CENTRAL BANKING CONTROL AND FUNCTIONS - U.S.A., U.K. AND JAPAN

Central banking as a concept is of fairly recent origin. Though

some Latin American Countries had a central banking system in the 19*

Cenhuy, this system really became popular only in the early 2 0 ~ century'.

Prior to the 20' Century. there was no clearly defmed concept of central

banking. A gradual evolution had been taking place in various countries over a

long period of time. But the process was not a conscious one and a

systematic and consistent technique had not yet been developed and

formulated.

The dictionag meaning of a Central Bank is a "State owned or

State controlled bank which carries out Government financial policy, regulates

the money supply, influences interest rates and acts as a link between the

Government and the banking".

1 In many of the countries, one bank gradually came to assume more and more the position of

a Central Bank, mainly due to its sole right of Note issue and acting as the Government's

Banker and agent. See M.H.de.Kwk, Cen6ral Banking (I 9991, p.3.

2 The Chambers Dictionary (1 9981, p.264.

Evolution of Central banking

Although the origin of central banking can be dated back to 1894,

the present day Central Bank of England was established and assumed new

dimensions only during the present century. The early institutions were mainly

concerned with the sole right of note issue. They did not know modem central

banking techniques. It was only through a process of trial and error did they

come to occupy a pivotal and strategic status which they enjoy in the present

day monetary and banking structure. Even during the beginning of the present

century, many countries were still without central banks. The international

financial conference held in Brussels in 1920 pointed out the urgency of

establishing a central bank in those countries, which did not have one till then.

The Geneva Conference in 1922 also emphasized the importance of a central

agency to correct the financial disequilibrium and to promote international

cooperation in the monetary world. There was a welcome reception to these

advices throughout the world. The next three decades saw many countries

equipping themselves with central banks. They have drawn their own statutes

in such a manner as to give novel meanings to central banks; drawing

inspiration from the experiences of older central banks.

Theoretical Basis of Cen fral Ban king

The essence of Central Banking is discretionary control of the

monetary system3. The purpose of central banking has been defined in various

ways : to maintain stability of the price level, to keep the economy on an even

keel and so on. These aims could be varied fm more than they are in theory.

Under some circumstances, the purpose of central banking might be defined as

the maintenance of the gold standard, sterling standard or of a dollar standard.

But these varieties are of a purpose. Central Banking is an institutional

arrangement that may be made to serve any one of a number of purposes. The

choice of purpose that is the object of monetary policy is not irrelevant to the

choice of method. A Central Bank is necessary only when the community

decides that a discretionary element is desirable. The Central Banker is the

man who exercises his discretion '.

Any discretionary action would be 'tinkering with the currency.'

Most of the arguments pointed out that men are not to be trusted with

discretionary powers. And it is not difficult to support this attitude by reference

3 R.S.Sayers, Central Banking afCer Bagekot (1967), pp, I , 2.

4 Vera C. Smitha , The Rationale of Cenbral Banking (1 9 3 6), p. 72.

to the monetary history of any country as even the most cautious have had their

episodes of rapid inflation5.

Discretionary control of the monetary situation thus bears within

itself the risk of exaggerating the ups and downs of trade and of undermining

the value of the monetary unit. Are we therefore to say that this is a realm in

which relevance on human discretion is so peculiarly dangerous that we must

prefer some automatic monetary system? But according to R.S.Sayers these

inherent weaknesses in Central Banking can at any rate in most countries be

kept within manageable bounds6. So we must have Central Bankers to exercise

a discretionary influence upon the monetary situation. It follows that there is

no code of eternal rules for them to follow. They have to adapt their ways to

the shape of the communities constantly changing financial habits. We have

Central Banks for the very reason that there are no such rules.

Most economies nowadays take it for granted that there must be a

central bank at any rate in every highly developed economy. Yet central banks

are comparatively novel. Even in England, central banking history falls well

within the last two hundred years, while in U.S. A and most other countries it

anson, son, Monetary Eheory and Practice (19751, p.61.

Milt on Friedman's, Essays in positive economics ( 1 9631, p. 13 5 .

is practically confined to the twentieth century. The very term 'Central

Banking' is not as old as the century7.

Are Central Banks universal& necessary ?

