This paper discusses the operations of a wide range of central banking institutions in developing countries. The considerable diversity of economic, financial, and political conditions within the Third World has brought forth a wide variety of central banking institutions. Four polar types have been identified as providing coherent alternatives to the central bank. Historical experience certainly indicates that legislation on its own may not be enough to guarantee prudent behavior. Although many countries' central banking institutions have not yet come close to violating foreign exchange cover requirements or restrictions on government lending, in other cases the rules have simply been sidestepped by technical adjustments, altered expediently, or merely ignored. The organizational structure established by legislation probably plays a more positive part in determining a central banking institution's characteristic behavior. Operating procedures, channels of communication, and lines of command all exert some influence on where and how decisions are made in practice. The balance of power between government and monetary authority does not only depend on personality and outside support but will also be influenced by the institutional framework in which their interaction is established.
A national central bank is usually high on the shopping list of a newly independent country. Such a country often inherits a currency board—a carryover from the colonial era—and wishes to establish a new monetary authority with far wider executive powers and public responsibilities. Although the principal motives for acquiring such an institution may well be profit and prestige, central banking consists of much more than printing money and attending international conferences. Central banks in developed countries typically conduct a broad array of banking, regulatory, and supervisory functions. In a developing country, however, the problems and opportunities facing the monetary authority may be radically different from those encountered in the developed world. In recognition of this fact, not all of these countries have chosen to set up a full-fledged central bank: many have preferred alternative institutional arrangements. While inevitably a number of common formulas have been applied in designing such new forms of monetary authority, central banking legislation has generally been adapted to fit national needs, capabilities, and aspirations, while the practical execution of a blueprint has often been gradual and idiosyncratic. The result is a wide range of central banking institutions and a corresponding variety of objectives, constitutional powers, policy instruments, and relations with central governments. This paper surveys the alternative institutional forms that have emerged and seeks to explain the observed diversity of experience.
Central banks in the developed world are given a wide range of public responsibilities and endowed with a correspondingly broad array of executive powers. The activities of these institutions can be grouped into five general functions:
The discussion of Section II presupposed a complex economy, a sophisticated financial system, and a welleducated population. The situation in a developing country when it chooses its central banking institution may be very different. Its economy may be dominated by a limited range of exports and faced by terms of trade beyond domestic control. Its financial system may be rudimentary, based on foreign-owned commercial banks financing commerce and export industries, an informal credit network serving much of the rural economy, and an inherited central banking institution which is essentially a currency board. Its population may be short of workers trained in the technicalities of finance and relatively unsophisticated in appreciating the economic realities of a situation. In these circumstances, an overriding consideration must be to ensure that the new monetary authority will be able to establish credibility as a responsible and effective body that is capable of instilling domestic and foreign confidence in the domestic currency and financial system. At the same time, it must be accepted that the new institution cannot hope to undertake immediately all of the functions of the full-fledged central bank, while the scope for central banking activities would be considerably different from that in a more developed country.
The transitional central banking institution, as its name implies, can be seen as a stepping stone in the transformation of a country's monetary authorities from a colonial currency board to a full-fledged central bank. The typical currency board issued domestic currency for foreign exchange and offered limited banking facilities to commercial banks. It did not have the power of fiduciary issue; it did not conduct monetary policy or even provide policy advice; it was not committed to acting as lender of last resort; it did not supervise the banking system or impose any prudential reserve requirements. Its basis lay in a financial system dominated by commercial banks originating in the colonial power, which were expected to be able to mind their own branches, and in a commitment to a fixed parity with the colonial power's currency, which implied a passive monetary policy. The primary raison d'être for the currency board lay in capturing the seigniorage benefits of currency issue for the colony itself. The external value of the currency was guaranteed by the requirement, implicit in the process of currency issue, that the currency be backed 100 percent by foreign exchange reserves.
This section discusses the supranational central bank, which may be characterized as carrying out all the functions of the central bank, but for a group of countries joined in monetary union rather than for a single country alone. Such an institution would consist of a central headquarters, in which broad policy decisions would be taken, and separate agencies in each country undertaking operational tasks. Each member country would have an equal but limited role in influencing overall policy, but a stronger influence over operations with mainly domestic significance.
In a currency enclave, the currency of a typically larger and more developed foreign country circulates alongside, or in some cases in place of, the domestic issue. This situation has arisen where extensive and unregulated trade with a dominant partner, predating the establishment of a national currency, has led to the customary acceptance of the partner's currency as a means of transaction. With such a high degree of financial openness, domestic interest rates and credit conditions in the enclave are strongly influenced by monetary conditions in the partner. Moreover, in this context, powers of fiduciary issue would be particularly limited as the domestic currency (often confined to coinage) may have only restricted acceptability as a means of transaction. In addition, if local contracts are denominated in the foreign currency, shifts in exchange rate parity do not alter relative prices. For all these reasons, the scope for independent monetary policy in a currency enclave is particularly narrow, and the role of the domestic central banking institution may be limited.
This section considers central banking institutions in countries with market-oriented economies, open to both trade and capital flows. As discussed in Section III, it may be very difficult in such countries to exert a strong influence on domestic interest rates or credit conditions. Moreover, successful export-led growth depends on foreign confidence in the continuation of the liberal trade and payments system and in the establishment of a stable monetary environment. To maintain such confidence, the central banking institution must be financially prudent; it must hold reserves, or at least have access to credit, sufficient to cover normal fluctuations in demand for domestic currency, and aim to restrict its own extension of credit to the increase in demand for its own liabilities. To provide some guarantee of such behavior, the central banking institution may be statutorily bound by restrictions on its fiduciary issue and on its lending to government.
This paper has discussed the operations of a wide range of central banking institutions in developing countries. It has been observed that the public responsibilities and executive powers of these central banking institutions are often less extensive than those normally associated with a central bank in a developed country, although development priorities may lead to the acquisition of special functions not found elsewhere. A variety of reasons have been suggested to explain why not all countries have full-fledged central banks. The three central points were: