Central banks have gradually recognized that, even though their main function was the conduct of monetary policy, they had to be concerned about the financial stability of the banking sector or, more broadly, the whole financial sector.
In a number of countries, the central bank has traditionally been vested with supervisory and sometimes regulatory powers over commercial banks. In other countries, where central banks had no supervisory or regulatory powers, they could still contribute to financial stability, albeit to a limited extent, as lenders of last resort.
The prudential supervision of individual banks (or microprudential supervision), however, while effective to monitor the solvency and liquidity of individual banks, is not always sufficient for the central bank to detect and avert systemic risks for the financial stability of the banking sector. Macroprudential supervision was undertaken, therefore, initially almost as an academic exercise and without any formal basis, to detect these systemic risks. Financial stability reports on economic and financial developments affecting the banking sector were published (see Cihák 2008), followed by stress tests conducted in cooperation with commercial banks, but many central banks had no authority to require changes in the banks’ financial structure.
In more and more countries, however, macroprudential supervision is now formally recognized as a component in the mandate of a central bank, with specified duties and powers that may vary with the nature of the tasks assigned to the central bank.
Scope of Macroprudential Supervision
Depending upon the applicable law, the scope of macroprudential supervision by the central bank may include one or more of the following functions:
Identification and assessment of systemic risks to the financial stability of the banking sector or, more broadly, the financial sector (including insurance companies, pension funds, and the securities market),1 and making recommendations as needed for improvements in the legal framework and business practices for the prevention of financial crises;2
Regulation: exercise of regulatory powers through enactment of subordinate rules3 for prudential purposes (that is, for financial stability, but not for monetary policy objectives, although there is inevitably some overlap). In some cases, the agency’s mandate will include the authority to enact regulations also for market conduct integrity and consumer protection (“integrated approach”),4 whereas, in other cases, two separate agencies will be established (“twin peaks approach”);
Supervision stricto sensu5: exercise of supervisory powers, that is, prudential supervision of systemically important6 banks or, more broadly, systemically important financial institutions to enforce applicable laws and regulations7 through (1) inspection and monitoring, including the conduct of stress tests for a micro- and macroassessment of risks,8 (2) issuance of instructions or recommendations for compliance with laws and regulations and for improvements in risk avoidance controls and procedures (for example, monitoring of traders’ operations), and (3) imposition of disciplinary sanctions for failure to comply with laws, regulations, or instructions. In some cases, the mandate may also cover supervision for market conduct integrity and consumer protection; and
Bank resolution for systemically important banks or, more broadly, for systemically important financial institutions.
Expansion of the Central Bank’s Mandate: Internal Changes and Questions
Making the central bank a macroprudential supervisor will require the hiring by the central bank of personnel with special expertise, particularly for the regulation, inspection, and resolution functions. These officials will have to be subject to specific rules, including a prohibition, for those who have access to confidential information related to the supervision or resolution of financial institutions, of sharing that information with any other person, including officials in other departments of the central bank.
There may also have to be some changes within the structure of the central bank, with different collegial bodies or senior officials (such as deputy governors) accountable for the performance of different functions.9
In addition, this expansion of the central bank’s mandate raises at least three questions:
Having to conduct monetary policy while acting as macroprudential supervisor, is the central bank now faced with conflicting objectives?
What is the potential liability and reputational risk for a central bank acting as macroprudential supervisor?
Should the central bank be granted the same operational independence for macroprudential supervision it has been given for the conduct of monetary policy, and, if not, could this affect its independence in the conduct of monetary policy?
Central Bank’s Objectives
Monetary Stability and Financial Stability Are Complementary Objectives . . .
It is often said that, as monetary stability contributes to financial stability and vice versa, the objectives of monetary policy and those of financial supervision are not only complementary but also mutually supportive (Gianviti 2010). This is generally true. In a stable macroeconomic environment, with reasonable price stability (that is, annual domestic consumer price increases around 2 percent10), interest rates are also fairly stable, which allows banks and other financial institutions to make more reliable risk assessments than in situations of price and interest rate volatility.
. . . Unless There Is a Major Financial Crisis . . .
When faced with a major financial crisis in which a substantial part of the banking system, while not insolvent, has become illiquid and is unable to meet the demand for cash withdrawals, the central bank acting as lender of last resort will have to increase the amount of central bank money in the country’s economy. A large addition to the volume of money in circulation could have an inflationary effect, unless it takes place in a recessionary context. This effect should be temporary, however, assuming that the banking system recovers and the excess liquidity is sopped up by the central bank.
. . . Or an Antideflationary Monetary Policy . . .
When price increases fall below 2 percent, central banks often engage in inflationary policies, with low interest rates, coupled sometimes with massive purchases of securities, including the purchase of long-term government and corporate bonds (“quantitative easing”). They may even impose negative interest rates on bank deposits with the central bank to prompt commercial banks to lend more to public and private entities.11 If there are not enough creditworthy private sector borrowers to absorb this additional liquidity, banks will have no choice but either to invest abroad or lend to the government, which may then be able to borrow at low or even negative interest rates.
. . . Undermines Financial Stability . . .
Theoretically, this easy money policy, unless it results mostly in large capital outflows toward countries offering higher interest rates, should rekindle inflation by increasing both credit to the private sector and public spending. As lower interest rates will usually result in a depreciated exchange rate, the cost of imports will rise, and higher import prices will help achieve the inflation objective. Moreover, a depreciated exchange rate will make the country’s exports more competitive, and an increase in exports will contribute to domestic growth.