The need for central banks in the major fmancial centers of the

world is now generally accepted but whether a central bank should be

established in every independent political unit is very much an open question.

Many bankers, especially central bankers among them say 'no', but the

politicians of countries without central bank insist that their countries ought to

have such institutions and that their absence leaves their countries

unreasonably subject to foreign influence. This conflict of view is a quite

recent development that is in the 1920's the leading central bankers of the

world favoured the establishment of more central banks in order to protect the

value of money £ram the short sighted behaviour of the politicians8.

In the 1950's by contrast, the bankers feared that the politician

would use central banks to the detriment of monetary stability, while the

politicians suspected that without a central bank a country's interest may be

7 T.Gregoty, The Present position of Central Bunks (1955), p.36.

* Aufright Hans, Comparative Survey ofCentral Banking Laws j 1 9651, p. 3.

sacrificed to the interests of foreign bankers. Obviously at the bottom of this

reversal of position there was a change in the relation between Central Banks

and Governments and their functions9, In the 1920's the function of Central

bank was restoration of the gold standard and to do this it needed the power to

control the supply of moneyto,

The dynamic changes in the economic pulse of each country raised

the status of its central banks from the position of a bank of issue to that of a

leader and symbol of economic development. The importance of central

banking institutions has thus gained universal recognition and they now

occupy a unique position in the economic map of every civilized country1 ', But

it would not be correct to say that central banking has attained its full growth.

Indications are that the role of central banks is continually expandingI2.

9 J.M.Keynes, Treatise on Money (1 930), p.2.

' O Experience seem to show monetary structure of a country oRen gave a Central Bank little

chance to exercise any real power. See Fisher Douglas, Money and Banking (197 1 ), p. 18.

I ' It took nearly three centuries for the art of central banking to attain the present day

importance.

I 2 In the words the Dekock "Central banks have developed their own code of rules and

practices which can be described as the 'art of central banking', but which in a changing

world is still in the process of evolution and subject to periodical readjustment". Supra. n. I .

Recent trends in Central Bmking

Among the recent trends in central banking the most striking feature

is the increased measure of control of the state over the central banks. Most of

the earlier central banks were originally established as private shareholders'

banks thus maintaining their political independence, During the First World

War and post War period the general opinion was against any kind of state

interference with the Central ~ a n k ' ~ . But during the last few years many

countries have nationalized their central banksI4. The nationalization of older

central banks and the establishment of new central banks as state owned

institutions during the last three decades reflects the modern tendency for the

state to own the central bank'5. Most of the central banks are either owned by

l3 The theory underlying this independence was based on the point that absolute state control

would pave the way for the mismanagement of currency and credit i-e. it becomes fatally

easy for the state to abuse its powers by reducing the central bank to a mere mechanism for

issuing notes, which can lead to currency depreciation and monetary chaos. The disastrous

financial policies pursued by certain Central European Governments during the war and post

war period is an example for the evils of subordination of the central bank to the state. See

W.F.Cricks, Common Wealth banking systems (1 965), p.22.

l4 The Rural Banking Enquiry committee in its report in May 1950 did not favour

nationalisation of the imperial Banks of India.. But only recommended greater governmental

supervision and control. See History of the RBI (1970), pp. 530-53 1.

l5 Cobbold Lord, Some thoughts on Cendral Banking, Stamp Memorial Lectures (1 965).

the state or are controlled by the state through the appointment of a governor or

a board16. The statutes of these central banks lay down express provisions

governing the relation between the state and the central bank. Of course these

provisions vary very much fkom country to country .In any case the state

exercises a considerable measure of control over the central bank whether or

not the former owns the latter.

They were not originally called central banks but were generally

known as banks of issue or as nations banks. The regulation of the Note issue

subject to safeguards imposed by the State and the maintenance of the

convertibility of the Notes into gold or silver or both were the principal

functions of these banks. In due course, such banks of issue acquired other

functions and duties until the term 'central bank' came to be generally used.

Generally speaking, a Central Bank is considered as the leader of

the money market. But several economists emphasize different roles for the

Central Bank. For e.g.- According to the ~ a w t r e ~ . ~ . ~ . ' ~ the essential

characteristic of a Central Bank is its functions as the 'lender of last resort'.

l6 This point is discussed elsewhere.

l7 R.G.Hawtrey, Art of Central Banking (19321, p. 13 1.

