4 December, 2020

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Governor & Board Members Are Not Owners Of The Central Bank

By W.A Wijewardena

Dr. W.A. Wijewardena

Dr. W.A. Wijewardena

Central Banking 18: Governor and board members are trustees and not owners of the central bank

A central bank can earn its living by printing money

A central bank is a unique species. It does not have to work in order to earn its existence. This is because it has been given a power which no one else in society has. That power is to have all the resources it wants just by assuming a liability through a mere book entry. For instance, suppose it wants to lend to the government by buying a Treasury bill. All it has to do is to debit a Treasury bill holding account in its books and debit that account and credit the value it has lent to the government to the government’s deposit account which it maintains in its books. Then, how does the government make use of the money lent to it by the central bank? It can do so by resorting to one of the two methods available to it. One is that it can write a cheque on its account with the central bank and make payments to somebody in the economy. The recipient of the cheque will collect cash from his bank which will collect it in turn from the central bank. Or else, the government can withdraw cash directly from the central bank and make payments to somebody in the economy. In either case, the central bank meets its liability by issuing currency which it can print at its pleasure. To print a currency note, the central bank does not have to incur a cost equivalent to the face value of a given currency note. This is because currency notes today are printed on paper and not made of precious metals like gold or silver. Hence, to issue a 5000 rupee note, the central bank incurs a cost of, say, about 10 rupees. This is a highly profitable business because it earns a profit of 4990 rupees for the central bank. Such profits are known in economics as ‘seigniorage’.

Monetary Board headed by Governor should live up to the trust placed by public in them

Hence, those who run central banks may be tempted to earn the maximum seigniorage for them as well as for the political masters who have appointed them. But excessive seigniorage means excessive printing of money and excessive printing of money means excessive inflation in the economy. The real harm which this process would do to an economy was discussed in a previous article in this series titled ‘Is a little bit of inflation necessary for economic growth?’. The article has argued that such a policy is a ‘lose-lose policy’ since both the government and the members of the public stand to lose at the end. The biggest loss to the public is the loss of wealth which they have kept in ‘money form’ trusting the central bank. Society has placed the responsibility for preserving that trust in a group of people called the Monetary Board headed by the Governor of the Central Bank.

ArjunaGovernor and Monetary Board are trustees and not owners

Thus, the Governor and the members of the Monetary Board are simply ‘trustees’ and not the owners of a central bank. A trustee has a legal meaning as well as an economic meaning. The legal meaning is that a trustee has to take the same care and caution when he handles the assets of the beneficiaries as when he handles his own assets. In other words, since he does not allow his own assets to perish but prosper, he should not allow the assets belonging to the beneficiaries to decay through negligence but take all measures to enhance their value. In this manner, the trustees of a trust are bound by a legal obligation and that legal obligation is known as ‘fiduciary obligation’ binding them.

Economic trusteeship requires the Board to take adequate risk mitigation measures

The economic meaning of a trustee too derives from the legal meaning but it goes beyond that. Economics does not recognise that one can always be successful in his enterprises. He can be a success or a failure depending on how he organises his enterprise and what sort of market conditions he faces. Accordingly, in economics, a person would take a reasonable risk in order to make an expected amount of profits. These people in economics are called investors and they differ from speculators. The latter will take excess risk in order to make super or extraordinary profits. Both investors and speculators live in an economy and they are found side by side with each other. Society does not expect the members of the Monetary Board headed by Governor to function as speculators. Instead, they should function like investors who know the extent of risk they take and are knowledgeable of the need for introducing risk mitigating mechanisms in running central banks.

No imprudent practices in a central bank

There are three prerequisites which Governor and the Monetary Board members should possess to perform the job of trusteeship cast on them. One is the constant awareness of the risks they would face if they follow imprudent practices. The second is the governance practices which both the Governor and board members follow requiring them to answer their own ‘conscience’ rather than a legal authority. The third is the knowledge base which they should acquire in order to function as an economic trustee.

Losses of central banks become a burden to taxpayers

It is the imprudent policy which a central may have adopted that would lead to its eventual bankruptcy. At this stage, the fact that a central bank can acquire assets by printing money will not come to its rescue. The rescue comes to it from following proper risk management in central banks. This was explained in a previous article in this series titled ‘Even mighty central banks can go broke if imprudent policies are adopted’. It was pointed out that a central bank should not get into speculation of currencies and exchange rates or into heavy foreign borrowings since the outcome would be an incurrence of embarrassing losses for the country’s taxpayers. Three widely publicised cases were discussed in the article. The first related to Bank Negara Malaysia speculating on the British pound in early 1990s and losing an estimated $ 5.5 billion. The second was how the Bank of Thailand sought to protect Thai Baht insanely in 1990s and lost $ 25 billion in the process. The third involved the Central Bank of the Philippines borrowing heavily to finance government’s loss making capital projects and becoming bankrupt in 1993. In all these cases, the losses were borne by taxpayers and therefore the governing boards of the respective central banks had failed to discharge their trustee obligations properly. Hence, proper risk management in a central bank is a must and the Governor and the board members should establish proper risk management mechanisms in them.

Good governance a must for a central bank

Good governance in central banks is important on three grounds. First, society looks up to central banks as model institutions to emulate. If they do not have good governance practices, then, the place of the central bank in society is grossly undermined. Second, central banks insist that all banks and financial institutions that are being supervised and regulated by them should have good governance practices. If the regulator does not have good governance practices, then, it cannot impose its will on banks. Third, good governance improves the internal management of a central bank and establishes a proper accountability mechanism in it. These issues were discussed in detail in the article titled ‘Governance of central bank boards’ published in this series. As the article has argued, governance principles that stipulate clearly the relationship which Monetary Board has with its stakeholders help it earn market confidence, establish financial integrity and promote economic efficiency.

Governance components in a central bank

There are several components of governance requirements which a central bank should follow. First it should address failures of market information flows, bad and incomplete communications and non-recognition of the risks faced by a central bank. Second, action should be taken to improve the quality of management of central banks at all levels. Third, it should make the best use of bank’s assets, resources and intellectual capital. Fourth, it should develop appropriate risk mitigation mechanisms inside central banks. Fifth, it should continuously communicate with the stakeholders the performance of the bank through regular and pre-announced communication actions. These are essential ingredients which Governor and the board members should master if they are to serve as trustees of people.

Handling proper money is the responsibility of the Monetary Board

The Monetary Board headed by Governor deals with money and it is therefore different from the board of a corporation. John Exter, the founding architect of the Central Bank of Sri Lanka explained this in the report he submitted to the government for the establishment of a central bank in Ceylon, known as Exter Report, as follows: “The word “monetary” in its name emphasizes again that the Board is intended to be very much more than simply the board of directors of another bank. It is a Governmental agency responsible for the determination of a particular kind of policy – monetary policy – and the regulation of a particular kind of economic activity – money, banking and credit” (p 11). Thus, it is imperative that Governor and the board members are people with knowledge on money and monetary policy.

Governor and board members should have rich experience and knowledge

This is the reason for filling the governing boards of central banks with non-executive members drawn from a pool of experience and knowledge in banking, economics, trade, commerce and industry. The objective is to draw on the rich experiences of each other to steer the policy of central banks towards the effective attainment of their goals and objectives. However, in some cases, deputy governors who are full-time executives of central banks have been made board members, but they are always being outnumbered by the non-executive members appointed from outside.

Deputy governors should also be people with knowledge, experience and maturity

Hence, in banks where the majority rule constitutes the decision making criterion, the appointment of deputy governors who are a minority, does not add value to the policy making of a central bank. Thus, in countries like Sri Lanka where deputy governors are not vote carrying board members but only in attendance at board meetings, an opportunity is provided for board members to consult them on important policy issues. However, for deputy governors to perform this job effectively, they should be well versed in all aspects of central banking and global developments in addition to having a detailed institutional memory which the board can tap whenever it has doubts about any policy action being contemplated.

John Exter: Governor should be of unquestioned integrity

In the case of Sri Lanka, the Governor who heads the Monetary Board should be a person with wide experience and knowledge in economic, financial and banking matters to lead the Board as well as the central bank in the proper direction. John Exter elaborated on this in the Exter Report as follows: “The Governor should be a man of recognition and outstanding competence in and understanding of the economic and financial problems of Ceylon, and of unquestioned integrity and responsibility” (p 16). This is not explicitly laid down in the Monetary Law Act under which the Central Bank has been set up in Sri Lanka. It is therefore left for the appointing authority to take it into account when he selects a particular person as the Governor of the Central Bank. However, in many central banking legislations, as noted by Exter, this has been incorporated as a guidance to the authority which appoints the Governor. This omission by Exter has led in Sri Lanka to appoint people who do not possess these qualifications to the post of Governor of the Central Bank with subsequent disastrous results.

Sri Lanka’s method of appointing Governor and board members is defective

The procedure for appointing the Governor and Monetary Board members in Sri Lanka is far from ideal. In the case of Governor, in terms of section 12 of the Monetary Law Act, the President can appoint anyone as Governor provided he is recommended by the Minister of Finance. In the case of other board members, once again the President can appoint any person to the Monetary Board if he is recommended by the Minister of Finance and the Constitutional Council set up under the 17th Amendment to the Constitution gives its concurrence to such appointment. As such, the qualifications and attributes which the Governor and board members should possess are seldom taken into account when appointing persons to the respective positions in the Central Bank. There have been occasions in the past that political loyalty has played the dominant role in the selection rather than the knowledge base and other attributes in the selection of persons to these high positions. It is simply a betrayal of the trusteeship which the people expect of the two high positions in the Bank.