An easy money policy should also allow governments to make structural reforms that would improve productivity. It often has the opposite effect, however, as it allows governments not to engage in unpopular structural reforms as long as they can finance their deficits and subsidize unproductive activities by borrowing at low or negative interest rates.
An easy money policy, however, may have a negative impact on the financial sector. Faced with lower returns on their investments and a higher cost of their deposits with the central bank, commercial banks turn to riskier loans to make a profit, or lend to stock market speculators who inflate the value of securities way beyond their realistic levels, thus creating a minefield of nonrepayable loans and asset bubbles. There may be a similar bubble in the real estate market, which, when it bursts, can jeopardize the stability of the whole banking system, as exemplified by the subprime debacle.
Insurance companies and pension funds that become unable to generate enough income from their safer investments, such as government bonds, to cover their payments may be tempted, or even encouraged by the authorities, to diversify their portfolios and engage in riskier but more profitable investments. This diversification is also a precautionary measure for the future. When interest rates return to a normal level, there will be an immediate depreciation of insurance companies’ and pension funds’ portfolios that were invested in low interest rate bonds, which will create a risk of insolvency.12 A temporary suspension of disbursements may be required to avoid bankruptcy.
. . . and Generates a Conflict of Objectives
Faced with the immediate and potential risks resulting from an antideflationary monetary policy, the agency vested with regulatory powers over the banking (or financial) sector will strengthen the prudential ratios to ensure the continued liquidity and solvency of banks (or, more broadly, financial institutions). For example, a higher capital-to-loans ratio will be imposed, which will reduce the profitability of banks. Similar measures may have to be taken for other financial institutions. Strengthening the prudential ratios, however, reduces the volume of credit that banks may inject into the economy, which is in direct opposition to what the central bank is trying to do.13
If the supervisor is the central bank, it is faced with a dilemma: should it go even further in its easy money policy while strengthening prudential ratios in a way that offsets the effect of its monetary policy on the banking sector? Or should it tone down this easy money policy because it undermines the stability of the financial sector and can be pursued only at the risk of having, at some point, to bail out banks and other financial institutions that have become illiquid and may soon become insolvent? It is a typical example of conflicting objectives, which can lead to a compromise giving a limited effect to each objective or be resolved by prioritizing one objective over the other.
Hierarchy of Objectives
When monetary stability is prescribed by law, not just as the primary objective of monetary policy but also as the primary objective of the central bank itself, this goal governs all the bank’s activities. Monetary stability trumps all the objectives that may be assigned to the central bank, either explicitly or implicitly, including the objective of financial stability. Under this scenario, the central bank must conduct monetary policy and, more generally, carry out its functions to achieve its monetary policy objective regardless of the impact it may have on financial stability. This would mean that it should be prepared to sacrifice the stability of the financial sector on the altar of monetary stability.
In practice, however, unless the legislation imposes a rigid, quantified inflation target, the central bank will generally have enough leeway in the implementation of its monetary policy objective (for example, by postponing the return to a 2 percent annual price increase) to preserve the integrity of the financial sector.
Central Bank’s Liability
Several types of liability risks can be envisaged. For instance:
The central bank abuses or misuses its power (with or without malice).
The central bank fails to exercise adequate supervision, resulting in a bank’s failure.
The central bank discloses confidential information obtained in the course of its supervisory activities.
A report published by the central bank contains substantially inaccurate information, which misleads depositors or investors and results in financial losses for them.
In all these cases, as the central bank’s wrongful conduct is actually a consequence of an action or failure to act by its governor, directors, or other officials, the question of these officials’ own liability may be raised.
Increased Risk with a Formal Mandate
The issue of liability could arise even if macroprudential supervision were carried out informally and without an explicit mandate in the legislation. If, for instance, inaccurate information were published without a disclaimer, the agency could be held liable to those who relied on that information in the conduct of their business. The issue is more likely to arise, however, if an explicit mandate is given to the central bank.
Liability may be incurred in the performance of any prudential task assigned to the central bank, but the task that will most likely give rise to liability issues is the enforcement of laws and regulations (prudential supervision). If, for example, a commercial bank becomes insolvent, the central bank will be the primary target of civil suits on the grounds that, had it acted in a timely and responsible fashion, these losses would have been averted.
The risk of civil actions against a central bank acting as supervisor cannot be taken lightly. The cases brought against the Bank of England in English courts and against the French Banking Commission in French administrative courts after the failure of the Bank of Credit and Commerce International show that these civil suits may result in substantial costs to the supervisor, in terms of damages when the plaintiffs succeed and, even if the plaintiffs’ action is eventually dismissed or dropped, in expensive legal fees.14
Different Rules on Bank Supervisors’ Liability
There are no uniform rules on the liability of bank supervisors, and there are substantial differences in national laws (see Andenas and Fairgrieve 2002; Athanassiou 2011; Dijkstra 2012; Nolan 2013). Even within the European Union, uniform rules have not been adopted. In the Peter Paul decision of 2004, the European Court of Justice, in response to a request by the Bundesgerichtshof (Germany) for a preliminary ruling, held that member-states of the European Union that have deposit-guarantee schemes may exonerate the banking supervisor of any liability to individuals for wrongful action or omission in the performance of its supervisory duties.15
The following are a few examples of the diversity of rules in the European Union.
German Law
In the Peter Paul case, the issue before the German courts was whether the German credit institutions’ supervisor could be liable in tort to a bank’s depositors for not properly supervising a bank, the failure of which had resulted in a financial loss for the plaintiffs. Under German law, the credit institutions’ supervisor was required to exercise its functions “only in the public interest,”16 which the courts interpreted as meaning that it could not incur any liability to depositors or other creditors.17 The question put to the European Court of Justice was whether this rule of German law was consistent with the European Directive on banking supervision.
