BANKING LAW

A CRITICAL STUDY OF CENTRAL BANKING INSTITUTIONS AND REGULATORY FRAMEWORK IN GLOBAL SCENARIO

NATIONAL LAW UNIVERSITY ODISHABANKING LAWIV SEMESTERJANUARY 2014-APRIL 2014

SUBMITTED TO:RAJAT SOLANKI(ASSISTANT PROF. OF LAW)

SUBMITTED BY: RIYANKA ROY CHOUDHURY (2011/BBA.LL.B/060) KISLAY KUMAR (2011/BBA LLB/027)

DECLARATION "The text reported in the project is the outcome of my own efforts and no part of this project assignment has been copied in any unauthorized manner and no part I it has been incorporated with due acknowledgement"

KISLAY KUMAR

RIYANKA ROY CHOUDHURY

TABLE OF CONTENTSINTRODUCTION..4OBJECTIVES..5HYPOTHESIS..5RESEARCH QUESTIONS.5SCOPE AND LIMITATIONS OF THE PAPER..5RESEARCH METHODOLOGY5 METHOD OF WRITING...5MODE OF CITATION5SEMINAL SHIFT IN CENTRAL BANKS POLICY-MAKING ROLES6MEANING OF CENTRAL BANK6FUNCTION OF THE CENTRAL BANK.7RESERVE BANK OF INDIA-CENTRAL BANK OF INDIA8THE RBIS REGULATORY ROLE...13UK CENTRAL BANK...18REGULATORY FRAMEWORK OF BANK OF ENGLAND......21FEDERAL BANK OF USA.......24REGULATORY FRAMEWORK OF FEDERAL BANK.26CONCLUSION...28BIBLIOGRAPHY......29FOOTNOTES.30

INTRODUCTIONHistory suggests that there is no constancy in the practice of central banking. This implies that there is no one size that fits all: we have to keep changing central banking functions as the need changes. We need to acknowledge this and then act accordingly. We need different horses for different courses.- Rakesh Mohan former Deputy Governor RBI

The continuing financial and economic crises have thrust central bankers centre stage and cast them as leading actors, simultaneously berated as progenitors of the crisis and hailed as potential saviours. It is not clear that all central bankers welcome this transition from membership of hitherto largely anonymous technocratic elite to an increasingly public role.Central bankers need to adjust to an increasingly public and prominent position on the political stage. A fundamental debate about the position of central banking and its relationship to government is now under way. The financial crisis has led to considerable interlinked economic, sovereign debt and financial sector turbulence. This has been accompanied by increasing volatility in the political arena and an unstable world against the backdrop of a wholesale macroeconomic global transformation. Central bankers have achieved a new prominence and become pivotal members of the policy-making establishments of both national and intergovernmental organizations.As a result of a growing responsibility for financial stability, coupled with their injection of massive amounts of liquidity into the financial system has, central banks in many jurisdictions, have extended their powers and remit beyond their traditional lender of last resort function. We suggest in this paper that this extension of powers is unlikely to be temporary and may not be entirely desirable. It raises far-reaching questions about the accountability and transparency of the principal activities of central bankers. In addition to their traditional monetary policy and governmental banking roles, central banks have become national and global firemen with growing responsibility for the resilience of economies, the stability of financial systems and individual financial institutions, macro-and micro prudential regulation, and macroeconomic and quasi-fiscal policy. While it is comparatively straightforward to set a target for inflation, how does one measure financial stability, and just what degree of financial instability is deemed acceptable? We will try to find the answers to these questions through this paper.

OBJECTIVESThe aim of the project is to present a detailed study of the Central Banking institutions and Regulatory Bodies in a Global Scenario through detailed study of various writings, articles & reports. HYPOTHESISIt is hypothesized that current law regarding Regulatory Framework in a Global Scenario holds a good position.

RESEARCH QUESTIONSThis paper tries to answer the question whether principals, agents or advisers, it is unimaginable that there would no longer be a strong political dimension to the activities of central banks. While it is comparatively straightforward to set a target for inflation, how does one measure financial stability, and just what degree of financial instability is deemed acceptable?

SCOPE AND LIMITATIONS OF THE PAPERThe paper would explore the evolution of RBI, Bank of England and Federal Bank over the years. And the limitations imposed by the Regulatory Framework.RESEARCH METHODOLOGY The project is basically based on the doctrinal method of research. The project is made with the use of secondary resources. METHOD OF WRITINGThe method of writing followed in the course of this research paper is primarily analytical. MODE OF CITATIONThe researcher has followed a uniform mode of citation throughout the course of this research paper.

