Banking Soundness and Monetary Policy


Charles Enoch, and J. Green
Published Date:
September 1997
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Ms. Arraes questioned whether the supervisory function should be in the central bank or be separated in a special institution, given the interactions between monetary policy and bank soundness. Mr. Le inquired whether the question was to achieve nominal or real stability. Mr. Wang stressed the need to balance the role of the market relative to that of the supervisors. Only an optimal combination of the two was likely to achieve a socially optimal number of bank failures. Governments, relying on supervisors alone, would probably bring about too few bank bankruptcies; the market, not taking account of systemic issues, would bring about too many.

Mr. Guitián responded, concerning the location of banking supervision, that the important issue was the need for the central bank to be aware of the situation of the banking sector. This could be achieved with banking supervision inside or outside the central bank. There were arguments, and well functioning examples, for either system. On exchange rate stability, Mr. Guitián clarified that he had not meant exchange rate fixity. The final policy objective for monetary policy was to achieve a low level of inflation; that was helped by a stable exchange rate. He agreed that the exchange rate had to also be consistent with an absorbable level of capital flows, which in some cases might imply increasing the variability of the rate. On the role of market forces compared to supervision, Mr. Guitián noted that there was a noticeable trend toward “more market.” All regulations now try to “mirror the market” rather than work against it.

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