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.
The characteristic features of a monetary union include: (1) a common currency (or at least a set of freely interconvertible currencies); (2) compatible external exchange restrictions; (3) minimal constraints on internal capital mobility; and (4) a coordinating institution holding a common set of exchange reserves. The usual “optimal currency area” rationale for the formation of a monetary union runs in terms of the advantages to be gained from the improvement of the intraregional allocation of resources, as exchange risk is eliminated (or at least reduced) and internal barriers to the flow of funds are removed, and from the reduction of the overall need for foreign exchange reserves, as balance of payments risks are pooled and intraregional transactions are conducted in a regional currency. On the other hand, membership of a monetary union requires that national monetary policies be subordinate to the common regional policy. National sovereignty is lost in the formulation of policy on domestic credit expansion, interest rates, and exchange restrictions.13
In a developing country, however, two additional advantages may be obtained by joining a monetary union and ceding sovereignty over monetary policy to a regional central bank. First, the centralization of the central banking functions of many countries within a single unit leads to organizational economies of scale and reduces the demands made on each country's human resources. Second, giving the supranational central bank responsibility for the overall direction of national monetary policy, and, in particular, for setting national limits on credit expansion, lowers the danger that a government would have a pernicious influence on policy formulation. Admittedly, the necessity of uniform regional interest rates might still be a drawback to such an arrangement. The costs attached to this uniformity would depend on the disparities existing between the economic situations in the different member countries of the union.
Three examples of monetary unions with supranational central banking institutions, drawn from Africa and the Caribbean, are discussed in this section. All three arrangements originated in colonial monetary integration, but central banking activities have been greatly extended since independence, particularly in the African cases. In the Caribbean example, the supranational authority still bears many features of the transitional central banking institution.
The West African Monetary Union and the Central African Monetary Area
The West African Monetary Union and the Central African Monetary Area are the two standard examples of monetary unions with regional central banks. Their constituent countries were formerly French colonies participating in the Franc Zone with the local currency, the CFA franc, being issued by two regional instituts d'emission.14 Following independence, these countries chose to remain within the Franc Zone but, at the same time, to broaden the regional institutional framework. They established supranational central banks, which were provided with substantial autonomous powers although still subject to French influence. Local control was strengthened further in reforms of both systems in the early 1970s.
The West African Monetary Union (WAMU) is now formed by Benin, Ivory Coast, Niger, Senegal, Togo, and Upper Volta. The Union continues to use the CFA franc as the common currency and sets no controls on capital mobility within the Franc Zone; each country imposes its own particular exchange and trade restrictions. The supranational central bank, the Banque Centrale des Etats de l'Afrique de l'Ouest (BCEAO), has headquarters in Senegal and agencies in each country. The headquarters is responsible for the formulation of policy and the management of the common pool of foreign exchange reserves: the agencies conduct local operations. Each country also has a National Credit Committee and is represented on the Council of Ministers which oversees the system and bears primary responsibility for membership and managerial appointments.
CFA francs are issued on demand by the agencies of the BCEAO, at a fixed parity with the French franc guaranteed by the French Treasury. In return for this guarantee, the BCEAO holds an operations account with the French Treasury and must deposit at least 65 percent of its nonoperational reserves with the Treasury; the French provide compensation to the BCEAO for any decline in the value of these reserves against a chosen index—currently the special drawing right. The BCEAO undertakes to replenish the operations account when necessary from its non-franc reserve holdings, and to raise domestic rediscount rates and reduce rediscount ceilings should the average value of net foreign assets fall below 20 percent of the BCEAO's demand liabilities for three consecutive months.
The BCEAO acts as banker to each of the member governments, subject to the restriction that total gross credit to any government must be less than 20 percent of its tax receipts in the previous year. Credit to the government may take the form of short-term advances, holding of long-term securities, and the rediscounting of commercial bank credit to government: all three are subject to the same overall credit limit.
The dominant feature of the BCEAO's relations with commercial banks is its refinancing of commercial bank credit. Refinancing is provided, at the authorities' discretion, for up to 35 percent of a bank's total credit; a preferential rate is available for lending to agriculture, small-scale construction, and small to medium-sized locally owned businesses. The BCEAO also organizes an inter-bank money market which provides a mechanism for the transfer of funds between banks and between countries within the WAMU. Commercial banks hold deposits with the BCEAO, but do not face specific reserve requirements although foreign deposits are limited to working deposits. Banking regulations are uniform in all countries except Senegal, and adherence to the regulations is supervised by the BCEAO.
Monetary policy in the WAMU is determined jointly by the BCEAO and the National Credit Committees. A credit budget is formulated for each country, taking into account national and regional considerations, with the BCEAO bearing responsibility for the national credit targets and the National Credit Committees having responsibility for the allocation of credit between different uses within the national limit. The main instruments available to the BCEAO to execute the resulting plan are its control over commercial bank refinancing and the setting of the interest rates in the money market. In the past, these instruments have not proven sufficient to prevent overrun of targets, and recently they have been augmented by direct ceilings on commercial bank lending. Bank deposit and lending rates can only be altered with the approval of the Council of Ministers and are adjusted infrequently to prevent the emergence of excessive differentials between rates ruling in WAMU and elsewhere in the Franc Zone.