SEMINAL SHIFT IN CENTRAL BANKS POLICY-MAKING ROLESMoney has been with us for more than 4,000 years; for most of that time, we did without central bankers. During the past 150 years in which Banks played an important role in the economic lives of leading nations, Central Banks influence has waxed and waned. But since the eruption of the global financial crisis in 2007 and the accompanying large-scale increase in government debt in the US, Europe and Japan, they have undergone a seminal shift with few precedents. Central bankers have risen significantly in the economic rankings to become a pivotal part of the policy-making establishment in both industrialized countries and in emerging market economies. The new landscape brings a range of consequences on a global scale, with repercussions on financial and business practices in many parts of the world.Greater exposure to politics and the media and fresh operational tasks require them to increase diversity of recruitment. In some cases, they are required to be more market-orientated and focused on profitability while also being more aware of commercial and financial risk. In the most well-known central banks, the Federal Reserve (Fed), the Bank of Japan (BoJ), the European Central Bank (ECB), the Bank of England (BoE) and even the firmly state-controlled Peoples Bank of China (PBOC), the new strains are noticeable. The same is true for many other central banks in industrialized and developing countries.MEANING OF CENTRAL BANKIn every country there is one bank which acts as the leader of the money market, supervising controlling the regulating the activities of the commercial banks and other financial institutions. It acts as a bank of issue and is in close touch with the government, as banker, agent and adviser to the latter. Institution charged with the responsibility of managing the expansion and contraction of the volume of money in the interest of general public welfare. It is an institution responsible for safe guarding the finance stab of the country.FUNCTION OF THE CENTRAL BANKThe function of the central bank differs from country to country in accordance with the prevailing economic situation. But there are certain functions which are commonly performed by the central bank in almost all countries.1. Monopoly of Note Issue2. Custodian of Exchange Reserves3. Banker to the government4 Banker to Commercial banksBroadly speaking, the central bank acts as the bankers bank in three different capacities: a. It acts as the custodian of the cash reserves of commercial banks. b. It acts as the lender of the last resort.c. It is the bank of central clearance, settlement and transfer.RESERVE BANK OF INDIA-CENTRAL BANK OF INDIAThe Reserve Bank of India (RBI) is the central banking institution of India and controls the monetary policy of the Indian rupee. The institution was established on 1 April 1935 during the British Raj in accordance with the provisions of the Reserve Bank of India Act, 1934. Reserve Bank of India plays an important part in the development strategy of the government. It is a member bank of the Asian Clearing Union. Reserve Bank of India was nationalised in the year 1949. The general superintendence and direction of the Bank is entrusted to Central Board of Directors of 20 members, the Governor and four Deputy Governors, one Government official from the Ministry of Finance, ten nominated Directors by the Government to give representation to important elements in the economic life of the country, and four nominated Directors by the Central Government to represent the four local Boards with the headquarters at Mumbai, Kolkata, Chennai and New Delhi. Local Boards consist of five members each Central Government appointed for a term of four years to represent territorial and economic interests and the interests of co-operative and indigenous banks[footnoteRef:1]. [1: Reddy&Appanniah:BankingTheoryandPractice, (2nd Ed.) 123]

HistoryThe bank was founded in 1935 to respond to economic troubles after the first world war. The Reserve Bank of India was set up on the recommendations of the Royal Commission on Indian Currency and Finance, also known as Hilton-Young Commission. The commission submitted its report in the year 1926, though the bank was not set up for another nine years. The Preamble of the Reserve Bank of India describes the basic functions of the Reserve Bank as to regulate the issue of bank notes, to keep reserves with a view to securing monetary stability in India and generally to operate the currency and credit system in the best interests of the country. The Central Office of the Reserve Bank was initially established in Kolkata, Bengal, but was permanently moved to Mumbai in 1937. After partition, the Reserve Bank served as the central bank for Pakistan until June 1948 when the State Bank of Pakistan commenced operations. Though originally set up as a shareholders bank, the RBI has been fully owned by the government of India since its nationalization in 1949. The national economy came down in July 1991 and the Indian rupee was devalued. Central Board of DirectorsThe Central Board of Directors is the main committee of the central bank. The Government of India appoints the directors for a four-year term. The Board consists of a governor, four deputy governors, fifteen directors to represent the regional boards, one from the Ministry of Finance and ten other directors from various fields.Governors and Supportive BodiesThe current Governor of RBI is Dr. Raghuram Rajan. The Board of Financial Supervision (BFS), formed in November 1994, serves as a CCBD committee to control the financial institutions. It has four members, appointed for two years, and takes measures to strength the role of statutory auditors in the financial sector, external monitoring and internal controlling systems[footnoteRef:2]. [2: MuranjanS.K.:ModernBankinginIndia, (6th Ed.)225]

TOOLS OF RBI Bank RateBank rate is official minimum rate of the Central Bank of the country to advance loan to commercial bank. The rate at which RBI rediscounts the bills.Repo RateAt which rate RBI lend to commercial Bank. Repo rate is the interest rate at which the Reserve Bank of India lends money to other banks.

Reverse Repo RateReverse repo rate is return banks earn on Excess funds parked with the Central bank against Government securities. Reverse Repo rate as the name suggests is the Rate at which RBI borrows from other Commercial banks.

Cash Reserve Ratio The CRR refers to the cash which banks have to maintain with the RBI as a percentage of their demand liabilities. Cash reserve Ratio (CRR) is the amount of funds that the banks have to keep with RBI. If RBI decides to increase the percent of this, the available amount with the banks comes down. RBI is using this method (increase of CRR rate), to drain out the excessive money from the banks.Statutory Liquidity Ratio The SLR is the ratio of cash in hand exclusive of cash balances maintained by banks for CRR. SLR (Statutory Liquidity Ratio) is the amount a commercial bank needs to maintain in the form of cash, or gold or govt. approved securities (Bonds) before providing credit to its customers.[footnoteRef:3] SLR rate is determined and maintained by the RBI (Reserve Bank of India) in order to control the expansion of bank credit. [3: Basu:TheoryandPracticeofDevelopmentBanking, (4th Ed) 286]

Monetary PolicyMonetary policy is concerned with the money supply and credit in the economy. The RBI increase or decrease money supply and credit in the economy depending upon market situation.Inflation If there is inflation in the country the monetary policy of the RBI will make attempt to reduced inflation. The RBI will attempt tight monetary policy. Money supply will control with various monetary policy instruments such as:DeflationIf there is deflation in the country monetary policy of the RBI will make an attempt to overcome deflation through adopting easy monetary policy. The RBI will try to increased money supply and credit in the economy through decreased interest rate, reduction in the C.R.R , S.L.R. which lead to increased more investment more investment will result in more production the surplus can be exported which turn to improve again BOP.Issue of currencyThe Reserve Bank of India is the nations sole currency issuing authority. Along with the Government of India, RBI is responsible for the Design and production and overall management of the nations Currency, with the goal of ensuring an adequate supply of clean and genuine notes[footnoteRef:4]. The Reserve Bank also makes sure there is an adequate supply of coins, produced by the government[footnoteRef:5]. [4: Salsman, Richard M. (1993) Bankers as Scapegoats for Government Created Banking Crises in U.S. History. In Lawrence H. White, ed., The Crisis in American Banking. New York and London: New York University Press, pp. 81-118. ] [5: Santoni, G. J. (1986) The Employment Act of 1946: Some History Notes. Federal Reserve Bank of St. Louis Review. (November 1986): 5-16. ]

