Banking on effective mandates

THIS COLUMN DISCUSSES the role of central banks and why it is important for them to have clear mandates. It then identifies some of the key elements required to enable central banks to perform their mandates effectively. Finally, it outlines some of the common concerns that arise in relation to central banks and their mandates.

For the purposes of the discussion, the term “mandate” is used to refer to the functions entrusted to the central bank, and the term “objectives” refers to the purposes for which those functions are discharged.

MANDATES AND OBJECTIVES

Central banks have traditionally had three key objectives. The first is to maintain price (or monetary) stability. Central banks do this by formulating and implementing monetary policy, which primarily involves controlling official cash rates and the money supply. This is particularly important in an inflationary context, as the world is currently experiencing. Traditionally, price stability has been the dominant objective.

The second objective is to maintain financial stability, including through regulating and supervising banks, providing emergency liquidity assistance, and managing the payment system. In many jurisdictions, the function of regulating and supervising banks and other financial institutions has been taken out of the central bank and vested in separate regulators.

An important tool in achieving the second objective is the central bank’s role as the lender of last resort, under which it provides credit to banks and other financial institutions that are experiencing financial difficulties, to help them maintain customer confidence and prevent a collapse.

Financial stability also involves promoting stability of the payment system. Since the global financial crisis of 2007-2008, it has been recognised that financial stability requires a two-pronged approach that involves maintaining the financial soundness of individual financial institutions and managing related risks (microprudential regulation), and also managing risk to the financial system as a whole (macroprudential regulation).

The third objective is to issue the currency. A further objective that is sometimes included in legislation governing a central bank is the promotion of financial development and financial inclusion. This objective can, however, create conflicts of interest with other objectives, in particular price stability and financial stability, and has often been a subject of concern expressed by the International Monetary Fund and the World Bank when assessing jurisdictions under the financial sector assessment programme (FSAP).

Typical central bank mandates (functions) and objectives are as follows:

Other functions often performed by central banks include the administration of deposit insurance and the management of foreign currency reserves.

It is widely accepted that all regulatory agencies, including central banks, should have clearly defined mandates, objectives and responsibilities. This maximises their effectiveness, efficiency and transparency. It also helps to ensure they enjoy operational independence.