In its ruling, the European Court of Justice held:
If the compensation of depositors prescribed by Directive 94/19/EC of the European Parliament and the Council of 30 May 1994 on deposit-guarantee schemes is ensured, Article 3(2) to (5) of that directive cannot be interpreted as precluding a national rule to the effect that the functions of the national authority responsible for supervising credit institutions are to be fulfilled only in the public interest, which under national law precludes individuals from claiming compensation for damage resulting from defective supervision on the part of that authority.
In the same ruling, the court also held that other European directives on credit institutions did not preclude the adoption of a rule under national law exonerating the supervisor of any liability to individuals.
French Law
In contrast to German law, French law has no similar provision exonerating the supervisor of any liability to a bank’s depositors. French administrative courts, therefore, applying general principles of French administrative law, have concluded in a number of cases that the French banking supervisor could be liable to depositors for failing to exercise proper supervision of a bank.18 To claim damages, plaintiffs have to prove gross negligence by the supervisor (faute lourde).19 The courts will also determine the extent to which the responsibility of the plaintiffs’ losses can be attributed to the banking commission, for its lack of adequate supervision, and to the bank’s directors, for their mismanagement of the bank. In the Kechichian case, where fraud was found to have been the main cause of United Banking Corporation’s bankruptcy, the state was held liable for only 10 percent of the depositors’ losses.20
Italian Law
Italian courts have recognized the liability, for lack of adequate supervision, of bank and other financial institutions’ supervisors to depositors and other investors.21
English Law
After the collapse of the Bank of Commerce and Credit International, the Bank of England, which was then the supervisor of banks, became entangled in lengthy and costly litigation with depositors who (unsuccessfully) claimed that the bank was responsible for their losses.22 The Three Rivers case, as it is known, gave rise to two decisions of the House of Lords, in 2000 and 2001.23 The plaintiffs had to prove more than negligence or gross negligence. By statute, the Bank of England could only be liable if the act or omission resulting in a financial loss “was in bad faith.”
Bad faith is interpreted in English law as malice. In the case of public agencies or officials, it is often described as “misfeasance in public office.”
Misfeasance may take two forms. It may be targeted at one or several persons or it may just be knowledge that the action or omission is wrongful and will injure someone. The House of Lords agreed, however, that indifference as to the risk of loss (recklessness) was sufficient to meet the condition of misfeasance.
Bad faith, even broadly defined to include indifference to the harmful consequences of one’s action or inaction, is still a very high standard. Clearly, the objective of this requirement of bad faith is to give the utmost protection, short of complete immunity, to the supervisor. Under such a test, the depositors really had no serious chance of succeeding in their claims against the Bank of England.
One consequence of this case may have been the 1998 change in UK legislation transferring the supervision of banks from the Bank of England to the Financial Services Authority. This responsibility was later transferred to the Prudential Regulation Authority, which was a corporate entity, until, in 2016, the Bank of England became the Prudential Regulation Authority. Under the UK Financial Services Act 2012, the principle is that the Prudential Regulation Authority and its officials do not incur any liability “for anything done or omitted in the discharge, or purported discharge” of the authority’s functions. The traditional exception, which requires proof of bad faith, has been retained.24
International Standard
The Basel Committee on Banking Supervision, in its Core Principles for Effective Banking Supervision of September 2012, has adopted the following recommendation (Principle 2, Essential criteria, paragraph 9).
Laws provide protection to the supervisor and its staff against lawsuits for actions taken and / or omissions made while discharging their duties in good faith. The supervisor and its staff are adequately protected against the costs of defending their actions or omissions while discharging their duties in good faith.25
Short of complete immunity, which would in any case be inconsistent with constitutional provisions in a number of countries and the European Convention on Human Rights, the adoption of this standard in national laws or international conventions would provide supervisors with the most effective protection.
The underlying assumption that led to the adoption of this standard may have been that the protection of depositors should be ensured instead by an adequate deposit-guarantee scheme.
This is not always the case, however. There are substantial differences in the level of protection afforded by these schemes, even among developed countries. For example, while deposits are guaranteed up to $250,000 in the United States, they are only guaranteed up to €100,000 (about $110,000) in the European Union. Moreover, the guarantee in the United States applies to each depositor’s account ownership category (checking accounts, savings accounts, money market deposit accounts, and certificates of deposit) in each bank insured by the Federal Deposit Insurance Corporation. By contrast, the guarantee in the European Union applies only to a depositor’s aggregated accounts in the same bank. This means that the total coverage per depositor in each bank is $1 million dollars in the United States compared to €100,000 in the European Union. A low level of protection for depositors is not very attractive and may compound the liquidity problem already faced by banks in some countries.
Single versus Dual Liability Standard
Single Standard
The liability standard used, for example, by the United Kingdom and advocated by the Basel Committee on Banking Supervision is a single standard: bad faith of the supervisor in the performance of official duties. It applies both to the supervisory agency, which is a government body or a public entity, and to its officials, who are individuals.26
The reason usually advanced for this very high standard is that liability for mere or even gross negligence would have a chilling effect on the performance of official duties by the supervisor. This is not a fully convincing reason. Whereas the chilling effect of litigation risk may affect the conduct of individuals managing or employed by the agency, the agency, which by its nature is not subject to human feelings, cannot be subject to that effect.
