Welcome speech
Transformation of
Central Banking
The Annual
Research Conference
Kyiv, 19 May 2016
Venue: HILTON KYIV
Time: 9:00 – 9:30
Good morning,
It is my great pleasure to open the first Annual
Research Conference, which we are organizing jointly with the Narodowy Bank Polski with
the support of the Government of Canada and the Kyiv School of Economics. I
hope it would become an important annual event not only for our country but
worldwide.
Together with our prominent speakers from different
countries, we are here today to discuss a wide range of knowledge and ideas,
which will help us all to address challenges in the area of central banking in
the future.
Before I give the floor to our notable panelists, let
me first make a few remarks that, I hope, will set the stage for the upcoming
discussions.
The world is changing fast, and central banks have to
transform with impressive speed to keep up with rapidly expanding and
increasingly complex economic processes and financial markets.
The Great Recession of 2008-2009 showed that the
traditional set of central bank’s tools might be insufficient to overcome the
crisis. Instead, over the past 10 years, central banks have developed new
"ammunitions" and approaches – from unconventional monetary policy
tools tomacroprudential supervision. Considering the fact, that all the
steps taken by the central banks as guardians of macroeconomic and financial
stability have serious implications for real economy and population, we need an
extensive discussion of the role and tools of central banks.
Take a look at the monetary policy.
In the past, the theory stated that central bank facing a continuing deflation
was in a trap. The conventional wisdom was that central banks could not set the
interest rate below zero. However, it turned out that they actually can.
Moreover, central banks of developed countries have
introduced even more unconventional tools to combat deflationary pressure.
‘Helicopter money’ once introduced rather as a theoretical concept is
now explored by major central banks as a way to boost demand and
inflation.
In addition, central banks have returned to
manipulations with exchange rate, an instrument considered too rough in the
past. For instance, Czech National bank actively uses the exchange rate
commitment and Swedish central bank promises to use FX interventions to
safeguard the low inflation.
All of these unconventional tools help central banks
to achieve their targets to certain extent, but in the same time, they create
the foundation for problems of another kind. Let me name just a few of them.
As a result of extreme generosity of central
banks, global economy has become over-dependent on stimulus provided by them.
Today a modern central bank is not only the lender of last resort, but also a
purchaser-of–last-resort of sovereign and corporate bonds. For example, ECB now
acts as an underwriter of over-indebted counties of EU. Central banks have
become even market-makers of last resort by now.
Having been introduced as an emergency measure,
QE has already become a permanent exercise. Now it is a question whether
turning QE into a routine element of economic management is sustainable and how
central banks should react to the heightened risk of asset bubbles. May be it’s
time to think about a new monetary policy regime – asset bubble targeting?..
Zero or negative interest rates has also
induced distortions of all fundamental approaches of "fair value"
principles. NPV does not work with negative rates (or works in an opposite way
when we are talking about European recession). It leads investors to wrong
decisions. As a consequence, we see markets which are overvalued and
overcrowded. Debt is shifting from private to public sector.
It is not a secret that as a result of the
crises investors have lost their confidence in the conclusions on the banks’
soundness made by leading credit agencies and audit companies.
What is even worse, investors have lost their
confidence in banking supervision carried by central banks considering they are
loosening their grip over the market. As we can see, it was immediately
captured by market prices of leading world banks with price/book ratios of
EU banks are now at 0.4.
The global crisis of 2008-2009, as well as the debt
crisis in the EU, also changed the perception of the main objectives of central
banks’ economic policy. Before the crisis, the common wisdom was that the
central bank should focus on price stability and sustainable economic growth.
This approach made regulators blind to the fact that the financial sector has
accumulated systemic imbalances and related risks, since neither price
stability, nor conventional banking supervision ensures that the systemic
financial sector risks are prevented. In particular, successful
implementation of basic rules on capital and liquidity doesn’t ensure
the absence of systemic financial sector risks.
So, after both crises there was consensus on the need
to put even more emphasis on macroprudential supervision based
on the analysis of systemic risks and aimed at preventing financial crises.
Today it is valued as the second or sometimes even equal to price
stability goal of modern central bank. Thus, now a modern central bank has not
a dual, but a triple mandate: price stability, financial
stability and economic stability. However, there is still no clear answer,
how all the three components would and should coexist within a mandate of a
modern central bank.
The management tools for capital flows have
changed a lot compared to pre-crisis practices as well. Recently a large
number of central banks have added administrative tools for managing capital
flows to their toolkit. Overall mood in central banking literature
seems to be supportive for them, despite the trend before the global financial
crisis was the opposite.
Technology is also changing the nature of the banking
system. Together with high capital costs and extensive regulation it shifts
banking business to so called ‘shadow banking’ and for
us as central bankers it is quite uncharted territory. Virtual currencies, blockchain applications, crowdfundingand
peer-to-peer lending… My main question here: is shadow banking a new mainstream
banking that could open the way to increased efficiency and innovative new
business models or all these FinTech just a new fashion trend?