Monetary arrangements in the Central African Monetary Area (CAMA)—consisting of Cameroon, the Central African Republic, Chad, Congo, and Gabon—are formally similar to those in the WAMU. The main substantive contrasts lie in the greater degree of national sovereignty exercised within the CAMA, and the correspondingly more subordinate role played by its central bank, the Banque des Etats de l'Afrique Centrale (BEAC). For example, banking legislation differs between each member of the CAMA and is enforced by national bodies rather than the BEAC, while deposit and lending rates are not set uniformly. Control over refinancing is the main instrument of monetary policy—there is as yet no interbank money market—but credit ceilings are applied flexibly. Overall targets are established by the National Monetary Committees, rather than by the BEAC, while no constraints are applied to the refinancing of agricultural loans and export credits. Essentially, credit policy has accommodated demand and has been sustained by the region's strong oil-based balance of payments position.
East Caribbean Currency Authority
The East Caribbean Currency Authority (ECCA) was set up in 1965 following the dissolution of the British Caribbean Currency Board. Its seven member countries—Antigua and Barbuda, Dominica, Grenada, Montserrat, St. Kitts-Nevis-Anguilla, St. Lucia, and St. Vincent and the Grenadines—are small island economies.15 These countries are also linked in the Caribbean Common Market and the Organization of East Caribbean States, which are intended to establish a uniform trade policy and promote regional development and integration. There are no controls on capital movements within the East Caribbean area, but external policy, lying outside ECCA jurisdiction, is not fully coordinated: tariffs are uniform across countries in theory, but tend to be diverse in practice due to national divergences in application; indirect taxes and foreign exchange purchase taxes vary between countries; and exchange controls are enforced with differing degrees of strictness.
The relatively large neighbor, Barbados, withdrew from the currency agreement in 1974 to establish its own independent central bank.
The principal functions of the ECCA have been the issue of the common currency, the East Caribbean dollar, and the management of the foreign exchange reserves. The East Caribbean dollar is at present pegged to the U.S. dollar; a change in parity requires the unanimous approval of member governments. The ECCA converts the East Caribbean dollar into foreign exchange on demand for the commercial banks and has no prior right to foreign exchange earnings. It is required to maintain the value of its foreign reserve cover to at least 60 percent of its demand liabilities and has generally operated with a substantial reserve cushion.
The 60 percent cover requirement acts as an overall constraint on ECCA lending to member governments. In addition, the ECCA's statutes restrict its holding of treasury bills issued by any member government to 10 percent of that government's estimated annual recurrent revenue, and its combined holding of other securities of member governments to 15 percent of the ECCA's demand liabilities. In practice, the ECCA estimates the total permitted availability of loanable funds each year and allocates borrowing rights to each member government in proportion to the government's estimated revenues. Not all member countries draw down their full quotas, and the ECCA has in the past retained leeway to extend additional temporary credit to governments facing emergency conditions.
The banking system in the ECCA member countries is dominated by branches of foreign banks. The main service provided by the ECCA to the banking system lies in the operation of a central clearing house for interbank payments. Participating banks are required to hold a minimum balance of noninterest-bearing call deposits with the ECCA and may be granted short-term overdraft facilities. The ECCA also accepts time deposits, paying rates of interest designed to induce banks to deposit funds with the ECCA rather than overseas. Although rates are slightly lower than available elsewhere and the ECCA applies no minimum liquid reserve regulations, foreign branch banks are generally willing to earn goodwill by placing deposits with the ECCA. The ECCA also offers rediscounting facilities, but these have not been utilized: commercial banks in each country have been liquid and are generally unwilling to extend local credit beyond local deposit resources. Thus, political problems that might be triggered if savings in one member country flowed into investment in another are avoided.
At present, the ECCA itself has no regulatory responsibilities or powers; it imposes neither reserve restrictions nor controls on interest rates or credit allocation. Commercial banks do, however, receive directions from host governments to hold deposits with the ministry of finance or to hold certain proportions of their deposit liabilities in government paper; these requirements usually depend on government financing needs rather than being designed to support any particular monetary policy. Foreign-owned banks are also subject to the dictates of their parent banks. In practice, these banks have opted for conservative policies, with low (often negative, in real terms) deposit rates and relatively high interest spreads, which have led to moderate rates of growth of assets but secure profits.
Given its limited array of powers, the ECCA has little scope for the exercise of monetary policy. Its organization combines features of the transitional monetary authority with those of the supranational central bank to curtail government's ability to sustain deficit finance. Governments seeking funds in excess of the ECCA's lending targets must face the discipline of external capital markets, while internal adjustment policies rely mainly on fiscal policy for stabilization purposes. The decision has now been made to convert the ECCA into a central bank more akin to the BCEAO and the BEAC. This new institution is to be endowed with statutory rights to impose reserve requirements on commercial banks, to set interest rate minima and maxima, and to regulate the availability of money and credit. The 60 percent foreign cover requirement and government lending limitations are to remain in force, but the new provisions will permit relaxation of these limits with the unanimous approval of member governments.
See the discussion in Nsouli (1981).
The institut d'émission in a French colony served the same basic role as the currency board in a British one.
The relatively large neighbor, Barbados, withdrew from the currency agreement in 1974 to establish its own independent central bank.