What is being protected, therefore, by requiring bad faith on the part of the agency, is taxpayer money.27 Probably, the same concern would not be relevant if the supervision of banks were entrusted to a private company.
As mentioned earlier, there may have been a tradeoff between a very high liability standard, which protects taxpayer money, and the adoption of deposit-guarantee schemes to protect depositors. These guarantee schemes offer no protection, however, to other creditors. Nor do they cover the losses incurred by shareholders as a result of a supervisor’s wrongful actions if they are not taken in bad faith.
Dual Standard
In contrast to this single liability standard, some legal systems have a dual liability standard. In French administrative law, for example, bad faith (faute personnelle) is a liability standard for civil servants, but not for the state or its agencies. The state or a state agency can be liable for negligence and, depending on the nature of the activity, the test may be simple or gross negligence.28 As noted previously, the French Conseil d’Etat has concluded that the relevant test for the banking supervisor’s liability was gross negligence.
This dual standard affords a substantially stronger protection to all those who have incurred losses due to a wrongful act or omission of the supervisory agency, while also protecting the agency’s officials who have acted in good faith in the discharge of their duties.
In the European Union, the dual liability standard for a supervisory/regulatory agency and its officials has been adopted for the European Banking Authority.29
Reputational Risk
A central bank that fails to prevent a bank’s failure may well be protected from liability suits, but the law will not protect it from public reproach. This is especially true in cases where many—and, particularly, small—depositors have lost their savings, if it appears that a more effective supervision of the bank could have prevented its failure.
If this sentiment is shared by the legislature, a parliamentary committee will be appointed to investigate the central bank’s conduct, providing an opportunity to reopen the eternal question of the central bank’s accountability in a democratic society. Inevitably, at stake will be not only the role of the central bank in macroprudential supervision but also its role in the conduct of monetary policy, including its independence in the conduct of that policy.
Central Bank’s Independence
The independence of central banks, which is now generally regarded as “best practice,” is part of a broader trend. In more and more countries, and for different reasons, legislation has been enacted to establish agencies that operate independently of the government.30 These entities are given the authority to perform tasks that would normally be the responsibility of the government, including the execution of specified laws.31 Some may be allowed by the legislature to enact regulations that will have the force of law. They may even be vested with judicial powers. What the term “independence” covers, however, is not uniform and does not always apply to all the functions performed by the agency.32
Formal versus Operational Independence
An agency may be described as independent simply because it is outside the framework of the government. But this independence from the government may be largely formal. Being outside the government’s framework does not necessarily mean that the government has no control over the agency. The government may have some control over the agency if it has the power, for example, to give instructions to the agency on some key aspects of its work, or to veto its major decisions, or to appoint and remove its chief executive officer and other senior officials, or to approve or make major cuts in its budget.
Formal independence, therefore, does not by itself give an agency the capacity to discharge its mandate if it may be subject to external interference in its decision-making process. An agency cannot be fully accountable for the performance of its functions unless it is able to operate at arm’s length from the government. Only an agency vested with operational independence can be regarded as truly independent and, therefore, fully accountable for its actions.
The Three Pillars of Operational Independence
An agency can be deemed to be truly independent when three conditions are met.
First, it should be allowed to perform its mandate without any external interference (in other words, it has full operational independence). In particular, it should not be subject to instructions or veto over its decisions.
Second, the status of its chief executive officer and other decision-making officials (board of directors, for example) should guarantee their independence. They should be appointed for a substantial period of time (for example, five years or more) and should have security of tenure.33 They should not serve at the pleasure, or in any way be subject to the authority, of any external individual, organ, or entity; only for incapacity or serious breach of duty or criminal offence can their appointment be terminated. As long as they are in office, their remuneration should not be reduced. Also, procedures designed to avoid any real or perceived conflict of interest (such as participation in entities within their jurisdiction) should be established.
Third, the agency should have its own sources of financing, or earmarked budget resources, allowing it to discharge its mandate properly. Clearly, this third condition is the most difficult to meet. When an agency is funded by annual budget appropriations, it is always at the mercy of targeted or across-the-board budget cuts and it may even become hostage to a political conflict between the executive and legislative branches. As central banks generate their own resources, they do not run that risk (unless they have to be recapitalized), but supervisory and regulatory agencies do run that risk, unless they are given the authority to determine the level of their fees in order to cover their costs, which does not seem to be a common feature of their charters.
Degrees of Operational Independence
When deciding whether the proper performance of a particular function requires full operational independence, consideration has to be given to the particular nature of that function and the need to prevent political interference in its performance.
It is also possible to envisage different degrees of operational independence, depending on the type of function being performed. For example, if a fully independent central bank receives a mandate to perform an additional function for which some but not full operational independence seems warranted, the government could be allowed to appoint and remove from office the decision-making officials (chief executive officer and board of directors) who are in charge of that particular function in the central bank, but without the authority to give instructions to them for the performance of that function. The government should not be allowed, however, to exercise that power against officials (for example, the governor of the central bank) who are also in charge of functions for which the central bank’s independence cannot be infringed. Otherwise, the government could use its disciplinary power as a threat to dictate their conduct of monetary policy.
Another possibility would be to require the government’s consent or give it a power of veto, but only for specified types of decisions (for example, a change in the banks’ capital ratio or a major bank’s liquidation involving a bailout by the government).34
Scope of Central Banks’ Operational Independence
In the European Union and many other parts of the world, central banks are established as formally and operationally independent agencies, but their operational independence does not necessarily extend to all the tasks within their mandates.