Act for governmentAs banker Reserve bank of India accepts deposits from govt. like deposited in govt. account transfer of fund from one state to other state and also provide advance short term loans to govt. on request and provide foreign exchange resources to govt. to pay the external debt[footnoteRef:6]. [6: Schuler, Kurt (1996) Should Developing Countries Have Central Banks? London: Institute of Economic Affairs. ]

As an agent The RBI play role of agent for govt. Collect taxes and other payment on behalf of govt. Represent the govt. in international financial institution like World Bank and IMF[footnoteRef:7]. [7: Ricardo,David (1951) The Works and Correspondence of David Ricardo, Volume I: On the Principles of Political Economy and Taxation. Cambridge: Cambridge University Press. ]

As an adviserRBI gives valuable advice to govt. on important issues like devaluation of currency, budgetary policy, commercial policy, exchange rate policy.Banker's Bank Like individual consumers, businesses and organizations of all kinds, banks need their own mechanism to transfer funds and settle inter-bank transactionssuch as borrowing from and lending to other banksand customer transactions. As the banker to banks, the Reserve Bank fulfills this role.[footnoteRef:8] In effect, all banks operating in the country have accounts with the Reserve Bank, just as individuals and businesses have accounts with their banks[footnoteRef:9]. [8: Rockoff, Hugh (1990) The Wizard of Oz as a Monetary Allegory. Journal of Political Economy, 98: (August), pp. 139-170. ] [9: Rothbard, Murray N. (1962) The Panic of 1819: Reactions and Policies. New York: Columbia University Press. ]

The central bank acts as banker's bank in three different capacities: Custodian of cash reserve of commercial banks. Lender of last resort. Bank of central clearance, settlement and transfer[footnoteRef:10]. [10: Posen, Adam (1998). Do Better Institutions Make Better Policy? International Finance, 1 (October): 173-205. ]

Lender of last resort When commercial banks are not able to secure financial accommodation from other sources, then as a last resort, they can approach the central bank for necessary facilities[footnoteRef:11]. The central bank, in such a case, will be prepared to grant accommodation against eligible securities. By lender of last resort, the central ink assumes the responsibility of meeting directly or indirectly all reasonable demands for funds in times of emergency[footnoteRef:12]. [11: Schwartz, Anna J. (2009) Origins of the Financial Market crisis of 2008. Cato Journal 29 (Winter): 19-23.] [12: Selgin, George and Lawrence H. White (1999) A Fiscal Theory of Governments Role in Money. Economic Inquiry 37 (January): 154-65. ]

The RBIs Regulatory RoleSupervision and RegulationBanks are fundamental to the nations financial system. The RBI has a critical role to play in ensuring the safety and soundness of the banking system and in maintaining financial stability and public confidence in this system[footnoteRef:13]. As the regulator and supervisor of the banking system, the R.B.I Prescribes broad parameters of banking operations within which the country's banking and financial system functions[footnoteRef:14]. Reserve Bank protects the interests of depositors, ensures a framework for orderly development and conduct of banking operations conducive to customer interests and maintains overall financial stability through preventive and corrective measures. Like licensing supervise and control commercial and co-operative banks. [13: Selgin, George, William D. Lastrapes and Lawrence H. White (2010) Has the Fed Been a Failure? Journal of Macroeconomics 34 (September 0212): 569-96. ] [14: Smith, Vera C. (1990; 1936) The Rationale of Central Banking and the Free Banking Alternative. Indianapolis: Liberty Press. ]

To issue the licenses for the establishments of new banks To issue licenses for setting up of bank branches To prescribe minimum requirements regarding paid-up capital and reserves, maintenance of cash and other liquid assets. To conduct the investigations, from time to time , regarding irregularities, frauds, complaints, etc. To control methods of operations of banks To control appointment, re-appointment, termination of appointment of the chairman and CEOs of Private sector banks[footnoteRef:15] [15: Hutchison, Michael (1987). A Model Central Bank? FRBSF Weekly Letter, Federal Reserve Bank of San Francisco, April 3. ]

RBI TOOLSThe Reserve Bank hasa two-tiered structure. The rst tier provides the basic framework for ourpayments systems[footnoteRef:16]. The second tier focusses on supervision of this framework. As part of thebasic framework, the Reserve Banks network of secure systems handles various types of payment andsettlement activities. Mostoperate on the security platformof theINFINET, using digital signatures for further security of transactions. Here is anoverview of the varioussystems used[footnoteRef:17]: [16: Kolko, Gabriel (1963) The Triumph of Conservatism. New York: The Free Press of Glencoe, 1963. ] [17: White, Lawrence H. (1989) Competition and Currency: Essays on Free Banking and Money. New York and London: New York University Press]

Retail paymentsystemsFacilitating cheque clearing, electronic funds transfer, through National Electronic Funds Transfer (NEFT), settlement of card payments and bulk payments, such as electronic clearing services. Operated through localclearinghouses throughout the country[footnoteRef:18]. [18: Pollock, Robert L. (2012) Memo to Romney: Expand the Pie. The Weekend Interview with George Shultz. Wall Street Journal, July 14-15, A11. 42 ]

Department of InformationTechnologyTech support for the payment systems and for the Reserve Banks internal IT systems. Going forward, we are proactively identifying and addressing issues that help mitigate the risksfor large value systems[footnoteRef:19]. Efforts on theretail payment system side will focus onoperational efciencies, cost effectiveness, innovation and riskmanagement. Efcient funds clearing was rst initiated in the80s through Magnetic Ink Character Recognition(MICR) technology[footnoteRef:20]. [19: Plosser, Charles I (2011). The Scope and Responsibilities of Monetary Policy, GIC 2011 Global Conference Series Presentation, The Central Bank of Chile, Santiago, Chile, January 17.] [20: Office of Management and Budget, www.whitehouse.gov/omb/budget/Historicals, accessed 6/29/12. ]

