approximately 150 bpts. These hikes continued through the first half of 2000 even though long-term rates had peaked in Januar y and (with the benefit of hindsight) appeared to be heading down. By Januar y 2001 long-term rates had fallen about 150 bpts from the peak and it appeared as though the Fed had overdone its tightening. The yield curve was inver ted in January 2001. This coincided with the bursting of the technology and stock market bubble.
February 2001–December 2001. Over the course of 2001 the Fed continued to cut rates aggressively and by the end of the year had cut nearly 500 bpts in total. At 1.25% the discount rate was at a historic low. Despite these cuts long-run rates continued to fall and by June 2002 had fallen a further 100 bpts. With very mixed signals of the economic outlook the Fed cut a further 50 bpts in November 2002 but these had little visible effect. The shape of the yield curve at the end of July 2003 remained largely unchanged from June 2002. The outlook in July 2003 remained very mixed with risks of a deflationary recession balanced by hopes of a modest recovery.