For example, the European Central Bank and the national banks that are members of the European System of Central Banks are independent for the performance of the tasks listed in the treaty provisions governing the monetary union, including the definition and implementation of monetary policy.35 National central banks in the European System of Central Banks, therefore, are not subject to instructions from their national authorities for the performance of these tasks, but their independence does not extend to additional tasks that could be conferred upon them by their national laws.36
In the United Kingdom, the Bank of England’s independence is limited to the conduct of monetary policy: it is subject to instructions from the Treasury “except in relation to monetary policy.”37
Independence in the Conduct Of Monetary Policy
The main reason for making central banks operationally independent of any other authority is related to the core function of their mandate, which is the conduct of monetary policy.38
The UK experience, in this respect, illustrates the policy considerations that lead a country to shift the conduct of monetary policy from the government to an independent central bank. In 1997, when the British Parliament was considering a bill giving effect to the promise by the Chancellor of the Exchequer (Gordon Brown) to transfer responsibility for monetary policy from the Treasury to the Bank of England, a research paper was prepared for the information of the House of Commons (Blair and Edmonds 1997). According to the paper, the former Chancellor, Nigel Lawson, although from the opposite party, had reached the same conclusion ten years earlier. After saying, in 1987, “I make the decisions and the Bank carries them out,” he had suggested, in 1988, giving “statutory independence to the Bank, charging it with the statutory duty to preserve the value of the currency, along the lines already in place and of proven effectiveness for the US Federal Reserve, the National Bank of Switzerland, and the Bundesbank” (Blair and Edmonds 1997, 9).
The research paper went on to explain that the case for an independent central bank rested both on empirical data and a theoretical argument. Empirical data provided by academic research showed that countries with the most independent central banks had the lowest inflation figures. If, therefore, low inflation was the objective, the conduct of monetary policy should be entrusted to an independent central bank. The theoretical argument was that a government, even if it has an objective of low inflation over the long term, has an incentive, in the short term, to “spring an inflation shock,” which “will reduce the value of its existing public debt and can temporarily increase output if workers’ wages respond only slowly to inflation” (Blair and Edmonds 1997, 24). If the government, therefore, is in charge of monetary policy, the immediate political gain to be obtained from an expansionary monetary policy will tend to prevail over the long-term objective of low inflation. An independent central bank that is not subject to the same pressure will be better able to achieve that objective.
Behind these economic considerations lies a political and ethical issue. On the one hand, it can be argued that the value of the currency issued by a state or on its behalf (by the central bank) and held by other persons is a claim on that state (or its central bank), which the state (or the central bank) should not be free to alter at will. An alternative argument is that the state (or the central bank) should be free to change the value of the currency as it pleases in order to achieve fiscal, economic, and/or political objectives.
A debasement of the currency, either by law or through monetary policy, will benefit debtors to the detriment of creditors,39 but the main beneficiary will be the state itself. Inflation increases the nominal value of the tax base (incomes, transactions, and property), which generates more fiscal revenue in nominal terms, while the nominal value of the state’s outstanding debt remains unchanged.40 The state may even be able to increase its fiscal revenue in real terms, as a percentage of the country’s gross domestic product, simply by not adjusting the tax brackets for inflation.
As Milton Friedman aptly put it in a nutshell: “Inflation is taxation without legislation.”
Making the central bank independent with a mandate of price stability should be seen as an assurance that the purchasing power of the currency within the country will be preserved. This assumes, of course, that the central bank does not betray its mandate in order to serve the government’s agenda.
Independence in Macroprudential Supervision
As noted previously, macroprudential supervision may be understood to cover at least four different functions (systemic risk assessment, regulation, supervision stricto sensu, and bank resolution). These functions may be performed by the same agency, which could be the central bank, or by separate (and preferably not overlapping) agencies. In any case, whether they are performed by one or several agencies, the reasons for granting or denying operational independence to the agency in charge should be the same. The fact that a central bank is independent in the conduct of monetary policy does not necessarily lead to the conclusion that it should have the same independence when performing other tasks or functions.
It is conceivable, therefore, that the central bank, while retaining its independence for the conduct of monetary policy, should be subject to instructions from the government when acting, for instance, as banking regulator. This could lead, however, to a conflict of objectives, in which the central bank could no longer achieve its monetary policy objectives because the government’s financial stability objectives would take precedence.
Systemic Risk Assessment
Regardless of whether the central bank, or any other agency performing that function, is given full operational independence, it would not make much sense for the government to dictate the contents of its publications. When a country’s financial and economic data are readily available to the public, not only the central bank but also other private and public (domestic or international) entities may become engaged in the same or similar exercises. The incentive for them to closely scrutinize these data and assess their credibility will be even greater if there is a perception that the government is interfering in the performance of that function by the central bank and is dictating the contents of the published reports.
When these data are not readily available to the public but only to the government or some of its agencies, such as the central bank, there may be greater temptation for the government to interfere in the drafting of these reports. One possible incentive is to increase confidence in the banking system when there are persistent rumors about the liquidity or solvency of some banks. If this were to happen, however, these reports would soon lose all credibility. The result may well be that the public, once it becomes aware that it is being misinformed, will overreact and lose any confidence in the banking system.
Regulation
Regulations are often described as subordinate legislation because they are an exercise of a delegated but limited power to enact rules. Full operational independence in the exercise of that power is conceivable only if its limits are clearly circumscribed and cannot be expanded by the regulating agency.