Maintaining Financial StabilityPursuit of nancial stability has emerged as akey critical policy objective for the central banks in thewake of the recent global nancial crisis. Central banks have a critical role to play inachieving this objective. In 2009, the Reserve Bank set up adedicated Financial Stability Unit mainly to, put in place a system of continuous monitoring of themacro nancial system[footnoteRef:21]. [21: ODriscoll, Gerald P., Jr. (2012) Central Banks: Reform or Abolish? Unpublished manuscript, January 15. ]

Financial Stress Indicator A contemporaneous indicator of conditions in nancial markets andin the banking sector[footnoteRef:22]; [22: ODriscoll, Gerald P., Jr. (2009) Money and the Present Crisis. Cato Journal 29 (Winter): 167-86. ]

Systemic Liquidity Indicatorfor assessing stresses in availability of systemic liquidity; Fiscal Stress Indicatorfor assessing build up of risks from the scal; Network Model of the bilateral exposures in the nancial system for assessing the interconnectednessinthesystem; Banking Stability Indicatorfor assessing risk factors having a bearing on the stability of the banking sector; and Aseriesof Banking Stability Measuresfor assessing the systemic importance ofindividual banks.

Financial Stability ReportDecember every year. Internally, quarterly SystemicRisk Monitors and monthly Market Monitors are prepared to place before the Banks Top Management a more frequent assessment of the risks to systemic stability of the economy. In the Union Budget for 2010-11, the Finance Minister announced the establishment of Financial Stability and Development Council (FSDC) toprovide, among other things, a highlevel focus to nancial stability.[footnoteRef:23] The Reserve Bank plays a critical role in the Council. The Governor, Reserve Bank, is the ex-ofcio chairperson of the Sub Committee of the FSDC the Councils main operating arm. The Financial Stability Unit ofthe Reserve Bank of India acts as theSecretariat for the Sub Committee.[footnoteRef:24] [23: Oatley T (1999). Central Bank Independence and Inflation: Corporatism, Partisanship, and Alternative Indices of Central Bank Independence. Public Choice, 98: 399-13. ] [24: Meltzer, Allan H. (2009) A History of the Federal Reserve, Volume 2: 1951 1986. Chicago: University of Chicago Press. ]

UK CENTRAL BANKIntroduction TheBank of England istheCentral bankof the whole of theUnited Kingdomand is the model on which most modern, large central banks have been based was established in 1694 to act as the EnglishGovernment's banker, nationalized in 1946.The Bank has a monopoly on the issue of banknotes inEngland and Wales. The Bank's headquarters has been located in London's main financial district, theCity of London, onThreadneedle Street, since 1734[footnoteRef:25]. [25: Meltzer, Allan H. (2012) Whats Wrong With the Federal Reserve? Wall Street Journal, July 9, A13. ]

History of the Bank England's crushing defeat by France, the dominant naval power, in naval engagements culminating in the 1690Battle of Beachy Head, became the catalyst to Britain rebuilding itself as a global power[footnoteRef:26]. England had no choice but to build a powerful navy if it was to regain global power[footnoteRef:27]. As there were no public funds available, in 1694 a private institution, the Bank of England, was set up to supply money to the King. 1.2m was raised in 12 days; half of this was used to rebuild the Navy[footnoteRef:28]. More recently, in 2007 the Bank of England, in its role as lender of last resort, helped supportNorthern Rock, a specialist mortgage lender that suddenly became unable to rely on wholesale market borrowing to finance its lending operation following the 2007subprime mortgage crisis[footnoteRef:29]. [26: Mayer, Thomas (1976). Structure and Operations of the Federal Reserve System: Some Needed Reforms. In Compendium of Papers Prepared for the Financial Institutions and the Nations Economy Study. Committee on Banking, Currency and Housing, 94th Congress, Second Session, GPO, Washington, June. ] [27: Mayer, Thomas (ed., 1990). Political Economy of Monetary Policy, Cambridge: Cambridge University Press. ] [28: Steil, Benn and Manuel Hinds (2009) Money, Markets and Sovereignty. New Haven and London: Yale University Press. ] [29: Taylor, John B. (2009) Getting Off Track. Stanford: Hoover Institution Press]

FUNCTIONS OF THE BANKMonetary stabilityMonetary policy is directed to achieving this objective and to providing a framework for non-inflationary economic growth[footnoteRef:30]. As in most other developed countries, monetary policy operates in the UK mainly through influencing the price at which money is lent, in other words the interest rate[footnoteRef:31]. Stable prices and confidence in thecurrencyare the two main criteria for monetary stability. Stable prices are maintained by making sure price increases meet the Government'sinflationtarget[footnoteRef:32]. [30: Temin, Peter (1969) The Jacksonian Economy. New York: W.W. Norton. ] [31: White, Lawrence H. (1989) Competition and Currency: Essays on Free Banking and Money. New York and London: New York University Press] [32: Lacker, Jeffrey M. (2012) Understanding the Interventionist Impulse of the Modern Central Bank. Cato Journal 32 (Spring/Summer): 247-53. ]

FINANCIAL STABILITYThe UK Financial SystemThe financial system is central to the functioning of the economy and modern life. The system handles millions of regular transactions - spending in the shops, paying bills, wages and savings - every day[footnoteRef:33]. Financial institutions, such as banks, manage vast sums of money on behalf of individuals and businesses. Financial markets facilitate trade across the world on a minute-by-minute basis - everything from company shares and commodities like oil, to complex financial instruments and, of course, money itself. And large IT systems facilitate payments between financial institutions, companies and individuals. [33: Carlstrom, Charles T. and Timothy S. Fuerst (2009). Central Bank Independence and Inflation: A Note. Economic Inquiry, 47 (January): 182-186. ]

One of the main purposes of the financial system is to bring together savers and investors, and so put money to work[footnoteRef:34]. One person's savings are the finance for another person's investment - for example, household savings are invested by pension funds in shares issued by companies to expand their business[footnoteRef:35]. [34: Cukierman, A. S (1992). Central Bank Strategy, Credibility, and Independence: Theory and Evidence. The MIT Press: Cambridge, MA. ] [35: Cukierman, A., S. Webb, and B. Neyapti (1992). Measuring The Independence of Central Banks and Its Effect on Policy Outcomes. World Bank Economic Review, 6(3): 35398. ]

