GEO

Stripping the National Bank of its banking supervision functions will inhibit it from fulfilling its constitutional duties

01 June, 2015

 

Parliament is currently discussing a legislative initiative on establishing an agency for financial supervision, which will be fully independent from the National Bank of Georgia (NBG).

According to the proposed changes to the Law on the National Bank, the agency will be established as a Legal Entity of Public Law within the system of the National Bank. However, the Agency would only be formally part of the system, because the NBG would no longer have any supervision mechanisms over the agency. Both Mr Mechiauri, an author of the initiative, and the draft law confirm that the agency will be fully independent.

According to the draft law’s explanatory note, the draft law was initiated to create an effective and independent institution, which will focus on the sustainability of the financial sector, help transparency, and protect consumer and investor rights.

According to Article 95 of the Constitution of Georgia, the NBG is independent in its activities and should contribute to a stable functioning of the financial sector.

We believe that the draft law has serious shortcomings. It is incomprehensible how the stable functioning of the financial sector will be promoted without banking supervision which includes monitoring of capital adequacy, external inspection, asset classification, operational risk management, and provisioning requirements among other issues, which directly relate to the stability of the financial sector. Therefore, stripping the National Bank of its supervision functions will inhibit it from carrying out its duties as set out in the constitution.

The fact that the draft law’s explanatory note does not mention international best practices in banking supervision is regrettable. After the 2008 financial crisis, it became clear that removing banking supervision functions from central banks, which had been a widespread practice before 2008, creates systematic weaknesses in the system. After the 2008 financial crisis, the European Central Bank took on added financial sector supervision functions, while the Bank of England, the United Kingdom’s central bank, again took on monitoring functions and financial supervision.

The context and timing of the initiation of the draft law are notable. Before the draft law was presented, ruling coalition leaders made statements which questioned the role of bank speculation in the devaluation of the national currency. Also, a number of politicians blamed the National Bank for the currency crisis. Apart from this, two parliamentary committees assessed the National Bank’s activities as inadequate.

At present, the role of commercial banks in the devaluation of the national currency is only a matter of speculation. There is no proof of commercial banks’ involvement in the devaluation. Requests made by specific commercial banks on the currency markets are based on requests made by their clients. Clients make requests based on their economic interests. Hence, it is not clear what commercial banks could be blamed for in relation to the devaluation of the national currency, when they themselves suffered from the devaluation.

It is notable that this is not the first time that the authorities have attempted to strip the National Bank of functions. About a year ago, the transfer of supervision of the Financial Monitoring Service from the National Bank to the Prime Minister drew severe criticism.

The authorities have referred to 2008, when the National Bank was stripped of banking supervision functions, viz., when the Banking and Non-Banking Supervision Departments were separated from the NBG to form an independent Financial Supervision Agency. We believe this argument is irrelevant, because the above noted department was reunited with the National Bank in 2009. During the previous authorities’ time in office, stripping the National Bank of supervision functions appeared to be connected to attempts to illegally pressure commercial banks. We believe it is important that the government does not repeat the mistakes of its predecessors.

Given the above, we think that the stripping of the NBG’s Financial Monitoring Service and the current attempt to take away banking supervision functions clearly aims to weaken the National Bank. We believe that political considerations rather than the actual needs of the financial system have prompted this legislative initiative. The initiative does not contribute to the stability of the system or its effective functioning. We think that any legislative initiative must help the system to function well rather than emerge based on the ruling party’s like or dislike of a specific individual.

We believe that:

  • If the initiative is passed, the National Bank will not be able to exercise the powers conferred to it by the constitution;

  • The Georgian banking sector is one of the most successful sectors in the Georgian economy. The National Bank’s effective supervision has played a significant role in the success of the banking sector and the effective functioning of the banking system. According to the assessment of the International Monetary Fund and the World Bank (Financial Sector Assessment Program (FSAP)), as noted in the 2014 National Bank Report, “As a result of significant reform and a conservative approach, the National Bank put in place a comprehensive, advanced, and risk oriented supervisory framework, which is geared towards identification of risks at an early stage and the most effective allocation of resources.” Therefore, stripping the National Bank of this extremely important role is highly questionable;

  • According to Article 95 of the Constitution, the National Bank is independent in its work. Its rights, responsibilities, governing regulations, and independence are set out in an organic law. The decision to strip the National Bank of its financial sector supervision functions is a very serious decision for the country’s financial regulation, which requires consultations with the National Bank. As one of the authors of the initiative noted, consultations with the National Bank had not been held, which again underlines the political nature of the initiative and its incompatibility with the constitution;

  • The creation of a new agency will necessitate additional costs. The explanatory note states that resources will be taken from the National Bank and not the government. We would like to remind Parliament and the general public that the National Bank’s resources are essential to the stability of the country’s financial system, which, as the government’s financial resources, need to be taken care of;

  • Any government action stemming from changes in the price of the lari should be considered in a particularly orderly manner. This is especially true as relates to institutions, because any inappropriate action can undermine confidence in the banking sector.

Author: Mikheil Kukava