We will discuss all of that during our conference.
Open-minded approach to innovations is a right way for us.
All above brings us to another important issue –
central banks’ earnings are evaporating day by day: under low yield
environment, excessive liquidity and lower demand for cash, central banks act
as buyers of last resort for troubled assets. Therefore, in the first place we
need to protect central banks’ balance sheets from bad assets and then to work
toward greater efficiency in managing our costs because of very limited income opportunities
down the road. It is time to have a proactive approach to automation of central
banking functions and we will discuss this issue as well.
Undoubtedly, the National Bank
of Ukraine cannot ignore global trends.
During the recent years, we have been going through
dramatic changes in monetary policy, banking sector supervision, and internal
structure and processes. I would like to share briefly this experience with
you.
What we had two years ago in Ukraine? Enormous macro
imbalances, exchange rate of hryvnia pegged to USD, significant fiscal
dominance, persistently poor banking oversight, high level of insider lending,
systemic breakdown in governance, non-transparent ownership, poor anti-money
laundering procedures… All of it was a legacy of previous 20 years we had
to face.
So, what we did?
First of all, we strengthened an institutional
and financial independence of the National Bank of Ukraine. And I
believe that by strengthening the independence of the National Bank, we have
reached a point of no return. We have made clear that our goal is to build a
modern, open and independent European central bank.
In addition, last year our mandate was updated.
Now the policy of the National Bank of Ukraine is officially aimed at
ensuring price and financial stability to promote sustainable economic
development of Ukraine.
In 2014, we switched to flexible exchange rate. Since
then, exchange rate of hryvnia is determined by fundamental factors
only. The NBU’s impact on it is limited to FX interventions aimed at smoothing
excessive exchange rate volatility.
Shift to the flexible exchange rate wasn’t expected
to be as hurtful, as it appeared to be after the conflict in the Eastern
Ukraine escalated. As it happened, economic situation in Ukraine became very
difficult. It was a triple crisis, which resembled of what I call a perfect
storm. First, we had a macroeconomic crisis: severe growth recession, hiking
inflation, sharp drop in exports, widening budget deficit. Secondly, it was
accompanied by the currency crisis: wide balance of payments deficit,
severe confidence crisis, multiple exchange rate practices amid flourishing
shadow FX market. Thirdly, it was followed by the banking crisis:
bank run, interest rates spike, credit crunch, mounting NPLs, capital shortage,
disastrous corporate governance.
Therefore, we had to react quickly and
unconventionally. In February-March 2015, we raised the key policy
rate twice from 14.5% to 30% in order to contain hiking inflation
and to absorb excessive hryvnia liquidity, which was overflowing to the FX
market and, thus, pressing on the exchange rate.
We introduced FX restrictions,
which were unconventional among the policy decisions made by the National Bank
of Ukraine. They were initially launched in 2014 and included 100%
and then 75% surrender requirement, the ban on repatriation of dividends and
rigorous verification of export and import contracts. Then additional
restrictions were launched in February-March 2015 as reaction to the
panic in the currency market, which intensified along with the escalation of
the conflict in Eastern Ukraine. We introduced new ones to impede the play on
hryvnia devaluation from short position and prevent outflows from most leaking
channels.
Of course, restrictions were not popular among business
and population. However, they helped us a lot to stop the panic in the currency
market, to reduce volatility of foreign currency supply, to limit the demand on
foreign currency and to prevent unproductive capital outflow from Ukraine.
The stabilization of the FX market allowed the
National Bank of Ukraine to start gradual removal of administrative
restrictions. In April 2015, the National Bank has developed and agreed
with the International Monetary Fund a roadmap for the gradual withdrawal of
temporary currency restrictions, which is not time-based, but condition-based. Also we
started to work on the operational plan for the liberalization of the entire
currency regulation system in Ukraine. A working group we established has
already carried an analysis of the regulatory framework and of the experience
of other transition economies in this area and has designed currency
regulation target model for Ukraine.
We want the liberalization process start with current
account operations and foreign direct investment inflow. Implementation of each
stage of the liberalization will be preceded by the certain conditions, including
macroeconomic stability, fiscal consolidation, improvement and dynamic
development of the banking system, the accumulation of sufficient international
reserves and, certainly, reform, including judicial reform and strengthening
investor protection. The plan for removal of administrative restrictions
introduced in 2014-2015, which was designed before with the IMF, now will be
integrated into this more broad-scale roadmap.
By the way, one of today’s panels of the conference on
the capital flows management might contribute a lot to our work on
liberalization of currency regulation.