Even with those limitations, there is no clear consensus that a prudential regulator should be given full operational independence. In the European Union, for example, the European Banking Authority has been given full independence in its decision-making process, but the status of most decision-making officials does not guarantee their independence.41 The members of the Board of Supervisors are not appointed to the Board in a personal capacity: they are members either in an official capacity, as heads of national supervisory agencies, or as representatives of another organ or entity of the European Union. The same is true of the Management Board, with the exception of the chairperson, who has no vote.42
Supervision Stricto Sensu: International Standard
According to Principle 2 of the 2012 Core Principles for Effective Banking Supervision, adopted by the Basel Committee on Banking Supervision, the supervisor should have full operational independence:
The supervisor possesses operational independence, transparent processes, sound governance, budgetary processes that do not undermine autonomy and adequate resources, and is accountable for the discharge of its duties and use of its resources. The legal framework for banking supervision includes legal protection for the supervisor.
The formulation of this standard seems to be based on the assumption that the banking supervisor has no supervisor. In the European Union, however, the national authorities in charge of banking supervision and, apparently, the European Central Bank itself when acting as supervisor of credit institutions,43 may receive instructions from the European Banking Authority for the performance of their functions in emergency situations.44
Bank Resolution: International Standard
According to paragraph 2.5 of the 2014 Financial Stability Board’s Key Attributes for Effective Resolution Regimes, a resolution authority for financial institutions should have full operational independence:
The resolution authority should have operational independence consistent with its statutory responsibilities, transparent processes, sound governance, and adequate resources and be subject to rigorous evaluation and accountability mechanisms to assess the effectiveness of any resolution measures. It should have the expertise, resources, and the operational capacity to implement resolution measures with respect to large and complex firms.
The European Single Resolution Mechanism provides an example of operational independence given to authorities or agencies in charge of recovery and resolution procedures for credit institutions and investment firms.
At the national level, the authority in charge of resolution, which may be the central bank,45 must have operational independence,46 which means that it “shall act independently and in the general interest.”47 At the European Union level, the Single Resolution Board also has operational independence, but this independence is more precisely defined and subject to some limitations resulting from some of its members’ status as officials of the member-states.
In its decision-making process, the Board must “act independently and in the general interest” and “neither the Member States, the Union’s institutions or bodies, nor any public or private body shall seek to influence the Chair, the Vice-Chair or the members of the Board.”48
The status of some board members, however, does not guarantee their full independence. While the chair, the vice chair (who has no vote except when representing the chair), and the four full-time members have tenure,49 the other members of the board are “appointed by each participating Member State, representing their national authorities.”50 This difference in status may explain a difference in the obligations imposed on board members. The chair, the vice chair, and the four full-time members “shall perform their tasks in conformity with the decisions of the Board, the Council, and the Commission. They shall act independently and objectively in the interest of the Union as a whole and shall neither seek nor take instructions from the Union’s institutions or bodies, from any government of a Member State, or from any other public or private body.”51 These obligations do not apply to board members appointed by each member-state, probably because they could conflict with their obligations as officials of their respective countries.
Conclusion
A few conclusions can be drawn from this survey.
First, as macroprudential supervision encompasses several functions, different agencies may be in charge of each function, in which case some form of coordination must be organized.
Second, if the central bank is one of these agencies, there is no reason why it should discharge its macroprudential mandate differently than any other agency that would be charged with the same tasks.
Third, the central bank, in the discharge of its macroprudential mandate, may have to pursue objectives inconsistent with those of monetary policy, in which case the latter should take precedence over the former, albeit with some flexibility in their implementation.
Fourth, when acting as macroprudential supervisor, the central bank may incur liability and reputational damage, which may trigger challenges to its independence in the conduct of monetary policy.
Fifth, if, in the exercise of macroprudential supervision, the central bank does not have the same degree of operational independence it has in the conduct of monetary policy, whoever has authority over the central bank (for example, the finance minister or the government) for the performance of macroprudential supervision may give instructions to the central bank that conflict with the achievement of the central bank’s monetary policy objectives.
References
Andenas, Mads, and Duncan Fairgrieve. 2002. “Misfeasance in Public Office, Governmental Liability, and European Influences.” International Comparative Law Quarterly 51: 757.
Athanassiou, Phoebus. 2011. “Financial Sector Supervisors’ Accountability: A European Perspective.” European Central Bank Legal Working Paper 12, European Central Bank, Frankfurt.
Blair, Christopher, and Timothy Edmonds. 1997. “Bank of England Bill.” House of Commons Library Research Paper 97/115, House of Commons, London.
Breger, Marshall J., and Gary J. Edles. 2015. Independent Agencies in the United States: Law, Structure, and Politics. New York: Oxford University Press.
Bullock, Charles J. 1930. “Dionysius of Syracuse—Financier.” The Classical Journal 25 (4): 260.
Cihák, Martin. 2008. “Central Banks and Financial Stability: A Survey of Financial Stability Reports.” In Current Developments in Monetary and Financial Law, 5. Washington, DC: International Monetary Fund.
Davis, Neal. 1993. “Political Will and the Unitary Executive: What Makes an Independent Agency Independent?” Cardozo Law Review 15: 273.
Dijkstra, Robert J. 2012. “Liability of Financial Supervisory Authorities in the European Union.” Journal of European Tort Law 3: 346.
Gianviti, Francois. 2010. “The Objectives of Central Banks.” In International Monetary and Financial Law, The Global Crisis, edited by Mario Giovanoli and Diego Devos, 449. New York: Oxford University Press.
Grass, Etienne. 2016. Génération réenchantée: chroniques du progrès. Paris: Calmann-Lévy. Nolan, Donal. 2013. “The Liability of Financial Supervisory Authorities.” Journal of European Tort Law 4: 190.
