Questions for our Central Bank

In June 2007, The Telegraph published an article in which the Bank for International Settlements pointed to a confluence of worrying signs alluding to mass issuance of new credit instruments, mounting household debt, dangerous craving for risk shown by investors and engrained imbalances in the world currency system. In addition, the paper stated clearly that the easy credit policy of the Federal Reserve and other central banks, and the failure to regulate the shadow banking system was of concern. It was felt that, sooner or later, the credit cycle will turn and default rates will begin to rise. Additionally, the levels of leverage employed in private equity transactions raised concern about their longer-term sustainability as the strategy depended on the availability of cheap funding.

One year later, in June 2008, The Telegraph warned that we might soon face challenges that were last seen during the onset of the Great Depression. Dr White, an Economist at the Bank for International Settlements, stated that the US sub-prime crisis was the “trigger”, not the cause, of the disaster.

Unless we understand the underlying causes of the almost cyclical financial systems failures, we will never understand what happened and will be unable to prevent repetition. Economic history suggests that almost every financial crisis starts with the belief that the provision of more liquidity is the answer, only for time to reveal that there were other real issues that were not addressed. The fundamental cause of the 2009 financial problems was excessive and imprudent credit growth over a long period as well as derivatives exposure.

In 2016, Central Banks started to admit that they still had not fixed the problems. Mark Carney, Governor of the Bank of England, said that the global economy risks becoming trapped in a low growth, low inflation, and low interest rate equilibrium. For the past seven years, growth has serially disappointed -sometimes spectacularly - as in the depths of the global financial and euro crises, often, grindingly as past debts weighed on activity.

Globally, Central Banks seem to be floundering on many key issues. The intention behind some of the decisions made after the financial crisis was to ‘break-up’ these ‘too-big-to-fail’ institutions - instead the result was that they made them bigger. Regarding mutual funds regulation, the US still uses the 1940 Investments Act and no regulator can agree on where the risks lie with these instruments and whether they even require capital. As they stumble to figure that out, the market and the instruments continue to evolve, and the Central Banks struggle to play ‘catch-up’. Another example is the use of digital currency. Globally, and even here in Trinidad, Bitcoin is used as a form of payment. The Central Banks are yet to agree on even the definition of what this is, far less to determine if and how it can be regulated. Another interesting example is the evolution of the Basel framework. This seems reactionary to financial crises and we are now at Basel 3. How many more ‘Basel’s’ before we get it right?

What about our own Central Bank? We too had to deal with our own financial crisis in 2009. At that time, questions were asked about our Central Bank dropping the ball in terms of regulatory oversight. It would almost appear that the Central Bank tends to be more reactive than proactive and as a result, fails to take a position on many issues. Does the Bank really undertake risk-based supervision? What about the failure to pass insurance legislation after ten years? What about pension legislation? Credit union legislation? What about all the out-dated guidelines? Is the Central Bank prepared to deal with the growing black market trade for US currency in Trinidad and Tobago? What about the mandate of the Central Bank regarding the protection of depositors, which appears contradictory to the existence of an almost collusive banking system that seems to practice extortion through bank fees?

Indeed, to date there has been no decision on a host of issues, a new white paper on financial sector reform, decision on the issue of a mega regulator. Is the concentration of power in the hands of a single individual heathy and appropriate for Trinidad and Tobago? There is also the issue of insurance legislation, credit union legislation, the oversight of Systemically Important Financial Institutions (SIFIs) - where is the legislation to guide this process? Have solutions been found to determine what should guide the decisions of the Governor of the Central Bank on whether monetary policy should always take priority over macro prudential regulation? Central banking globally and locally needs to get its act together.