The perspectives in respect of both central banking and commercial banking have been undergoing significant changes in the post-financial crisis world. While no real global consensus has been reached through the now influential G-20 forum, broad contours are evident that can be captured in some sort of a crude and simplified framework.
Analysing the Western world and its framework first, we see that after the breakdown of the Breton Woods system in the early 1970s, the West embarked upon financial liberalisation and deregulation, and the thinking on the role of the central banks also underwent a parallel change. In simple terms, the central banks became purist and commercial banks became more and more non-purist.
To further elaborate on this, we can interpret a purist central bank as one that pursues a single objective, uses a single instrument, and one which enjoys operational independence in monetary policy formulation and implementation without, in particular, the government’s political influence.
Thus, the pursuit of price stability as the single or primary objective, with inflation targeting, use of short-term interest rate as a single instrument combined with a committee approach to interest rate setting, came to be regarded as the golden rules for central banks to imbibe. Multilateral institutions, as part of their structural conditionality, incorporated these views strongly while advising country authorities. A notion which we know was not only accepted, but also endeavoured upon by many emerging markets in the last 10 to 15 years.
The purist approach to central banking also resulted in the central banks being stripped of supervisory responsibilities by separating supervision from regulation, and the debt management function from the monetary management function.
In parallel, the commercial banking operations were, however, liberalised and deregulated. A purist commercial bank, on the other hand, can be interpreted to mean a bank that accepts deposits and provides credit, particularly the production/manufacturing credit, with, of course, prudent internal cash and liquidity management rules in place.
A purist commercial bank (originally) was not expected to enter into investment business, in particular in equities and real-estate markets, and was in fact prevented from taking speculative positions.
However, somewhere along the way the lines got blurred and we find that the post-Breton Woods paradigm after deregulation resulted in significantly diluting the distinction between commercial and investment banking. Supervisory powers over commercial banks became more off-site than on-site and more macro than micro. This change can be interpreted to mean commercial banking transforming itself from purist into non-purist.
In the post-crisis (financial) world, there is a general tendency of reversal of the above trend. Central banks are turning non-purist: multiple objectives incorporating financial stability are not shunned, regulation is ideally viewed as optimal if it is combined with supervision in the hands of the central bank, and questions are raised about the wisdom of debt management separated from monetary management.
We saw that in the post-crisis period, the central banks have been forced to adopt multiple instruments such as the extraordinary and rather unconventional measures of ‘quantitative easing’ with government support. They now do not appear to be as independent as they were prior to the crisis, and the treasury’s influence and overriding powers have become all-pervasive. In short, central banks are turning into non-purist from purist.
Our traditions here though tend to be different. In contrast to the West, our domestic situation has not radically changed overtime, despite several reforms first taken by the Nawaz Sharif government in the early 90s and then later on under the Musharraf regime in the period 2001-2005.
Fundamentally, the state of Pakistan remains non-purist. It has multiple objectives, multiple instruments and does not enjoy operational autonomy of the kind required legally or by convention. The ‘financial stability’ objective was added to its arsenal, well ahead of the global financial crisis.
Ironically, the local commercial banking system that until recently was largely purist, to a great extent, is now also fast moving towards becoming non-purist, as the government involves it more and more for creating its liquidity and sadly the private/public commercial banking system plays along by becoming a sort of partner in the ‘crime’ by assuming very high portfolios of governmental (sovereign) debt.
What it needs to realise is that thus far its success amidst an ocean of turmoil has mainly been due to following a gradualist approach to imbibing Western reforms, particularly in the speculation-related financial sector and in showing restraint to taking on large amounts of sovereign debt. “Reforms without disruptions” was the motto prior to the tenure of the present economic managers and this prudence and conservatism served us well.
The main advantage of this approach was that Pakistan escaped through various financial-cum-banking crises - which effected several emerging markets earlier and the Western world in the recent past - without serious damages to it.
Whereas the Western world still stands confused or unclear on how to re-emerge successfully from their current impasse, the choices for Pakistan on our ‘way forward’ are quite clear. Interestingly, we see that the West yearns more and more for the culture we had until a few years back, while we, on the other hand, seem hell bent on committing ‘hara-kiri’ by shaking the very foundations that historically served us so well.
Today, we need to once again weigh and balance our approach and adapt practices that suit our environment, albeit with care that in our eagerness to redirect we do not become a victim of any type of dogmatic ideological stance and push the pendulum too far back towards the other (purist) side.
It would be appropriate that as Pakistan attempts to fall in line with its global commitments vis-à-vis international lending institutions including the IMF, it simultaneously ensures that enough flexibility is retained to follow policies that are conducive to achieving our own development goals and priorities.
It would be in the fitness of things if the State Bank of Pakistan gains more operational autonomy, and the commercial banking system is freed, to some extent, to enable it to raise additional capital that would be required and then go on to leverage its operations in a way that provides security and comfort to its depositors that their money with them is safe!
n The writer is an entrepreneur and economic analyst.