At the time this chapter was written, François Gianviti was General Counsel and Director of the Legal Department of the IMF.
Macroprudential supervision of the different components of the financial sector may also be entrusted to separate agencies, in which case some form of cooperation among them has to be organized.
For an example of the various tasks involved in this function, see Article 3 of Regulation (EU) No. 1092/2010 of the European Parliament and of the Council of 24 November 2010 on European union macroprudential oversight of the financial system and establishing a European Systemic Risk Board.
These rules are “subordinate” in the sense that they have to be consistent with the relevant legislation authorizing their adoption.
The European Banking Authority is an example of an integrated approach; see Regulation (EU) No. 1093/2010 of the European Parliament and of the Council of 24 November 2010, Article 1.5.
There is a considerable degree of confusion in the use of the terms “regulation” and “supervision.” A “supervisor” may or may not have regulatory powers. Conversely, a “regulator” may or may not have supervisory powers. Some countries make a clear distinction between supervision and regulation. Others do not.
The definition of “systemically important” may vary over time and from country to country. The supervisor may also be allowed to determine, on a case-by-case basis, whether a particular financial institution is “systemically important.”
These laws and regulations include, but are not always limited to, those enacted for prudential purposes.
In addition to a microprudential assessment of internal risks within each institution, these tests take into account systemic risks, such as a real estate bubble leveraged by unsustainable credit growth, and their possible impact on the financial system, including spillover and feedback effects.
For instance, in the European Central Bank, a Supervisory Board has been established for the supervision of credit institutions. Within the Bank of England, its functions as Prudential Regulation Authority are carried out by a separate structure under the authority of the Prudential Regulation Committee.
This monetary policy objective of slow and regular increases in consumer prices is based on the assumption that these prices are not artificially manipulated. If they are regulated or subsidized by the government, monetary policy has no impact on them. Moreover, a stable consumer price index does not necessarily mean that the standard of living remains the same. For example, higher income or real estate taxes, which reduce the amount of disposable income, are not counted as price increases in the consumer price index; they may even result in a lower price index if they are used to subsidize consumer prices.
It has also been suggested that the central bank should distribute a uniform amount of money as grants to every resident in order to stimulate demand (“helicopter money”). A distribution of central bank loans was also recently proposed, but for a different purpose, namely, the financing of one-off allowances for individual projects (see Grass 2016). Sooner or later, an economist will argue that central banks should extend “nonrefundable loans” to governments, at zero or negative interest rates, under the condition that the proceeds be disbursed within a short period of time to boost inflation.
Another risk for holders of government bonds is that higher interest rates may also affect a highly indebted government’s ability to service its debt, which could result in a restructuring or consolidation of outstanding debt.
The negative impact of stringent prudential ratios on economic growth is more pronounced in countries, such as those of the European Monetary Union, that rely heavily on the banking sector for credits to the private sector than in countries, such as the United States, where the funds come to a much larger extent from the issuance of stocks and bonds.
On these cases, see Andenas and Fairgrieve 2002, 757.
Peter Paul, ECJ Decision of 12 October 2004, Case C-222/02.
Belgium and Luxembourg have enacted similar laws. See Athanassiou 2011.
Statutory immunity would be unconstitutional in Germany, but limiting the scope of an agency’s functions (for example, by imposing a duty of care only to the public) is not. The supervisor would still be liable, however, to the bank itself for its wrongful actions against the bank. See Andenas and Fairgrieve 2002, 771–72.
Until 2003, the banking supervisor (separate from the regulator) was the Commission bancaire; it was a government body, not a legal entity. Since 2003, the Autorité des marchés financiers has been the regulator and supervisor of all financial sector activities; it is a legal entity.
Although some lower courts had concluded that simple negligence was sufficient, the Conseil d’Etat held that gross negligence had to be established. See the cases cited by Andenas and Fairgrieve 2002, 768–71.
Conseil d’Etat, 30 November 2001, No. 219562.
See the cases cited by Andenas and Fairgrieve 2002, 772–73.
The plaintiffs abandoned their claims after 12 years of proceedings and with a £73 million bill in legal fees; see Nolan 2013, 205.
Three Rivers District Council and others v Governor of the Bank of England and Company of the Bank of England [2000] 2 WLR 1220 and [2001] UKHL 16.
See UK Financial Services Act 2012, Schedule 1ZB, Part 4, paragraph 33. For an identical provision on the liability of litigators, see section 88 of the Act. In the same provisions, however, there is now a second exception, albeit a very limited one, to the principle of nonliability. The Prudential Regulation Authority’s and its officials’ exoneration of liability in damages does not apply either if “(a) the act or omission is shown to have been in bad faith, or (b) so as to prevent an award of damages made in respect of an act or omission on the ground that the act or omission was unlawful as a result of section 6(1) of the Human Rights Act 1998.”
As good faith should be presumed, the burden of proving bad faith has to be on the plaintiffs. The UK legislation, in this regard, is better than the Basel Committee’s recommendation as it explicitly requires proof of bad faith.
The Financial Stability Board, in its 2014 Key Attributes for Effective Resolution Regimes (paragraph 2.6), has adopted a similar standard for resolution authorities: “The resolution authority and its staff should be protected against liability for actions taken and omissions made while discharging their duties in the exercise of resolution powers in good faith, including actions in support of foreign resolution proceedings.”
As the agency has no mind of its own, its “bad faith” can only be the bad faith of individuals acting on its behalf. Deeming the agency to have acted in bad faith because of these individuals’ actions allows the plaintiffs to sue the agency as a solvent principal for the wrongful actions of its agents.
