FINANCIAL STABILITY AND ROLE OF CENTRAL BANKS

1
FINANCIAL STABILITY AND ROLE OF CENTRAL BANKS

• Presented by
•  
•   
• FRANKLIN AHONKHAI
• DEPUTY DIRECTOR,
• FINANCIAL POLICY REGULATION DEPARTMENT
• CENTRAL BANK OF NIGERIA
• ABUJA
• Being a Paper Presented at the
•  
•  ANNUAL CONFERENCE OF THE EGYPTIAN BANKING
  INSTITUTE
• NOVEMBER 2012

2
Outline

• Introduction
• The concept of financial system stability
• Financial system stability mandates of Central
  Banks
• Tools of financial system stability
• Challenges to maintaining financial system
  stability
• Efforts of the Central Bank of Nigeria at
  Ensuring Financial Stability
• Conclusion.

3
Introduction

• The recent crises (2007-8) that affected the
  global financial system and most economies,
  including those of African countries, brought to
  the fore the need for central banks, particularly
  those of Africa to broaden their mandates of
  ensuring financial stability.
• African economies were initially believed to be
  insulated from the global financial crisis in
  view of their relatively low level of integration
  with global financial markets.

4
Introduction (contd)

• However, the benefit of hindsight from the crisis
  indicated that this belief was erroneous.
• Nigeria, for instance, witnessed
• a major decline in oil revenue as the
  international prices of crude plummeted from
  about US140 to about US40.
• huge divestment from the capital market by
  foreign portfolio investors thus depressing
  stock prices.

5
Introduction (Contd)

• The Nigerian Banking industry was heavily exposed
  to the capital market through margin loans and
  to the oil and gas through loans, which
  performance were affected by the global financial
  crisis.

6
Introduction (Contd)

• The financial system is the engine of economic
  development and financial regulators world seek
  to design and implement policies that aim at
  preventing crisis in the sector, and where they
  occur to minimize their impact and ensure early
  and orderly resolution.
• In Nigeria, the Central Bank of Nigeria (CBN) is
  the agency with responsibilities to ensure
  monetary and price stability and promote a stable
  and sound financial system.
• These roles complement each other as price
  stability cannot be achieved in an environment of
  unstable financial system.

7
The Concept of Financial Stability

• Financial system stability is a concept that
  seems to defy consensus definition.
• It is the resilience of the financial system to
  shocks that may arise from time to time.
• Financial system stability is not an end point
  but a process and therefore, the mechanism for
  establishing the stability of the system is
  dynamic.
• It also refers to the resilience of a financial
  system against major vulnerabilities.

8
Concept of Financial Stability (Contd)

• - It should ensure the smooth functioning of the
  financial intermediation process coupled with
  confidence in the operations of key financial
  institutions and markets within the economy.

9
Concept of Financial Stability (Contd)

• Essential features of financial stability in
  include
• Resilience of the financial system to
  unanticipated shocks
• Effective functioning of the financial system
  intermediation process
• Efficient allocation of financial resources
  facilitated by the flow of funds between savers
  and borrowers
• Improvement in the general economic welfare and
  living standard of the people
• Confidence in each of the sectors that
  constitutes the financial and market systems of
  an economy and
• Promotion of economic growth and development.

10
Concept of Financial Stability (Contd)

• International Monetary Fund (IMF, 2004) describes
  financial stability as a system that is not only
  able to support the performance of an economy but
  also, able to absorb financial imbalances
  resulting from unfavorable developments.
• Financial system stability is assumed where
  there is confidence in the operation of key
  financial institutions and markets within the
  economy, thus allowing for a smooth
  intermediation process.
• A stable financial system supports the efficient
  allocation of resources and effective risk
  distribution across the economy.

11
Concept of Financial Stability (Contd)

• Financial stability requires proper coordination
  between fiscal and monetary authorities to avoid
  working at cross-purposes and to achieve the
  desired level of financial stability.
• Coordination of decisions at the various stages
  of economic planning ensures that issues that are
  significant to the stability of the financial
  system are identified and addressed to stave-off
  vulnerabilities.

12
Central Banks and Financial Stability

• The primary roles of central banks include
• Issuance of legal tender
• Lender of last resort
• Banker to the government
• Serving as bankers bank
• Promotion of a sound and stable financial system
  
• Ensuring monetary and price stability and
• Maintaining external stability.

13
Central Banks and Financial Stability (contd)

• These mandates aim at stabilizing the financial
  system.
• In developing economies like Africas, however,
  such mandates may include, the implementation of
  programmes aimed at stimulating economic
  development.

14
Central Banks and Financial Stability (contd)

• In 2011, a study group commissioned by the Basel
  Committee on Banking Supervision (BCBS) carried
  out research on central bank governance and
  financial stability and released a report in May
  2011, with the following conclusions
• That central banks shall be involved in the
  formulation and execution of financial stability
  policy to achieve effectiveness
• That central banks financial stability mandates
  and governance arrangements shall be compatible
  with their monetary policy responsibilities

15
Central Banks and Financial Stability (contd)

• That, besides charging central banks with the
  responsibility of financial system stability, it
  is appropriate to complement such
  responsibilities with necessary tools,
  authorities and safeguards for effectiveness and
• That role clarity and the responsibilities of the
  authorities involved in financial system
  stability policies (central banks, supervisors,
  deposit insurers, treasuries and competition
  authorities) are essential for proactive
  decision-making and accountability.

16
Central Banks and Financial Stability (contd)

• According to the report, there are three key
  reasons why central banks should play prominent
  roles in financial system stability
• Financial system instability can affect the
  macro-economic environment, with serious
  consequences on economic activity, price
  stability and monetary policy transmission
  mechanism.
• Central banks are the ultimate sources of
  liquidity in the economy, which is a major
  instrument of financial system stability and
• The monetary policy functions afford them the
  opportunity of understanding market dynamics
  relative to macro-prudential role.

17
Central Banks and Financial Stability (contd)

• The report underscores the importance of
  financial system stability and canvassed for an
  explicit authorization in the enabling Act of
  Central Banks with respect to transparency and
  accountability.
• In Nigeria, the Central Bank of Nigeria had to
  carry out quantitative easing in 2009 by
  creating schemes for credit to reinvigorate the
  sectors which are critical to the development of
  the economy, including special funds for
  agriculture, manufacturing, aviation as well as
  small and medium business sub-sector.

18
Central Banks and Financial Stability (contd)

• In many jurisdictions, there is no clear
  consensus among policy makers as to who should
  anchor oversight over banks and the metrics of
  such oversight. In most countries of the world
  however, the responsibility is ceded to the
  central banks in view of the important role they
  play in the economy.
• The general mandates of Central Banks with
  regards to Financial System Stability mainly
  consist of
• The promotion of a sound and stable financial
  system through effective regulation and
  supervision of the banking system
• Ensuring monetary and price stability through the
  implementation of appropriate monetary policy
  and
• Maintaining external stability by striving to
  achieve relative stability in its exchange rate
  regime.

19
Central Banks and Financial Stability (contd)

• In Nigeria, the CBN derives its mandate from the
  CBN Act of 2007 and the Banks and Other Financial
  Institutions Act of 1991, as amended to date.
• These Acts empower it to independently design and
  implement regulatory frameworks to, among others,
  promote a sound financial system. Pursuant to
  these powers, the Bank, in the last three years,
  sustained the reforms that were started in 2004.

20
Central Banks and Financial Stability (contd)

• The Act also empowers the CBN to
• Ensure monetary and price stability
• Issue leger tender currency in Nigeria
• Maintain external reserve to safeguard the
  international value of the legal tender currency
  
• Promote a sound financial system in Nigeria and
• Act as banker and provide economic and financial
  advice to the Federal Government.

21
Central Banks and Financial Stability (contd)

• In the effort to ensure the effectiveness of its
  Monetary Policy function, the CBN has put in
  place a Monetary Policy architecture which
  includes
• The Monetary Policy Committee (MPC) whose
  composition and mandates are expressly stipulated
  in the CBN Act, 2007
• A Monetary Policy Department (MPD) within the
  CBN
• Monetary Policy Implementation Committee (MPIC)
  and
• Liquidity Assessment Group (LAG).

22
Central Banks and Financial Stability (contd)

• As part of the efforts to address vulnerabilities
  in the banking system, the CBN went through a
  process of internal restructuring by changing the
  erstwhile financial sector surveillance
  directorate to financial system stability
  directorate.
• It also created three new departments in an
  effort to strengthen the CBNs regulatory and
  oversight capabilities
• Financial Policy Regulation Department(FPRD)
• Risk Management Department(RMD) and
• Financial Markets Department (FMD).