Amend MLA to introduce a better appointment system

Because of the possibility for abusing the appointing power by politicians, many central bank laws have specified a long head-hunting, screening and selection process for the post of Governor and board members. In the case of the Bank of Canada, searches for a potential candidate for Governor’s post begin long before the incumbent Governor is due to retire from the post. A similar practice is being followed by the Bank of England too. Even in new central bank laws in Nepal and Bhutan, selection is made from out of a number of short-listed candidates. In the case of the Chairman of the Federal Reserve System in USA, the nominated candidate has to face a screening public interview at the Congress. These provisions have been made in order to facilitate the selection of the best candidate for the post of Governor since it is in his hands the society places the responsibility for protecting the moneys they hold. It is therefore an urgent priority under the good governance regime to amend to Monetary Law Act to provide for a better selection and appointment system for the post of Governor and other board members.

Value comes from knowledge, experience and maturity and not from political loyalty

Both the Governor and Monetary Board members should possess a clear and high knowledge of economics, banking, finance etc. They should have a very wide global outlook. They must be aware of the emerging global conditions and make suitable changes to the domestic monetary and financial policies to mitigate the risks involved. Above all, as Exter had highlighted, they should be people of ‘unquestioned integrity and responsibility’. What this means is that if anyone’s integrity has come to be questioned, he does not fit to hold the high post of Governor of the Central Bank or become a member of its Monetary Board. The same requirement holds equally for the senior career officers of the central bank too.

*W.A Wijewardena, a former Deputy Governor of the Central Bank of Sri Lanka, can be reached at waw1949@gmail.com 

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Latest comments

  • 3
    1

    Yahapalanaya is working on the overdrive as Ranil and Ravi duo try to tell us. Arjuna Mahendran cannot be a Victim but a Victor for the oligarchs have schemed over 600 million rupees in just four days on the side lines.

    So it is Good that Dr G. Usvatte-Aratchi, Dr. A.C. Visvalingam and Chandra Jayaratne submitted a petition to the Supreme Court on Treasury Bond issue.

    Extract from Ratnapala’s comment:

    ARJUNA MAHENDRAN
    Update – 26th march 2015

    Original Article;

    Either Way the Central bank scam has generated over 500 million in commissions !! to his family or his colleagues..
    Read the stunning finding of the laska investigative team on srilankan news that has rocked the Yahapalanaya Regime ..
    1. the players – Arjun Mahendran (central Bank Governor), Arjun Aloysius (son-in-law & director of Perpetual Treasuries), Mrs. Shiromi N Wickramasinghe (sister of former governor Nivad Cabraal & director of Perpetual Treasuries), Bank Of Ceylon

    2. The Game – Central Bank issues Bond for for 1 billion at 9% interest which was subsequently increased to 10 Billion at 12.5% interest rate of which 5 billion were giver to Mr. Mahendran’s Son-in-laws company!

    He then re-sells the bonds to affiliated companies like insurance co-operations/ multinaionals etc at a lower interest rate, in this case around 9.5% (slightly above the original rate)thereby making a quick big buck of around 3% of the interest payable upfront by the institutions for his services!

    3. the Excuses –
    Arjunas Excuse : he says he Was informed that there were bids for over 20 billion so he informed the bank to increase the value from 1 billion to 10 billion ! the catch is ..

    a) why did he increase the interest rate as well when the issue was oversubscribed ?

    b) why were all primary dealers not informed of this

    Arjun Aloysius Excuse : conveniently resigns from the Perpetual Treasuries board with a back dated resignation letter and sells the company to his friend Ishara Nanayakkara for 650 million rupees 4 days after the deal!!

    4. The Plot –

    a)This is where the web of corruption expands as the company has no funds nor the financial might to bid for a Bond of this nature and yet it received a loan of 3 billion from the bank of ceylon!! how did this happen is the divine perpetual million dollar question ? :)
    b) of 36 bidders, how did one company receive 50% of the Bonds ??

    5. The profit – in excess of 5 million dollars !

    6. The Crime – this is a clear case if insider trading

    Arjun Aloysius is implicated in many deals involving the EPF, especially the purchase of grain elevators and LOLC resulting in losses in the billions,it was once rumoured that his company plundered EPF to the tune of Rs3B with the connivance of Namal Rajapaksa who in turn received a kick back of Rs500M!
    Arjuna grandfather is the infamous “Karawala Mudalali” Kattar Aloysius who defaulted over Rs.500 million to the Bank of Ceylon in the 1990s

    it is also well known that Arjuna Mahendran is a very good friend of Nivaad Cabral and got his help to organize the Primary Dealer license for his son in laws (Perpetual) company. The very fact that he was appointed as central bank governor while his son-in-laws company is a primary dealer made him no better than the dubious and corrupt former governor

    Its hard to disqualify Finance Minister Ravi Karunanayake as beneficiary of this transaction as it is he who appointed Brian J Sinniah the Chief Financial Officer of Ravi Karunanayake owned Global Group to Bank of Ceylon from 9th February 2015 along with Ranel Wijesinghe, Pushpa Wellappili and Ronald C. Perera (as BOC New Chairman).
    These appointments paved the way for Bank of Ceylon to give over Rs.3 billion credit to Arjun Aloysius’ Perpetual Treasuries without any security to apply and bid for bonds worth nearly Rs.3 billion via Bank of Ceylon.