According to Kisch & ~ l k i n ' ~ , the main h t i o n of the Central Bank is to

maintain the 'stability of the money standard'. O n the other hand,

haw.^.^." lays emphasis on 'credit control' as the major function of Central

Bank.

The principles on which a Central Bank operates are different from

the ordinary banking principles to the extent that,-

(a) The Central Bank unlike an ordinary bank does not operate with the

motive or objective of making profit, but is primarily meant to

shoulder the responsibility of safeguarding the financial and

economic stability of the Country;

(b) The Central Banking being the reservoir of credit and lender of last

resort cannot look to or rely on other banking institutions to

come to its aid in case of need and has to therefore keep its

assets as liquid as possible so that other banks and financial

institutions can approach it for accommodation.

l8 C.M.Kisch & Elkin, Central Banks (1 930), p.74.

19 W.A.Shaw, Theory and Principles of Central Banking (1930), pp.78,80.

(c) The credit machinery of the Country needs to be stabilized quite

often. This is done by the Central Bank by manipulating the

bank rate and open market operations. This power is vested

only in the Central Bank.

Functions of Central Banks

It is difficult to lay down any hard and fast rule regarding the

functions of a Central Bank. The powers and range of functions vary from

Country to Country. The most important and the earliest of the functions is

that of acting as a bank of issuez0. In addition, it is Banker's Bank and a lender

of the last resort, an agent, adviser and banker to the Government, a custodian

of the nation's metallic reserves and controller of the currency. The nature of

these functions points out one basic fact, viz. that Central Banking is entirely

different from commercial or other branches of banking and that its aim is to

serve in the public interest and not to secure profits21. The situation of a

Central Bank is such that it must often undmtake@operations which are not

profitable but result in losses, thus its aim must be the economic welfare of the

Country.

20 H.P.Whillis, Theory and Practice of Central Banking (19361, p.264.

*' Venkitaraman, Centrd Bank Independence (1 9921, p. 1 .

Although the orthodox theory of central banking condemns the

policy of central banks taking any active part in financing economic

development, many countries especially the underdeveloped are not averse to

allow the central banks to take part in their nation building activities. There

were always useful things for a central bank to do. It could look after the Note

issue, it could be the Government's banker and so on. But these tasks useful as

they were, were not the central banks's raison d'etre and others could

efficiently undertake them. Similarly the financial problems of the war period

afforded an opportunity for the central bankers to make themselves useful, if

only as technical advisers. The importance of central bankers for these

purposes of war and peace gave them a prestige they had lacked and so helped

to give them a more practical influence in internal financial matters where they

had earlier been powerless. There have also been political factors in certain

countries22, giving force to demands for the establishment of new Central

Banks.

22 This is an important aspect in Sri Lanka and Myanmar, where central banks have been

established since war and later in Africa. See B.K.Kim, Central Banking Experiment in a

Developing Economy (1 9641, p.24.

Of the existing central banks, the Rikes Bank of Sweden is the

oldest in the sense that it was the first to be e~tablished~~. But the Bank Of

England was the first bank of issue to assume the position of a central bank and

to develop what are now generally recognized as the fundamentals of the art of

central bankingz4. The history of the Bank Of England is thus universally

accepted as illustrating the evolution of central banking, principles and

technique.

Central Bank of England

The Bank of England is U.K's Central Bank. Although the origin of

central banking may be dated back to 1694, the present day Central Bank of

England was established and assumed new dimensions only during the present

century. It was established in 1694 as a joint stock company by an Act of

Parliament under the official designation of the Governor and Company of the

Bank of England. The early institutions were mainly concerned with the sole

right of Note issue. They did not know modern central banking techniques. It

-.

23 From a privately owned bank founded in 1656 and reorganized as a State Bank in 1668,

followed in the foot steps of the Bank of England and gradually developed into a Central

Bank.

24 S.K.Basu, Central Banking in Emerging Countries ( 1 968), p.63

was only through a process of trial and error did they come to occupy a pivotal

and strategic status which they enjoy in the present day monetary and banking

structure.