23
Central Banks and Financial Stability (contd)

• The FPRD acts as a policy research shop and
  think-tank team for financial system stability.
• It has the responsibility for policy formulation,
  analysis, review and impact assessment
  macro-prudential analysis AML/CFT policies and
  licensing of financial institutions.
• It also provides a Secretariat for the Financial
  Services Regulation Coordinating Committee a
  statutory body established to promote
  inter-agency cooperation among regulators of the
  financial services industry.

24
Central Banks and Financial Stability (contd)

• The RMD develops frameworks for the
  identification, management and control of risks
  to the achievement of the Banks statutory
  mandates.
• FMD evaluates market dynamics and develops
  initiatives that deepen the resilience of the
  domestic money market, especially as the bond
  market grows.

25
Central Banks and Financial Stability (contd)

• Earlier in 2012, the Consumer Protection
  Department, was created from the FPRD to enhance
  public confidence in the banking system.
• Its mandates include
• consumer education
• promotion of financial literacy and
• the resolution of bank-customer relationship
  conflict

26
Central Banks and Financial Stability (contd)

• The Assets Management Corporation of Nigeria
  (AMCON) was established in 2010 to relieve banks
  of the burden of Non-performing Loans (NPLs).
• It has impacted the industry in the following
  ways
• The acquisition of delinquent assets by AMCON
  helped to clean the balance sheet of banks and
  improved asset quality in the industry from the
  high rate of 34.44 to below 5.0 currently.
• It helped improve liquidity in the banking system
  by providing much-needed cash for the delinquent
  assets.
• It has helped to put Nigerian banks among the
  safest in the world.

27
Central Banks and Financial Stability (contd)

• In Nigeria, other regulatory agencies share the
  responsibility for the stability of the financial
  system with the CBN.
• These include
• The Securities and Exchange Commission (SEC),
• Nigerian Deposit Insurance Corporation (NDIC),
• National Insurance Commission (NAICOM),
• National Pension Commission (PENCOM),
• Corporate Affairs Commission (CAC) and
• Self-regulatory bodies, e.g Chartered Institute
  of Bankers of Nigeria (CIBN).

28
Tools Used in Entrenching Financial System
Stability

• The following are some of the tools used in
  Nigeria to ensure financial system stability
• Banking Supervision and Regulation
• Effective and efficient supervision and
  regulation of banks is imperative for financial
  system stability because of the leading role
  played by banks in most economies.
• The tools used by the CBN in the supervision of
  banks and OFIs include on-site examination
  off-site supervision and issuance of financial
  policies.

29
Tools Used in Entrenching Financial System
Stability (contd)

• The CBN has signed home-host MoUs with nine
  jurisdictions where Nigerian banks are operating.
• The purpose of the MoUs is to facilitate
  information sharing which will enhance the
  assessment of the cross-border risks inherent in
  the operations of the institutions and help
  prevent contagion.

30
Tools Used in Entrenching Financial System
Stability (contd)

• Macro-prudential Surveillance and Regulation
• Macro-prudential regulation involves evaluating
  the financial system as a whole to identify
  weaknesses and threats and develop appropriate
  remedial interventions.
• Through research, collaboration with other
  agencies in the financial sector, central banks
  have information that allows them to monitor
  trends in financial markets.
• Macro-prudential tools such as stress testing,
  Early Warning Signs (EWS), trend analysis, etc
  are used to analyze the information for early
  detection and resolution of potential threats to
  financial system stability.

31
Tools Used in Entrenching Financial System
Stability (contd)

• Monetary and Price Stability
• The objectives of monetary policy may vary from
  country to country.
• Monetary policy broadly seeks to achieve price
  stability and other macroeconomic objectives.
• Central banks with no authority for banking
  supervision and regulation influence the
  stability of the financial system through the
  monetary and price stability mandates.

32
Tools Used in Entrenching Financial System
Stability (contd)

• Other Tools and Policies
• The Central Banks of developing economies play
  developmental roles to provide an improved
  macro-environment in which their policies can be
  more effective.