Regulatory framework of Bank of EnglandIn anticipation of legislation to create a Financial Policy Committee (FPC), outlined in the Governments consultation document, A new approach to financial regulation: building a stronger system, the Government and the Bank announced the establishment of an interim Financial Policy Committee on 17 February 2011.The Bank of England is currently experiencing its most important institutional and functional changes in a generation. Failings in pre-crisis arrangements have prompted the Government to introduce wholesale changes to the UK regulatory landscape which come into force in April 2013[footnoteRef:36]. This regulatory reform has resulted in the Bank gaining significant new responsibilities, including for: microprudential regulation of insurers, deposit-takers and major investment firms, through the creation of the Prudential Regulation Authority; macro prudential regulation of the financial system as a whole, through the creation of the Financial Policy Committee; and supervision of some critical post-trade financial market infrastructure providers[footnoteRef:37]. [36: Meltzer, Allan H. (2003) A History of the Federal Reserve, Volume 1: 1913 1951. Chicago University of Chicago Press. ] [37: Meltzer, Allan H. (2009) A History of the Federal Reserve, Volume 2: 1951 1986. Chicago: University of Chicago Press. ]

The Financial Services Act 2012 (the Act) introduces important changes to the regulatory framework of financial services in the United Kingdom, many of which affect the Bank of England.[footnoteRef:38] The Financial Services Authority (FSA), which was previously responsible for regulation of financial firms from both a prudential and conduct perspective, will cease to exist[footnoteRef:39]. [38: Cargill, Thomas F. and Takayuki Sakamoto (2008). Japan Since 1980. Cambridge University Press: New York. ] [39: Friedman, Milton (1962) Capitalism and Freedom. Chicago and London: University of Chicago Press. ]

The Prudential Regulation Authority will be part of the Bank and will be responsible for the microprudential regulation of deposit-takers, insurers and major investment firms[footnoteRef:40]. This includes setting standards and supervising financial institutions at the level of the individual firm so as to promote their safety and soundness, seeking to minimise the adverse effects that they can have on the stability of the UK financial system; and contributing to ensuring that insurance policyholders are appropriately protected. The PRA will be a subsidiary of the Bank and will be the United Kingdoms microprudential regulator for deposit-takers, major investment firms and insurers. The PRAs new role will be grounded in two statutory objectives[footnoteRef:41]: [40: Friedman, Milton (1961) The Lag in Effect of Monetary Policy. The Journal of Political Economy 69 (October): reprinted in Friedman (1969): 237-60. ] [41: Ferrell, Robert H., ed. (2010) Inside the Nixon Administration: The Secret Diary of Arthur Burns, 1969-1974. University Press of Kansas. ]

To promote the safety and soundness of all the firms it supervises. This will be achieved primarily by minimising the harm that firms can cause to the stability of the UK financial system, in particular the harm resulting from disruption to the continuity of provision of financial services.[footnoteRef:42] [42: Dwyer, Jennifer Holt (2012). Explaining the Politicization of Monetary Policy in Japan. Social Science Japan Journal. 15(Summer): 179-200. ]

And, specifically for insurers, to contribute to the securing of an appropriate degree of protection for those who are, or may become, policyholders[footnoteRef:43]. In addition to its statutory objectives, the PRA must have regard to a series of regulatory principles set out in the Act, including efficient use of its resources; transparency; proportionality; the desirability of sustainable growth in the economy of the United Kingdom; and the need to minimise any adverse effect on competition arising from the discharge of its functions[footnoteRef:44]. [43: Economist (1998) William Martin obituary, August 6. ] [44: Ferguson, Niall (2009) The Ascent of Money. New York: Penguin Books. ]

Financial Policy CommitteeThe primary statutory objective of the FPC is to exercise its functions with a view to helping the Bank achieve its financial stability objective[footnoteRef:45]. The responsibility of the FPC in achieving [45: Cargill, Thomas F (1989). Central Bank Independence and Regulatory Responsibilities: The Bank of Japan and the Federal Reserve. Salomon Brothers Center for the Study of Financial Institutions. New York: New York University. ]

that objective relates primarily to the identification of, monitoring of, and taking of action to remove or reduce systemic risks with a view to protecting and enhancing the resilience of the UK financial system.(1) The FPCs task will not be to achieve resilience at any cost, however it should not act in such a way as to likely have a significant adverse effect on the capacity of the financial sector to contribute to the growth of the UK economy in the medium or long term[footnoteRef:46]. [46: Cargill, Thomas F., Takatoshi Ito and Michael M. Hutchison (2000). Financial Policy and Central Banking in Japan. The MIT Press: Cambridge, MA. ]

The Financial Conduct Authority (FCA), a separate institution from the Bank, will be responsible for ensuring that relevant markets function well[footnoteRef:47]. In doing so, it will aim to advance the protection of consumers, the integrity of the UK financial system and promote effective competition[footnoteRef:48]. It will be responsible for the conduct regulation of all financial services firms. This i[footnoteRef:49]ncludes acting to prevent market abuse and ensuring that financial firms treat customers fairly. [47: Friedman, Milton (1968) The Role of Monetary Policy. The American Economic Review 58 (March); reprinted in Friedman (1969): 95-110. ] [48: Friedman, Milton (1969) The Optimum Quantity of Money and Other Essays. Chicago: Aldine. ] [49: Fry, M., D. Julius, L. Mahadeva, S. Roger, and G. Sterne (2000). Key Issues in the Choice of Monetary Policy Framework. In L. Mahadeva and G. Sterne (eds), Monetary Policy Frameworks in a Global Context, Routledge: London. ]