It was nationalized in 194625 and the main object was to acquire a

greater measure of direct control over the strategic and important position and

power of the Bank so as to make its policies in conformity with economic

policies pursued by the ~overhment~~. For all practical purposes, this change

in the pattern of ownership was of little more than symbolic importance

because the Bank was conducting its operations even before the nationalization

in the public interest in close cooperation with the Treasury. The

nationalization of Bank of England appears to have been largely a concession

to partisan political banking.

The Management of the Bank is vested in a Court consisting of the

following members:-

1 ) One Governor and one Deputy Governor appointed by the Crown, on the

recommendation of the Govt., for a period of five years. They are eligible

for reappointment.

--- - - -

2s Under the Bank of England Act 1946.

26 W.M.Dacey, The British Banking Mechanism (1967), p.45

2 ) Sixteen Directors appointed by the Crown on the recommendation of the

Govt. for a period of four years, four of them retiring each year. They are

also eligible for reappointmentz7.

The Governor and Deputy Governor and not more than four full

time Directors form the Chief Executive of the Bank. This body administers

the day-to-day affairs of the Bank. Besides there is a "Committee of Treasury"

consisting of the Governor, the Deputy Governor and five Directors elected

from among the sixteen Directors. After nationalization certain important

powers have been conferred upon the Bank of England. Accordingly the Bank

is given specific statutory authority to issue directions to the commercial banks

with the approval of the ~reaswy~', Although the Bank of England is

27 In the terms of the Act of 1946 , members of the House of Commons, Ministers of the

Crown, Civil Servants and aliens should not be appointed to any of these offices. So also

persons over 66 years of age will not generally be appointed. See A.H.Hudson, Commercial

Banking Law (1 978), p.5

See Clause 3 of Clause 4 of the 1946 Act. This clause was subjected to vehement criticism.

It was feared that this would affect the traditional secrecy of the Banker-Customer

relationship. But the qualification added to this sub clause provide ample protection to this

secrecy.

endowed with such wide powers, it seldom uses its oficial authority over the

commercial banks29.

Another important change effected by the Act of 1946 is the power

given to the Treasury to issue directions to the Bank. This provision merely

formalizes the traditional relationship of the Treasury with the Bank of

England. Under the Act, " the Treasury may &om time to time give such

directions to the Bank, as after consultation with the Governor of the Bank,

they think necessary in the public interest3'".

As the Central Bank of the U.K. and as the channel of

communication between the Government and the privately owned banks, the

Bank of England exercises a general supervision" over the activities of those

other banks, makes known to them the wishes of the Government with regard

29 AS per section 4(1) of Bank of England Act, 1946, bank usually exercises its influence over

the commercial banks through the art of 'persuasion'. See R.R.Penington, A.H.Hudson,

Commercial Banking Law (1 978), p.7.

30 In the words o f Dr. Dalton " His Majesty's Govt. and British people felt that the time had

come for the close and intimate relationship existing between the Old Man of the Treasury

and the Old Lady of the Threadneedle Street to receive the sanction of law and the two

parties should be joined in lawful wedlock lest anybody should thing of the danger of their

living in sin". See, C.F.Dunbar, Theoqv and Practice of Banking (l948), p.80.

'' Discussed elsewhere, .lnfia. p.229.

to operations carried out by them which have a substantial effect on the

economy of the country and induces them by persuasion32 to conform to its

own and the Government's specific policy rules so as to ensure that the

banking system remains sound and meets the financial needs of the country.

The bank's powers to advice and persuade are reinforced by legal to

seek information and with the approval of the Treasury to issue directions and

to secure compliance with the recommendations made. In practice, the Bank

of England rarely exercises its legal power and when it does it uses them

merely to embody the requirements of Government monetary policy formally

and in a specific and detailed form.

The U.K. banking system is not a symmetrical or Logical structure, it

has grown up gradually over the last three centuries and is always undergoing

change. In many ways it is untidy and overlapping, but its virtues are its

flexibility and adaptability to new circumstances. And as such the law relating

to the banking system in the U.K. is equally unsystematic and uncertain.