33
Challenges to Maintaining Financial System
Stability

• Some challenges to maintaining financial
  stability include
• Poor corporate governance
• Major weaknesses in the business environment
• Large capital flows to emerging economies
• Weak micro-prudential supervision framework
• Weak legal provisions/enforcement
• New and complex financial instruments
• Weak macro-prudential analysis framework

34
Efforts of the CBN at Ensuring Financial
Stability

• The CBN, in 2008, took several steps to stem
  decline in the financial system. These steps are
  discussed below
• Sustenance of reforms
• Central banks generally access information on the
  threat to financial stability through their
  research and surveillance functions. The
  information provides the basis for various
  interventions and policy initiatives as the need
  arises, to strengthen financial system stability.

35
Efforts of the CBN at Ensuring Financial
Stability (Contd)

• The Banks latest set of reforms, which commenced
  in 2009, includes
• internal restructuring within the CBN itself
• enhancing the quality of banks
• establishing financial stability
• enabling healthy financial sector evolution and
• ensuring that the financial sector contributes to
  the real economy.

36
Efforts of the CBN at Ensuring Financial
Stability (Contd)

• Enhancing the quality of the banks - This entails
  the various industry remedial programmes targeted
  at enhancing the operations and quality of banks
  in Nigeria. These programmes include
• implementation of Risk-Based Supervision (RBS)
• adoption of the International Financial Reporting
  Standards (IFRS) in the Nigerian Banking Sector
  by end 2012
• close collaboration with other stakeholders etc
• establishment of a consumer protection
  department
• capacity building on RBS methodology in the CBN
  and NDIC and
• promoting good corporate governance.

37
Efforts of the CBN at Ensuring Financial
Stability (Contd)

• Establishing Financial Stability - The primary
  focus of this pillar is to
• strengthen the financial stability committee in
  the CBN
• establish hybrid monetary policy and
  macro-prudential rules
• develop directional economic policy as well as
  counter-cyclical fiscal policies by the
  government and
• further develop the capital markets as an
  alternative to bank funding.

38
Efforts of the CBN towards Ensuring Financial
Stability (Contd)

• Enabling Healthy financial Sector evolution -
  The focus of this pillar of the reform is to
  ensure
• the emergence of a competitive banking industry
  structure
• provision of the required supportive institutions
  for the financial system such as the credit
  bureau
• improvement in the cost structure for banks
  through cost control and business process
  outsourcing
• reliable and secure payments system
• reduction of the informal sector and greater
  financial inclusion.
• Foreign bank participation would be encouraged in
  order to improve and strengthen the financial
  system provided

39
Efforts of the CBN towards Ensuring Financial
Stability (Contd)

• Ensuring that the Financial System contributes to
  the Real Economy
• In addition to the reforms in the banking sector,
  the CBN has focused on facilitating economic
  development in Nigeria through its developmental
  role.
• In this regard, the CBN has taken the lead in the
  financing of the real sector and infrastructure
  projects as well as enhancing credit to the real
  sector

40
Efforts of the CBN towards Ensuring Financial
Stability (Contd)

• b) Use of market-driven monetary policy tools
• Central banks use quantitative and qualitative
  tools to achieve price stability.
• In Nigeria, the CBN uses more of qualitative
  tools, including open market operations to
  influence the direction of monetary policy.
• The policy thrust has always hinged on the need
  to influence the cost and availability of credit
  to the critical sectors of the economy.

41
Efforts of the CBN towards Ensuring Financial
Stability (Contd)

• c) Provision of safety nets through lender of
  last resort Lender of last resort is one of the
  traditional safety net functions used by central
  banks in addressing financial instability and
  crisis management.
• It involves both the provision of liquidity in
  normal times as well as during crisis periods.
• This tool has primarily focused on banks and is
  justified by the vulnerability of banks to
  liquidity crises that often trigger systemic
  crises.
• A major milestone was achieved by the Central
  Bank of Nigeria in the effort to promote
  stability with the establishment of the Assets
  Management Corporation of Nigeria (AMCON) which
  relieved banks of the yoke of their delinquent
  assets and injected liquidity into the banking
  system.

42
Efforts of the CBN towards Ensuring Financial
Stability (Contd)

• d) Promoting financial stability through an
  effective payment system
• The payments system, being the channel through
  which financial resources flows within as well as
  in and out of the economy, plays a very crucial
  role in promoting financial stability.
• It, therefore, represents the major foundation of
  the modern market economy.
• Central Banks, through the effective deployment
  of its statutory powers of oversight over the
  payment system is able to prevent and or manage
  risks related to the disruption of the payment
  system due to failing participants.
• Credit balances across banks in a netting system
  can trigger contagion risks. Central banks
  develop mechanisms and arrangement to limit the
  potential increase of these risks in the payment
  system.