    Kattar’s grandson Arjun Aloysius married then (1970-80’s) UNP backer Charlie Mahendran’s son Arjuna Mahendran’ Daughter Anjali Mahendran in 2012

    Irrelevant of the finding of the 3 member committee headed by mr. Gamini Pitipana whose knowledge of Bonds may be limited to the movie James Bond

    it is clearly evident that Arjuna Mahendran is No Victim and is part of a group who made a quick buck on bonds that will finally have to be paid by you and me

  • 1
    1

    New Governor of the Central Bank proved that he was a white -collar thief. Because he gave sweet deal to his son in law but to no one else that included the govt banks.

    Apparently, he gave the largest chunk of bonds to his son in law with the highest interest to be paid for those and as the newly established company, specifically for this purpose, did not have money, governor had given to that private company a low interest loan to buy the bonds too.

    Besides, central bank, because of this governor did not have to pay interest for thirty years when the loans to be paid with this money would have lasted last only a few years.

    Secondly, the politician who appointed that man as the governor did not have enough leadership to accept what his appointee did. Instead, he accused the previous govt and what they did wrong

  • 1
    1

    [ Governor & Board Members Are Not Owners]
    No that only happens in corrupt Western countries. In new sanitised Sri Lanka Governor is appointed as the Gamekeeper and the poacher thus cutting the middle man to make his job easier. When previous Governor Cabarala was in charge he had to satisfy hordes of middle men first.

  • 0
    0

    Did not RanilW and co say during the last few years that Chinese work is shoddy and of very inferior quality, hugely expensive, their companies are corrupt to the core and have deals with MR? Only 80 days in to Ranil/Chandrika/Siriena troika governance, topsy-turvy choice of their new friends and funding mean nothing is not forthcoming and economy is going downhill. Stupid buggers do not know that the neocon west is almost bankrupt and they themselves rely on the Chinese funds. Illy buggers lack of foresight may befall economic nightmares on us sooner than later. Mahendran and his son-in law have sting a day light robbery and ruined the confidence of the CB. By rolling out saradial budget and bravado like halting ‘Port City’ like project, RanilW, Harsha and the mahadanamutta clique have already busted 25% of our reserves. Raviya has no clue of what he does or utters. By the time ruling troika come to senses or being toppled, we’ll be half way towards Greece like situation.

  • 3
    0

    “Governor & Board Members Are Not Owners Of The Central Bank”
    Who said so? Yes of course! The CB is the sole property of the new Governor and his son-in-law. Just ask Ranil – no not the sleepy one but the crafty one.

  • 1
    0

    Arjun is safe because he is Sri Lanka.

    Imagine what would have happened to him if he did this in Dubai or Singapore!!!!!

  • 1
    0

    “Imagine what would have happened to him if he did this in Dubai or Singapore!!!!! “

    …he would have got his you-know-what chopped off.

  • 0
    0

    Dr. W.A. Wijewardena – Where were you 9 months ago ? Were you not are Not were they behaving like the owners of the Central Bank, but like the owners of the whole country. The Governor was always travelling round the globe on political trips. All the gold was smuggled out and sold, the country was being mortgaged to the Chinese etc. Instant diplomatic relations were established with African nations where its a heaven for money laundering activity.. and you kept quite, as if nothing was happening. Now you have suddenly woken up from the deep slumber to realities. Is it because you have freedom of speech now under good governance. Then, first try to recover all the stolen wealth of country and repay its debts before you preach justice..

    • 1
      0

      Reuben P: Thanks for the intervention and you have all the reasons to be angry at what has taken place in SL in the past 10 years.

      Just by way of a clarification, I was the first and the only person to bring these issues to public focus through my weekly column in Daily FT since 2010 tagged My View – Economics Matters (available at: http://www.ft.lk/category/columns/w-a-wijewardena-columns/). Pl go through the articles which were continuously published every week without failure and what you have commented on is the 220th piece. The same could be accessed through CT as well.

      The cost was enormous: in addition to being branded as partisan and unpatriotic, there were attempts at framing fake charges and frightening through ‘white vans’ visiting the house in the middle of night. What I write today is in the same spirit of bringing in a better economic management for the country.

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