The Ba& of England's functions are various and are nowhere

exhaustively catalogued in an Act of Parliament. The Bank of England's

32 Supra n. 1 .

3 9 a n k of England Act, 1946, s.4(3).

banking department maintains accounts for the Government and Central Banks

and for international authorities such as the IMF. The legal relationship

between the bank and these account-holders is precisely the same as that

between a commercial bank and its customers. But unlike the commercial

banks, the Bank of England does not offer the facilities of current accounts to

the public at large. Due to Bank of England's close connection with the

Government, it acts as the agent of the Treasury, the advisor and the financia1

adjutant of the Government in many different contexts. In short, the Bank of

England holds itself at the Government's disposal to give financial and

economic advice and to carry out specific missions on the Government's

behaIf such as raising loans and arranging currency exchange facilities with

foreign Governments and international monetary authorities.

Federal Reserve System

The Federal Reserve system" is the USA's central bank. It was

established by an act of Congress in 19 13 and consists of the seven members

of the Board of Governors in Washington D.C. and twelve Federal Reserve

District Banks. The Congress structured the Fed to be independent within the

Govt. that is although the Fed is accountable to the Congress, it is insulated

34 Called the "Fed" for short.

from day to day political pressures35. This reflects the conviction that the

people who control the country's money supply should be independent of the

people who h e the Govt.'s spending decisions36, What mmak the Fed

independent?37. Three structures make the Fed independent. Firstly,

appointment procedure for Governors, secondly, appointment procedure for

the Reserve Bank presidents, and lastly funding.

The seven Governors of the Federal Reserve Board are appointed by

the President of the U.S.A. and confirmed by the Senate. Independence is

derived from a couple of factors. First the appointments are staggered to reduce

the chance that a single U S President could "load" the Board with appointees,

35 Most studies of Central Bank independence rank the Fed among the most independent in

the world. It is so only in the sense that if decisions do not have to be ratified by the President

or any one else in the executive branch of the Govt. The Federal Reserve must work within

the framework of the overall objectives of economic and financial policy established by the

Govt. and thus the description of the system as " independent within the Govt." is more

accurate.

36 Woodrow, Central Banking-US. Monetary Policy: An introduction, via FRB San

Francisco (20001, p. 1.

37 It is a public institution with a public purpose, but it has some private features -Directors,

Stock holders and selling services. It is Governmental, but it is independent within the God.

The entire system is subject to oversight by the U S Congress because the Constitution gives

to Congress the power to coin money and set its value - a power that in the 191 3 Act the

Congress itself delegated to the Federal Reserve. Article ( I ) Section (8) of the Federal

Reserve Act, 19 1 3.

second their term of office is fourteen years- much longer than elected

officials' terms. After serving a few terms a Board member may not be re-

appointed. Two of them are appointed as the Chairman and Vice-Chairman.

Each Reserve Bank president is appointed for a five year term by

that Bank's Board of Directors, subject to final approval by the Board of

Governors and is the Chief Administrative Offlcer. This procedure adds to

independence because the Directors of each Reserve Bank are not chosen by

politicians but are selected to provide a cross section of interests within the

region, including those of Depository Institutions, non-financial businesses,

labour and the public. The Fed is structured to be self-sufficient in the sense

that it meets its operating expenses primarily from the interest earnings on its

portfolio of securities. Therefore it is independent of Congressional decisions

about appropriations38.

On analyzing these features one can see that on one hand though it

was created by and reports to Congress, its high officials, the members of the

board of governors are appointed by the President and confirmed by the Senate

. .-

38 Even though the Fed is independent of Congressional appropriations and administrative

control it is ultimately accountable to Congress and comes under Govt. audit and review. The

Fed also reports to Congress regarding its finances. Congress at any time can amend the

Federal Reserve Act.

and its earnings and assets ultimately are returned to the U S treasury. On the

other hand, the Fed operates on its own earnings rather than Congressional

appropriation, the Board of Governors' terms are long and staggered, limiting

the President's influence and unlike other nations. Central Banks it is separate

from the treasury39. Like those who guided the formation of the American

system of GOW. the framers of the Federal Reserve System were concerned

about vesting too much power especially money power in the hands of too few.

With this complicated system of checks and balances the Federal Reserve is

the unmistakable offspring of the American political This

complicated structure no doubt can be confusing but it ensures that the Fed's

decisions are broad - based and properly insulated from narrow and partisan

interests. In the end this structure helps the Fed accomplish its overall mission

that is fostering a sound financial system and a healthy economy4'.