CENTRAL BANK OF USAFEDERAL BANK"History of Central banking in the United StatesThe first paper money issued in the United States was by the Massachusetts Bay Colony in 1690[footnoteRef:50]. Soon other colonies began printing their own money as well. The demand for currency in the colonies was due to the scarcity of coins, which had been the primary means of trade at the time[footnoteRef:51]. A colony's currency was used to pay for its expenses, as well as a means to loan money to the colony's citizens. In 1791, which was after the U.S. Constitution was ratified, the government granted the First Bank of the United States a charter to operate as the U.S.'s central bank until 1811[footnoteRef:52]. Unlike the prior attempt at a centralized currency, the increase in the federal government's powergranted to it by the constitutionallowed national central banks to possess a monopoly on the minting of U.S currency. Nonetheless, The First Bank of the United States came to an end when President Madison refused to renew its charter[footnoteRef:53]. [50: Fujiki, Hiroshi (1996). Central Bank Independence Indexes in Economic Analysis: A Reappraisal. Monetary and Economic Studies, (December): 80-101. 41 ] [51: Cargill, Thomas F. (2012) A Critical Assessment of Measures of Central Bank Independence. Economic Inquiry. Online version published January 12, 2012 with journal version forthcoming. ] [52: Bade, Robin and Michael Parkin (1988). Central Bank Laws and Monetary Policy. University of Western Ontario, Unpublished Manuscript, http://economics.uwo.ca/faculty/parkin/, October. ] [53: Alesina, Alberto and Lawrence H. Summers (1993). Central Bank Independence and Macroeconomic Performance: Some Comparative Evidence. Journal of Money, Credit and Banking, 25 (May): 151-162. ]

Creation of First, Second and Third Central BankThe first U.S. institution with central banking responsibilities was the First Bank of the United States, chartered by Congress and signed into law by President[footnoteRef:54]. The charter was for twenty years and expired in 1811 under President Madison, because Congress refused to renew it[footnoteRef:55]. A series of bank panics, in 1873, 1893, and 1907, provided strong demand for the creation of a centralized banking system. The main motivation for the third central banking system came from the Panic of 1907, which caused renewed demands for banking and currency reform[footnoteRef:56]. The National Monetary Commission returned with recommendations which later became the basis of the Federal Reserve Act, passed in 1913[footnoteRef:57]. [54: Bade, Robin and Michael Parkin (1982). Central Bank Laws and Monetary Policy. University of Western Ontario, Unpublished Manuscript.] [55: Cargill, Thomas F., Takatoshi Ito and Michael M. Hutchison (1997). The Political Economy of Japanese Monetary Policy. The MIT Press: Cambridge, MA. 40 ] [56: Cargill, Thomas F (2011). Meltzers History of the Federal Reserve: A Review Essay. International Finance, 14: 183-207. ] [57: Cargill, Thomas F (1995a). The Statistical Association between Central Bank Independence and Inflation. Banca Nazionale del Lavoro Quarterly Review, (June): 159-172. ]

Federal Reserve actThe head of the bipartisan National Monetary Commission was financial expert and Senate Republican leader Nelson Aldrich. Aldrich set up two commissionsone to study the American monetary system in depth and the other, headed by Aldrich himself, to study the European central banking systems and report on them. The plan adopted in the original Federal Reserve Act called for the creation of a System that contained both private and public entities. There were to be at least eight, and no more than 12, private regional Federal reserve banks (12 were established) each with its own branches, board of directors and district boundaries[footnoteRef:58]. [58: Friedman, Milton and Anna J. Schwartz. (1963) A Monetary History of the United States, 1867-1960. Princeton: Princeton University Press. ]

Purpose of the Federal Reserve SystemThe primary motivation for creating the Federal Reserve System was to address banking panics[footnoteRef:59]. Other purposes are stated in the Federal Reserve Act, such as "to furnish an elastic currency, to afford means of rediscounting commercial paper, to establish a more effective supervision of banking in the United States, and for other purposes"[footnoteRef:60]. Before the founding of the Federal Reserve, the United States underwent several financial crises. A particularly severe crisis in 1907 led Congress to enact the Federal Reserve Act in 1913. Today the Fed has broader responsibilities than only ensuring the stability of the financial system[footnoteRef:61]. [59: Cargill, Thomas F (1995b). The Bank of Japan and Federal Reserve: An Essay on Central Bank Independence. In Kevin D. Hoover and Steven M. Sheffrin (eds), Monetarism and the Methodology of Economics: Essays in Honour of Thomas Mayer. Edward Elgar Publishing Co.: England. ] [60: Kotlikoff, Laurence J. 2010. Jimmy Stewart Is Dead: Ending the Worlds Ongoing Financial Plague with Limited Purpose Banking. Hoboken, NJ: John Wiley & Sons. ] [61: Schoenmaker, Dirk. 2013. Governance of International Banking: The Financial Trilemma. New York: Oxford University Press. ]

Current functions of the Federal Reserve System include To address the problem of banking panics[footnoteRef:62] [62: Tarullo, Daniel K. 2013. Macroprudential Regulation. Speech at the Yale Law School Conference on Challenges in Global Financial Services, New Haven, CT. September 20. Link http://www.federalreserve.gov/newsevents/speech/]

To serve as the central bank for the United States[footnoteRef:63] [63: Bulletin articles including Lambert, R (2005), Inside the MPC, Bank of England Quarterly Bulletin, Spring, pages 5665.]

To strike a balance between private interests of banks and the centralized responsibility of government[footnoteRef:64] [64: Rakesh Mohan, Diversity to combat groupthink, OMFIF May Bulletin, 18 May 2012, pp. 67.]