Proof of simple negligence is normally sufficient for administrative as well as civil liability (In lege Aquilia et levisssima culpa venit). Proof of gross negligence is required in administrative law only in special cases, such as hazardous activities (for example, riot control) or functions where a complete knowledge of all relevant data is particularly difficult to obtain (for example, supervision of municipalities’ activities). Administrative courts have gradually restricted the number of cases in which gross negligence is required.
See Regulation (EU) No. 1093/2010 of the European Parliament and of the Council of 24 November 2010, Article 69:
Liability of the Authority
1. In the case of non-contractual liability, the Authority shall, in accordance with the general principles common to the laws of the Member States, make good any damage caused by it or by its staff in the performance of their duties. The Court of Justice of the European Union shall have jurisdiction in any dispute over the remedying of such damage.
2. The personal financial liability and disciplinary liability of Authority staff towards the Authority shall be governed by the relevant provisions applying to the staff of the Authority.
The term “government” is used here to designate the organ of the state that exercises the executive power, that is, is in charge of executing the laws. In some countries, it is called the cabinet. In the United States, where the term “government” includes the executive, legislative, and judicial branches, the equivalent of the cabinet is the executive branch, sometimes referred to as the [president’s name] administration.
The establishment of such agencies may raise constitutional issues. Does the legislature have the authority to divest the government of powers (enforcement of laws) conferred upon it by the constitution? Conversely, if the government refuses to enforce laws that it disagrees with, should not the legislature have the authority to establish agencies that will enforce these laws? Moreover, the proliferation of independent agencies may be seen, in a democratic society, as a sign of distrust in the people’s representatives as more and more powers originally vested in elected officials are being gradually transferred to unelected technocrats who are expected to be guided in their decisions by other than political considerations.
On the legal and policy issues raised by the various types of independent agencies in the United States, see Davis 1993 and Breger and Edles 2015.
Preferably, their terms of office should not coincide with the tenure of the person or body making the appointment.
For an example of government approval being required for certain decisions, see the UK Bank of England and Financial Services Act 2016, Section 13, Part 3A, section 30C, on the operational independence of the Bank of England as Prudential Regulatory Authority.
See Article 127 of the Treaty on the Functioning of the European Union.
See Article 130 of the Treaty on the Functioning of the European Union.
This exception was introduced by the Bank of England Act 1998. In the conduct of monetary policy, the Bank of England has unlimited operational independence, but not goal independence. An annual inflation target is determined by the Chancellor of the Exchequer; if the target is missed by one percentage point above or below the target, the Governor of the Bank will send an open letter to the Chancellor explaining why the target was missed and what actions the bank intends to take to get back to the target.
Emergency lending (also called emergency assistance) provided by the central bank as lender of last resort is generally not regarded as a monetary policy measure. It may be subject to instructions from, or prior approval of, the Treasury.
According to Plutarch, there is some evidence, albeit not fully documented, of one of the first examples of a devaluation designed to alleviate debtors’ indebtedness, namely, Solon’s decision as archon of Athens, in 594 BC, to depreciate the Athenian drachma by reducing its silver content. Some of his Athenian friends, who knew of this impending measure, borrowed large sums of drachmas to buy property and made a fortune. Perhaps inspired by Solon’s example, Dionysius, ruler of Syracuse from 407 until his death in 367 BC, having emptied the public coffers and borrowed heavily to finance wars, constructions, public spectacles, and his own lavish lifestyle, ordered all the coins in the city to be brought to him, under penalty of death, then had each one-drachma coin stamped with a two-drachma mark, and finally used the new coins to repay his debt at a 50 percent discount in real value (Bullock 1930).
There is one exception: the nominal value of the debt will be adjusted if it is subject to a maintenance of value clause. Also, as a result of inflation, some foreign currencies may have appreciated against the national currency, in which case the cost of servicing the state’s debt denominated in these currencies will increase.
See Regulation (EU) No. 1093/2010 of the European Parliament and of the Council of 24 November 2010 establishing a European Supervisory Authority (European Banking Authority), Article 42.
See Regulation (EU) No. 1093/2010, Articles 45 and 48; on the status of the Executive Director, see Article 48.
On the role of the European Central Bank as supervisor of credit institutions, see Council Regulation (EU) No. 1024/2013 of 15 October 2013, conferring specific tasks on the bank concerning policies relating to the prudential supervision of credit institutions. Also see Regulation (EU) No. 468/2014 of the European Central Bank of 16 April 2014 establishing the framework for cooperation within the Single Supervisory Mechanism between the European Central Bank and national competent authorities and with national designated authorities (SSM Framework Regulation).
See Regulation (EU) No. 1093/2010, Article 18.
The national authority is not necessarily the central bank.
See Directive 2014/59/EU of the European Parliament and of the Council of 15 May 2014 establishing a framework for the recovery and resolution of credit institutions and investment firms, Article 3.3.
See Regulation (EU) No. 806/2014 of the European Parliament and of the Council of 15 July 2014 establishing uniform rules and a uniform procedure for the resolution of credit institutions and certain investment in the framework of a Single Resolution Mechanism and a Single Resolution Fund, Article 47.1.
See Regulation (EU) No. 806/2014, Article 47.1 and 3.
See Regulation (EU) No. 806/2014, Articles 43.1 (a) and (b) and 56. They are appointed for five years and their removal from office is subject to substantive and procedural conditions.
See Regulation (EU) No. 806/2014, Article 43.1 (c).
See Regulation (EU) No. 806/2014, Article 47.2.