Independence of central bank in the age of populism

Populism, we may say, springs from activities where policies of a government are driven by popular public demand ignoring rules, regulations or any resultant negative impact in future. From economic point of view, some economists have used the term in reference to governments which, ignoring ground realities, engage in substantial public spending financed by foreign loans, resulting in hyperinflation and emergency measures. In popular discourse, the term has sometimes been used synonymously with demagoguery to describe politicians who present overly simplistic answers to complex questions in a highly emotional manner in an attempt to please voters without rational considerations as to the best course of action.

Being biased by populism, governments may tinker with interest rates in the name of encouraging investment. In many cases proper monitoring, supervision, disciplinary actions taken by the central banks are not implemented and political considerations interfere with important regulatory matters.

In the 1970s, it was rather normal for politicians to manipulate interest rates to boost their own popularity. That led to a hyperinflation in many countries. However, in course of time, developed countries and many developing ones, too, shifted to a system in which politicians set a broad goal and left independent central banks to realise it. In a single generation, billions of people around the world have grown used to low and stable inflation and to the idea that the interest rates on their bank deposits and mortgages are under control.

Today, this success is threatened by a confluence of populism, ultra-nationalism and economic forces that are making monetary policy political again. If we observe the present condition of central banks worldwide, we would find that central banks everywhere are struggling to stay above politics. In December 2018, the governor of the Reserve Bank of India (RBI) resigned just weeks after the government moved to exert more control over the RBI's regulatory powers. In July 2018, US President Donald Trump began criticising the Federal Reserve's interest-rate increases, breaking with more than two decades of White House tradition of avoiding comments on monetary policy -- out of respect for the independence of the Fed. In Turkey, President Recep Tayyip Erdo?an, who holds the unconventional belief that high interest rates cause rather than curb inflation, has repeatedly been pressurising the central bank of the country to restrain borrowing costs. After winning re-election in June, Erdogan assumed the power to appoint the bank's rate-setters and put his son-in-law in charge of economic policy. The meddling sent Turkey's currency tumbling. Central banks in Pakistan, Russia, Nigeria, South Africa, Thailand and Bangladesh have also been experiencing undue pressure from politicians in recent years.

Compliance on financial regulatory issues is highly important for the economy of a country. Banks and many non-banking financial institutions (NBFIs) accept money from depositors through various mechanisms and invest it in businesses as their assets. For keeping the depositors' money safe, making the lending process proper and secured, as well as managing liquidity and profitability efficiently are the foremost concerns of each and every financial institution.

People always run after money and wealth. Some people want to become rich overnight, making money by any means. During the last 25 years, the culture of becoming wilful defaulter has flourished alarmingly. A significant number of businessmen or entrepreneurs are not allegedly utilising the funds taken from banks and diverting those to various unproductive sectors. Lack of proper monitoring, supervision, proper project appraisal, appropriate process in selection of clients and so on are instrumental in promoting the default culture.

For safeguarding depositors' money lying in the financial institutions and building a strong capital base, the recommendations of the Basel Committee on Banking Supervision (BCBS) is under implementation all over the world. The implementation of the updated recommendations of the BCBS gained pace after the devastating financial meltdown in the Western countries, especially in the USA a few years back. The financial institutions in Bangladesh are also under immense pressure to implement the three pillars of Basel-III, such as maintaining minimum capital requirement, strong and rigorous supervisory review process and upholding market discipline at any cost under the proper guidance of the Bangladesh Bank.

Even a single bad investment or small irregularity could lead a financial institution to a state of bankruptcy and also make the capital base severely vulnerable. As a by-product of bad investment, there comes provisioning, adverse affect on the capital base, less profit, fall of share prices, damage of business reputation and what not.

Regulatory issues and independent regulatory bodies regarding financial institutions are very much sensitive and important for smooth and steady growth of the economy of a country. A widely cited 1993 paper by Alberto Alesina and former US Treasury Secretary Lawrence Summers concluded that independent central banks are better at controlling inflation than central banks under political control. Shielded from pressures of day-to-day politics, the paper noted, they can take a longer view and make unpopular but prudent decisions.

So, monitoring, supervision and disciplinary actions taken by central bank on the financial institutions must be kept out of all sorts of undue influence, political pressure, nepotism and above all, populism for maintaining overall discipline in the economy, making the asset quality better and building confidence among investors and depositors.

Alam Siddiqui is a banker and freelance columnist. 

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