To supervise and regulate banking institutions To protect the credit rights of consumers To manage the nation's money supply through monetary policy to achieve the sometimes-conflicting goals of[footnoteRef:65] [65: Rakesh Mohan, Growth with Financial Stability, Central Banking in an Emerging Market, Oxford University Press, 2011, p. xvi.]

maximum employment stable prices, including prevention of either inflation or deflation moderate long-term interest ratesFederal fundsFederal funds are the reserve balances (also called federal reserve accounts) that private banks keep at their local Federal Reserve Bank[footnoteRef:66]. These balances are the namesake reserves of the Federal Reserve System[footnoteRef:67]. The purpose of keeping funds at a Federal Reserve Bank is to have a mechanism for private banks to lend funds to one another. This market for funds plays an important role in the Federal Reserve System as it is what inspired the name of the system and it is what is used as the basis for monetary policy[footnoteRef:68]. [66: New York Times (2010) Times Topics: Alan Greenspan, April 7. ] [67: www.treasury.gov/initiatives/ofr/research/Documents/OFR_AMFS_FINAL.pdf] [68: Campillo, Marta and Jeffrey A. Miron (1997). "Why does Inflation Diverge across Countries". In Christina D. Romer and David H. Romer (eds), Reducing Inflation: Motivation and Strategy. University of Chicago Press: Chicago. ]

Government regulation and supervisionMembers of the Board frequently testify before congressional committees such as this one[footnoteRef:69]. The Senate equivalent of the House Financial Services Committee is the Senate Committee on Banking, Housing, and Urban Affairs. Federal Banking Agency Audit Act enacted in 1978 as Public Law 95-320 and Section 31 USC 714 of U.S. Code establish that the Federal Reserve may be audited by the Government Accountability Office (GAO)[footnoteRef:70]. The GAO has authority to audit check-processing, currency storage and shipments, and some regulatory and bank examination functions; however there are restrictions to what the GAO may in fact audit[footnoteRef:71]. [69: Dudley, William C. 2013. Remarks at Panel Discussion on OTC Derivatives Reform and Broader Financial Reforms Agenda. Conference Held by the Banque de France, Paris. http://www.newyorkfed.org/newsevents/ speeches/2013/dud130912.html] [70: Duffie, Darrell. 2013. The Leverage Ratio and Bank Capital Requirements: Presentation on the Limitations of a Leverage Limit. Brookings Conference, October 31. ] [71: Financial Stability Board (FSB). 2010. Principles for Reducing Reliance on CRA Ratings. ]

Regulatory Framework of Federal Bank of USABank regulation in the United Statesis highly fragmented compared with otherG10countries, where most countries have only one bank regulator[footnoteRef:72]. In the U.S., banking is regulated at both the federal and state level[footnoteRef:73]. Depending on the type of charter banking organization has and on its organizational structure, it may be subject to numerous federal and state banking regulations.[footnoteRef:74] Unlike Japan and the United Kingdom (where regulatory authority over the banking, securities and insurance industries is combined into one single financial-service agency), the U.S. maintains separate securities, commodities, and insurance regulatory agenciesseparate from the bank regulatory agenciesat the federal and state level[footnoteRef:75]. [72: Holmstrm, Bengt. 2008. Commentary: The Panic of 2007. Comment on a Paper by Gorton. Jackson Hole. Link: http://www.kc.frb.org/publicat/sympos/2008/Holmstrom.03.12.09.pdf] [73: Humphrey, Thomas M. 2010. Lender of Last Resort: What It Is, Whence It Came, and Why the Fed Isnt It. Cato Journal 30 (2).] [74: Kayshap, Anil K., Raghuram Rajan, and Jeremy C. Stein. 2002. Banks as Liquidity Providers: Explaining the Co-Existence of Lending and Deposit-Taking. Journal of Finance 57 (1): 3373.] [75: Blinder, Alan S. (1998) Central Banking in Theory and Practice. Cambridge, MA: The MIT Press. ]

Regulatory authorityA bank's primary federal regulator could be theFederal Deposit Insurance Corporation, theFederal Reserve Board, or theOffice of the Comptroller of the Currency[footnoteRef:76]. Within the Federal Reserve Boardare 12 districts centred around 12 regional Federal Reserve Banks, each of which carries out the Federal Reserve Board's regulatory responsibilities in its respective district[footnoteRef:77].Credit unionsare subject to most bank regulations and are supervised by theNational Credit Union Administration[footnoteRef:78]. TheFederal Financial Institutions Examination Council(FFIEC) establishes uniform principles, standards, and report forms for the other agencies[footnoteRef:79] [76: Buchanan, James M. and Richard E. Wagner (1977) Democracy in Deficit: The Political Legacy of Lord Keynes. New York: Academic Press. ] [77: Financial Stability Forum. 2000. Report of the Working Group on Capital Flows: Meeting of the Financial Stability Forum. Link: http://www.financialstabilityboard.org/publications/r_0004.pdf2001. Goodfriend, Marvin. 2013. The Elusive Promise of Independent Central Banking. ] [78: Gorton, Gary, and Andrew Metrick. 2009. Securitized Banking and the Run on Repo.] [79: Ahsan A, Skully M, & Wickramanayake J. 2006. "Determinants of Central Ban Independence and Governance: Problems and Policy Implications." Journal of Administration and Governance 1, 47-67.]

Deposit account regulationThe United States was the second country to officially enactdeposit insuranceto protect depositors from losses by insolvent banks[footnoteRef:80]. In 1933 theGlassSteagall Actestablished the Federal Deposit Insurance Corporation (FDIC) to insure deposits at commercial banks[footnoteRef:81]. [80: Ahsan A, Skully M, & Wickramanayake J. 2008. "Central bank Independence and Governance: Definitions and Modelling." In Central banking Governance: Issues and Perspectives, edited by Jain RK, Sohani AK, pp 59-73. Hyderabad: The Icfai University Press.] [81: Amtenbrink F. 2004. The Three Pillars of Central Bank Governance - Towards a Model Central Bank Law or a Code of Good Governance?]

In 1970 Congress established a separate fund forcredit unions, the National Credit Union Share Insurance Fund. The NCUSIF insures all federally chartered credit unions and many state-chartered credit unions (98% as of 2009)[footnoteRef:82].Some others are insured by the private guaranty corporationAmerican Share Insurance(156 as of 2009). In 1978 foreign banks operating in the United States were required to hold the same level of reserves under the specifications of theInternational Banking Act[footnoteRef:83]. [82: Arnone M, Laurens BJ, Segalotto J-F, & Sommer M. 2007. Central Bank Autonomy: Lessons from Global Trends. In: International Monetary Fund Working Paper WP/07/88] [83: Bade R, Parkin M. 1988. Central Bank Laws and Monetary Policy. In: Department of Economics Working Paper, University of Western Ontario, edited by.]