39 Chairman, other Governors and Reserve Bank Presidents report regularly to the Congress

on monetary policy, regulatory policy and a variety of other issues and meet senior

administration officials to discuss the Federal Reserve's and the Federal Govt.'s economic

programmes.

40 Milton Friendrnann, A Monetary History of [he US. 1867-1960 (1 963), p. 14.

41 Bruce K. Maclaury , Perspectives on Federal Reserve independence- A changing structure

for changing times ( 1 976), p. 1.

The Banking Acts of 1933 and 1935 are important milestones in the

history of the Board of Governors. They considerably enlarge the power of the

Board, thus making it in effect a Central Bank of Central ~ a n k s ~ ~ . Originally

the Federal Reserve Board was composed of seven members, including five

appointed members, the secretary of the treasury who was ex-oficio chairman

of the Board and the Comptroller of the Currency. In 1922 the number of the

appointed members was increased to six. The Banking Act of 1935 changed

the name of the Federal Reserve Board to the Board of Governors of the

Federal Reserve System and provided that the Board should be composed of

seven appointed members, that the secretary of the treasury and the

Comptroller of the Currency should serve as members till 1'' Feb 1936 and that

the appointed members in ofice should continue to serve till lSt Feb 1936 or

until their successors were appointed and had qualified and that thereafter the

term of members should be fourteen years and that the designation of

Chairman and Vice-Chairman of the Board should be for a term of four

years43. The members of the Board are not allowed to resign their omce

before expiry of their terms and accept any position with a member bank

42 Clarence W. Nelson, Reflections from History - The Minneapolis Federal Reserve Bank

(1 9731, p. 7.

43 Speech by Richmond, Fed President, on Central BankingThen and now, (1978). Also

refer Banking Act of 1 93 5 .

within two years. In fact no other modem nation had ever undertaken through

democratic processes such complete and broad reform of its financial system.

The Board enjoys extensive powers. It is empowered to examine the books and

affairs of the Federal Reserve Banks and to require such statements and reports

as it may think necessary. Accordingly the Board examines the Federal

Reserve Banks at least once in a year and the member banks at least twice in a

year. It has also to publish a weekly statement showing the position of each

Federal Reserve Bank as regards assets and liabilities as well as a combined

statement for all Federal Reserve Banks. The Act further empowers it to

regulate margin requirements, maximum interest on Time Deposits and

Reserves of member banks. Originally the main responsibility in the

determination of Policy had been left with the different Federal Reserve Banks

because they were thought to be in more immediate contact with the economic

affairs of the several parts of the country and hence in a better position to

devise and execute appropriate policies. However subsequent amendments to

the Act gave the Board of Governors substantial powers in approving the

Discount Rate fmed by each Federal Reserve Bank and other credit policies44,

The board is further empowered to suspend the Reserve requirement for

member banks and Federal Reserve Banks for limited periods in times of

44 B.H.Beckhart, Federal Resewe Polices - Discussion (1 926), p.325.

emergency, suspend or remove the officers and Directors of any member banks

which continues to violate the law or engage in unsound banking practices

despite being warned.

The establishment of regulation that interprets the application of the

Federal Reserve Act is also vested with the ~ o a r d ~ ~ . But some economists do

not agree with the view that the U S Central Banking system is entirely an

independent one. Their argument is that all the fundamental Central Banking

operations are under the control of Governors of the Federal Reserve System

who are appointed by the President with the approval of the Senate.

Further the Chairman along with two other members of the Board of

Directors is chosen by the Board of Governors. In other words for all practical

purposes the American Central Banking System is administered by men

appointed by the Govt. of that country46.

Bank Of Japan

Bank of Japan is the Central Bank of Japan. The Japanese

Banking System is a highly segmented structure that includes various types of

45 A.Frederick Bradford, The Banking Act of 1935 (I 935), p.667.

46 J. William Brown, The Dual Banking System in the United States (1 968), p. 6 .

private institutions as well as several Govt. institutions and Japan's Central

~ a n k ' ~ . In Japan two entities are responsible for ensuring the safety and

soundness of the nation's banking system - Ministry of ~ i n a n c e ~ ~ and the

Bank of ~ a ~ a n ~ ~ . MOF as a Governmental Agency has the sole responsibility

for licensing banking institutions and for developing and enforcing banking

regulations. Although both MOF and BOJ have responsibilities for the safety

and soundness of the financial system, the basis for their respective authority is

different and they function largely independent of each others0.