43
Efforts of the CBN towards Ensuring Financial
Stability (Contd)

• e. Adoption of good governance principles
  Central banks play a vital role in fostering the
  soundness of financial institutions through
  effective supervision and regulation.
• Since banks in many economies constitute the
  dominant share in the financial sector, their
  failure could trigger financial instability and
  disrupt the effective functioning of an economy.
• To promote sound corporate governance in the
  banking system, the CBN issued a code of
  corporate governance, the adoption of which has
  been made mandatory for banks in the country. The
  code which was first issued in 2006 is currently
  being reviewed to strengthen it and bring it in
  line with international best practices. To
  complete the code, Guidelines for whistle-blowing
  in the banking industry are, also being developed
  to provide avenues for the reporting of
  wrong-doing in the industry

44
Efforts of the CBN towards Ensuring Financial
Stability (Contd)

• f. Purpose driven-banking model
• The CBN, on realizing that the practice of
  Universal Banking Model in its jurisdiction
  resulted in the expansion of banks operations
  into a broad range of financial services, for
  which they lacked the requisite skills, and thus
  exposed them to higher risks, increased their
  propensity to apply depositors funds to risky
  non-banking businesses, and consequently heighten
  the risk of financial system instability, decided
  to abolish it.
• The CBN consequently introduced a new banking
  model, which is designed to ring-fence banks
  against the negative impact of non-banking
  activities, and thus to enhance stability in the
  Nigerian financial system.

45
Efforts of the CBN towards Ensuring Financial
Stability (Contd)

• g. New Prudential Guidelines
• The Prudential Guidelines issued to the industry
  in 1990 had become obsolete. The CBN therefore
  issued Revised Prudential Guidelines in July
  2010.

46
Efforts of the CBN towards Ensuring Financial
Stability (Contd)

• The objectives of the new Prudential Guidelines
  which are designed to enhance the financial
  health of banks and thus financial system
  stability include the following
• enhanced provisioning requirements, which are
  consistent with sound risk management practices
  for Nigerian banks
• provisioning requirements which are aligned with
  the life cycle and gestation periods of specific
  industry loan types
• provide a framework to ensure that provisioning
  guidelines are counter cyclical (pro-dynamic)
  and
• provide a framework that recognizes credit risk
  deceleration and mitigation through haircuts
  adjustment for lost facilities.

47
Efforts of the CBN towards Ensuring Financial
Stability (Contd)

• Also in 2010, the CBN Guidelines for Supervisory
  Intervention in Banks was issued to establish
  triggers for regulatory intervention when
  prudential ratios and other thresholds fall out
  of the comfort zone.
• The guidelines provide general and specific
  thresholds for regulatory interventions in banks
  in respect of the specified prudential
  indicators.
• It also provides the regulators with benchmarks
  for a global concern regarding the safety and
  soundness of the banking system.

48
Efforts of the CBN towards Ensuring Financial
Stability (Contd)

• h. Others Other reform measures aimed at
  promoting financial stability include
• enforcement of a common year-end for banks
  implementation of risk-based supervision
• review of the Microfinance and Bureaux de change
  policies
• review of criteria for top management
  appointments in banks and other financial
  institutions and
• the implementation of cross-border joint
  examination of banks.

49
Conclusion

• Ladies and gentlemen, the financial system is a
  platform for the allocation of financial
  resources to the productive sectors of the
  economy and in view of its strategic importance,
  the Central Bank of Nigeria consider the
  involvement of all the supervisors in the
  financial system, including self-regulatory
  agencies like the Bankers Institutes quite
  helpful in ensuring effective supervision of
  financial institutions.
• We therefore, commend The Egyptian Banking
  Institutes for providing this platform for us to
  share experiences. The opportunities provided by
  this conference for African Central Banks and
  other financial sector regulators/supervisors
  will go a long way in drawing attention to issues
  of financial instability across the continent as
  well as the need to evolve measures for
  addressing them. It is by so doing that economic
  growth and development can be sustained in the
  continent.

50

• THANK YOU!