In 1934, Congress created the Federal Savings and Loan Insurance Corporation to insuresavings and loandeposits. In the 1980s, during thesavings and loan crisis, the FSLIC became insolvent and was abolished; its responsibility was transferred to the FDIC[footnoteRef:84]. [84: Banaian K, Burdekin RCK, & Willett TD. 1995. "On the Political Economy of Central Bank Independence." In Monetarism and Methodology of Economics: Essays in Honour of Thomas Mayer, edited by Hoover KD, Sheffrin SM, pp 178-197. Aldershot, UK: Edward Elgar.]

Central banking regulation Extensions of Credit by Federal Reserve Banks(Regulation A) establishes rules regardingdiscount windowlending, the extension of credit by the Federal Reserve Bankto banks and other institutions[footnoteRef:85]. The Federal Reserve Board made significant amendments to Regulation A in 2003, including amendments to price certain discount-window lending at above-market rates and to restrict borrowing to banks in generally sound condition[footnoteRef:86]. In amending the regulation, the Federal Reserve Board noted that many banks had expressed their unwillingness to use discount-window borrowing because their use of such a funding source was interpreted as sign of the bank's financial weakness or distress[footnoteRef:87]. The Federal Reserve Board indicated its hope that the 2003 amendments would make discount window lending a more attractive funding option to banks.[footnoteRef:88] [85: Adrian, Tobias, and Hyun Song Shin. 2010. Liquidity and Leverage. Journal of Financial Intermediation 19 (3): 41837.] [86: Aghion, Philippe, and Enisse Kharroubi. 2013. Cyclical Macroeconomic Policy, Financial Regulation and Economic Growth. Working Paper 434, December. Bank for International Settlements, Basel, Switzerland.] [87: Bank of England. 2013a. A Framework for Stress Testing the UK Banking System. Bank of England discussion paper, October. ] [88: . Financial Stability Review. Issue no. 20. Link: http://www.bankofengland.co.uk/publications/Documents/fsr/2006/fsrfull0606.pdf]

Regulation of bank affiliates and holding companiesTransactions between Member Banks and Their Affiliates (Regulation W)regulates transactions, such as loans and asset purchases between banks and their affiliates. The term "affiliate" is broadly defined and includes parent companies, companies that share a parent company with the bank, companies that are under other types of common control with the bank (e.g. by a trust), companies with interlocking directors (a majority of directors, trustees, etc. are the same as a majority of the bank's), subsidiaries, and certain other types of companies[footnoteRef:89]. When passed September 18, 1950 Regulation W included a prohibition on instalment purchases exceeding 21 months, which was shortened to 15 months on October 16 of the same year[footnoteRef:90]. [89: Schwartz, Anna J. (2009) Origins of the Financial Market crisis of 2008. Cato Journal 29 (Winter): 19-23. ] [90: Pollock, Robert L. (2012) Memo to Romney: Expand the Pie. The Weekend Interview with George Shultz. Wall Street Journal, July 14-15, A11. 42 ]

CONCLUSIONS/RESEARCH FINDINGS/RECOMMENDATIONS We reach three major conclusions: The crisis has fundamentally changed the roles of central banks and central bankers, and there will be no reversion to the previous status quo. Adjusting to an increasingly public and prominent position on the political stage will be one of the lasting legacies for central bankers. The role of the central banker has become inherently more powerful, more complex and more contentious[footnoteRef:91]. [91: Taylor, John B. (2009) Getting Off Track. Stanford: Hoover Institution Press. ]

The price of extending the activities and powers of central banks is likely to be restrictions on their hitherto sacrosanct independence. In many countries there will be a growing and vigorous debate about the transparency of the activities of central bankers and of accountability to government and the wider electorate[footnoteRef:92]. [92: Temin, Peter (1969) The Jacksonian Economy. New York: W.W. Norton. ]

Many central banks are confronting a new set of policy and operational challenges. In a palette of disciplines ranging from overall strategy and governance, through risk management, and on to the core operational platform, there is much work to be done in attaining organizational fitness to manage significantly increased and more complex roles[footnoteRef:93]. [93: White, Lawrence H. (1989) Competition and Currency: Essays on Free Banking and Money. New York and London: New York University Press]

The paper argues that the role of central bankers is changing and will continue to change fundamentally and irreversibly. There are multiple challenges, ranging from the grandly philosophical and strategic to more prosaic concerns[footnoteRef:94]. Paradoxically, in the final analysis, it may well be that expanded powers and responsibilities for central banks will lead to a full or partial loss of the independence that has, particularly in the Western world, become the cherished hallmark of central banking[footnoteRef:95]. [94: ODriscoll, Gerald P., Jr. (2012) Central Banks: Reform or Abolish? Unpublished manuscript, January 15. ] [95: Office of Management and Budget, www.whitehouse.gov/omb/budget/Historicals, accessed 6/29/12. ]

Although the origin of central banking may be dated back to 1694 when the The Governor and the Company of Bank of England, the present day Bank of England was established, the art of central banking assumed new dimensions only during the 20th century. Central banking is essentially a 20th century phenomenon[footnoteRef:96]. It took nearly three centuries for the art of central banking to attain the present day importance. The role of central bank is continually expanding. In the words of, De Kock, central banks have developed their own code of rules and practices , which can be descriced as the art of central banking but which ,in changing world, is still in the process of evolution and subject to periodical adjustment[footnoteRef:97] [96: Plosser, Charles I (2011). The Scope and Responsibilities of Monetary Policy, GIC 2011 Global Conference Series Presentation, The Central Bank of Chile, Santiago, Chile, January 17. ] [97: Plosser, Charles I (2011). The Scope and Responsibilities of Monetary Policy, GIC 2011 Global Conference Series Presentation, The Central Bank of Chile, Santiago, Chile, January 17. ]

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FOOTNOTES

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