MOF is headed by the Ministry of Finance, a Cabinet Member

appointed by the Prime Minister. The Ministry is one of twelve Ministries

reporting to the PM. MOF's organizational structure consists of one

'' This smcture is a legacy of Reforms originally instituted to promote economic recovery

during the post World War LI period.

48 Called MOF for short.

49 Called BOJ for short.

SO The Japanese Parliamentary System and Japanese Law gives MOF wide ranging and

diverse responsibilities to supervise and inspect financial institutions. In contrast BOJ's

oversight authority is obtained through its contractual agreements with client financial

institutions. Only MOF has the legal authority to take enforcement actions against financial

institutions. BOJ has no legal authority to do this.

Secretariat and seven ~ureau?'. The Banking Bureau is the main bureau

responsible for regulatory guidance and supervision of ~ a n k s ~ ~ . BOJ is headed

by its Governor. Governor is appointed by the Cabinet for a term of five years

and may be reappointedH. The Governor is the link between the Bank's

executive board and BOJ's policy board. The policy board which is the BOJ's

highest decision making body is the sole decision making body for monetary

policy". Board Members includes BOJ's Governor and representatives from

MOF, the Economic Planning Agency and four individuals with experience in

and knowledge of banking, commerce , manufacturing or agriculture.

Government Representatives from MOF and Economic Planning

Agency are non-voting members. The four knowledgeable and experienced

31 The seven bureaus are Budget, Tax, Customs and Tariff, Financial , Securities, Banking

and International Finance.

52 The Banking Bureau consists of five divisions and one department- three divisions-

commercial banks division, special banks division and small banks division share

responsibilities for providing supervision and regulatory guidance to banks. J.B.Hal1

Maxmillan, Financial Reform i~ Japan (1998), p.32.

53 Historically BOJ Governors have alternated between individuals with MOF or BOJ

backgrounds.

54 The Policy Board was established in 1949 by amendments in the 1942 Bank of Japan Law.

The amendments were in response to a desire to modemi= the Japanese monetary and

economic system and to enhance BOJ's independence. Refer Indicative Planning in Japan,

Journal of Comparative Economics, Volume XIV 4' Nov. (1 990), p.74.

members who are appointed by the Cabinet with approval from the DIET^*,

serve renewable four year terms without restrictions.

MOF plays an active role in approving key appointments and

fmancial assistance decisions. The Minister of Finance appoints the Governor

and MOF approves the Executive Directors and Committee Member

appointments to Deposit Insurance Corporation. According to Bank Officials

MOF has the authority to correct the operations of a troubled financial

institution.

It can also remove Bank Managers fiom their positions and order

the restructuring of a Bank's Management or suspension of its business if

violations of Law and Regulations are found. Although MOF has such legal

enforcement authority, until recently it has not been used56. The formulation,

55 The national legslabre of Japan.

'' Banking Industry Representatives are of the opinion that M 0 F prefers to rely on

administrative guidance as its primary means of enforcement. This guidance basically

involves the agency interpreting existing laws and regulations and providing these

interpretations to Banks. This guidance can be either oral or written. M 0 F sees this

flexibility as one advantage of administrative guidmce and they prefer this than initiating

legal proceedings in the Japanese Court system which can be a lengthy process. Although this

guidance is not legally enforceable Govt. officials and Bankers say that Banks are expected to

act on it and they typically do. The Economist (200 I), Japanese Banks, London, 27'h

January.

execution and coordination of the national budget allows MOF to play a

pivotal role within the National Govt., this role currently includes approving

BOJ's Budget. Japan's Banking Reforms are lessons for the Indian financial

sector because the world watched with bated breath as Japan faced the worst

economic crisis since the second world war. The cause of the problem was the

overhauling of the banking sector choked with bad loans in the heydays of the

1 980's5'.

The investigation shows that in the World over central bankers have

been playing a very crucial role in stimulating the growth of national economy.

The goals of a country's economic policy provide the context for the

firnctioning of a Central Bank. This being the position in other countries, it is

necessary at this juncture to analyse the structure and functioning of the

Central Banking in India.

57 Source: Report of the Banking Regulatory structure in Japan for 75 years from 192 1 - 1 996 (1 996).