The stabilization of the FX market together with
elimination of fiscal dominance were the preconditions for the National Bank to
shift to inflation targeting.
In August 2015, the NBU Board approved the draft
Strategy of monetary policy for the next four years. This document provides the
path to achieving that level of inflation, which we consider optimal for
Ukraine - namely 5%. The level of target inflation is 12% this year, 8% - next
year, 6% in the 2018, and finally 5% by the end of 2019.
When preparing for the new monetary policy regime we
put an end to the dominance of fiscal policy over monetary and introduced all
necessary internal procedures.
Namely, we established the Monetary policy committee,
introduced decision making process by the NBU Board in accordance with the
announced schedule, started publishing quarterly Inflation report and
established systemic communications of monetary policy decisions.
Last month we eventually streamlined the operational
framework of monetary policy to enhance the effectiveness of monetary
instruments. Since then, we have the interest rate framework common for
inflation-targeting central banks. We emphasized the role of the key
policy rate (currently the interest rate on 14-day certificates of deposits)
and set a symmetric corridor around this, bound by the overnight standing
facilities. Also, the NBU streamlined the procedures and liquidity
management instruments.
Though inflation targeting is only being launched,
the NBU’s monetary policy has already seemed quite effective. In April
inflation, which peaked at the level over 60% a year ago, has moderated to
one-digit number.
What we did in the area of banking supervision during
last two years one can hardly call a usual practice for the central bank
either.
First, we made a massive cleanup of the banking sector
during an impressively short period. Since the early 2014, the National Bank of
Ukraine withdrew 73 banks from the market. Of course, fast and uncompromising
actions of regulator were a shock to the entire banking sector of Ukraine.
However, none of these banks was withdrawn from the market unfairly. Many of
them resembled more of the money laundering machines rather than European
financial institutions.
Meanwhile, the National Bank of Ukraine started
diagnostic study of banks to identify their needs in additional capital. We
plan to perform such diagnostic studies on the regular basis in order to reduce
exposure of Ukrainian economy and public to banking system risks. Diagnostics
of the first 20 banks were completed last year, and now banks started
to perform unprecedented three-year plan of capital increase. We agreed with
the IMF on the plan none of the countries implemented before. The capital of
the Ukrainian banks was allowed to be at zero adequacy rate at the
end of 2015. Instead, it should increase gradually. By the autumn 2016 the
adequacy rate is expected to reach 5%, and during the next three years to enter
the normal level of 10%.
The level of transparency of the banking system is 98%
now. Only a few small banks have not approved their owners yet. However, two
years ago, the situation was completely different. At that time, 27% of the
banking system was non-transparent. We were aware of the actual owners of some
banks, who were hiding behind so-called football teams of 11 nominal owners and
National Olympic of 51 nominal owners. However, in many cases we did not even
know who the main shareholder of a bank was in fact. Therefore, we started with
amendments to the law imposing unlimited liability on owners and major
shareholders to force them to act more responsibly and prevent them
"simply handing in the keys if the bank fails". In countries where
ownership is opaque, it’s important to clarify ultimate ownership and
the lines of management reporting and control.
We have also done a lot for the transformation
of the National Bank of Ukraine. Our team has found the National Bank
as a huge organization with many thousands of staff, 500 of fleet vehicles, and total
of 150 thousand square meters of premises. For decades, the NBU has been
overgrowing with extrinsic to central bank functions and assets. The central
bank used to own university and academy, TV channel, hotels in resorts areas,
hospitals and sports complexes. It performed any function but not a quality
central banking.
We started the transformation project in 2014, and it is
mostly completed by now. While focusing on basic central bank functions we
have disposed of most of the non-core functions and assets. The National
Bank is evolving towards the branchless central bank by closing the regional
offices and centralizing all key functions in the NBU in Kiev. We have already
closed 25 regional branches. At the same time, we’ve also
massively optimized the number of staff. In 2014 we had about 12 000
employees, as of the end of 2015 this number was lesser by 55% - 5 300.
Today the National Bank of Ukraine is striving to the
best global practices in the area of central banking though they are
permanently changing and developing. Our targets are based not on the
image of the perfect central bank of the past, but on the image of the future -
the point where central banks are moving and where they see themselves in 5-10
years.
How the central bank of the
future should look like?
There is no final answer yet. And the lack
of the answer is the reason why we decided to arrange our inaugural research
conference and dedicate it to that topic.
Our conference is a place where bright minds of both
central bankers and representatives of academia can work together by discussing
recent trends in central banking, challenging each other and, eventually,
deciding what unconventional tools and policy decisions should become
traditional in the arsenal of all central banks and which are too dangerous to be
used.
So we have a very tense agenda. Let me conclude
by wishing you very productive discussions throughout the next two days. I am
confident they will help us to answer the question how the central bank of the
future should look like.
Thank you!
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