Question

conclusion for a project on bank rates

Answer 1

Answer:

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Answer 2

Explanation:

1. Central banks exist for different purposes than commercial banks. They pursue

national welfare, not profits. Their financial results are often a poor guide to

their success.

2. Central bank gains and losses belong to society. Beyond this, financial results

may be important for a central bank even though it can always create money to

pay its bills, cannot be declared bankrupt by a court, and does not exist to make

profits. Losses or negative capital may raise doubts – however erroneous –

about the central bank’s ability to deliver on policy targets, and expose it to

political pressure.

3. Standalone financial strength can therefore buttress a central bank’s credibility,

especially where that has been weakened by its historical record, institutional

arrangements or the political climate. Conversely, where credibility is otherwise

unquestioned, financial strength may add little to a central bank’s capacity to

execute policy successfully. This alone makes it challenging to say what level of

financial backing a given central bank needs.

4. In addition, financial strength should be scaled to the financial demands of the

functions for which the central bank has independent responsibility. These

financial demands may be much greater in a crisis than in normal times. Recent

experience underscores this point. It is no easy task to assess the financial

demands that might be encountered in times of stress for central bank

operations, and to understand the specific crisis responsibilities of central banks.

5. If financial resources are scaled to match possible emergency demands, large

buffers may build up in normal times, particularly for central banks with wide-

ranging crisis management responsibilities. To ensure that central banks have

independence in deploying them, such buffers need to be on the balance sheet,

and available for use. Achieving this with capital invested in government

securities need not be costly when viewed from the perspective of the whole

public sector. But legal or practical (eg market pricing) limitations related to the

size of the gross public debt, and to the central bank’s ability to hold such debt,

may exist. Moreover, political risks may arise, given what might (wrongly)

appear to be an unneeded pot of public money available to fund desirable

projects.

6. The size of financial buffers needed to assure a continuing independent

operational and policy capability is affected by accounting policies, profit

distribution and recapitalisation mechanisms, capital targets and risk-sharing

arrangements. Decisions on these factors should be made in concert with

decisions on a central bank’s independent responsibilities and its consequent

need for independent financial strength:

 With respect to accounting policies, this may imply departing selectively

but transparently from International Financial Reporting Standards.

 With respect to distribution mechanisms for profits, this requires avoiding

a bias towards decapitalisation or arrangements that impede a rapid

rebuilding of equity.

 With respect to risk-sharing arrangements, again the issue is to match

financial independence with the demands of policy independence.