Banking Soundness and Monetary Policy


Charles Enoch, and J. Green
Published Date:
September 1997
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Referring to the role of the exchange rate in the Israeli stabilization, Mr. Iltchev asked Mr. Frenkel whether a currency board—where no discretionary monetary policy was possible—would be an adequate system for a country facing a banking crisis. Mr. škreb questioned the ability to withstand the pressures of international money laundering, especially in smaller transition economies. He wondered whether globalization had actually increased the settlement risk between countries. Mr. Kovacs supported Mr. Škreb’s view that the liberalization of short-term flows might be dangerous. Asset price movements often reflected over reactions to short-term capital movements, and it was unlikely that fiscal policy could play a mitigating role, especially in the short run. Mr, Khandruyev questioned whether there was a contradiction between the ongoing globalization of capital markets and central banks’ “paternalistic” approach.

Mr. Frenkel responded that a currency board was no blueprint and no policy prescription was appropriate for all countries and all times. A currency board was normally called for where other systems were unlikely to arrive at monetary control. It was important though that the necessary preconditions were in place and that the government was fully aware of what it was doing. It was also important to use the instrument carefully. If there was a sudden crisis and one currency board was failing, this most likely would have negative repercussion effects on all other currency boards. To avoid a crisis it was important to know in advance where the lender-of-last-resort facility was located—for instance with the budget—in which case a currency board was most likely sustainable. Concerning short run capital flows, Mr. Frenkel supported liberalization as soon as possible. “Use an opportunity when it comes, but don’t jump if the parachute is not in place.”

Mr. Crockett said that settlement risk did increase with globalization, and, especially, with the resultant sharp increase in the number and volume of transactions. Other risks, such as foreign exchange settlement risk (“Herstatt risk”) had become more important. Given the volumes involved (US$ 1.3 trillion per day, usually outstanding for two days) this risk was much bigger than initially thought. Institutions were now much more concerned about such matters than before, and he was optimistic that the issue could be mastered in the near future. Concerning money laundering, Mr. Crockett stressed that the “know your customer rule” was becoming ever more important. In fact, this was part of a bank’s duty. He stressed that banks violating this duty should be subject to supervisory action. Concerning bank soundness, Mr. Crockett said that the issue of asset price variability (as possibly caused by capital flows) implied a need for much greater capitalization.

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