Towards a new paradigm in the COVID-19 Era (Two)

Central Bank Accountability:

As noted in the first part of this series, of those who run the central bank, the most important, in my opinion, is the board, which is sacrosanct and must be maintained so. Thus, the first line of accountability would have to be the board of the central bank and it must be made accountable to the people in the respective countries. That said, what are the changes required to ensure this? Specifically, this, in effect, would translate into the following:

1. Using the board as the key evaluator of central bank’s performance: Treating the board as the key evaluator of the central bank’s performance[2] and that of the governor[3] (both as a leader and manager). The nonexecutive (independent) members must be capable of performing this task appropriately and independently. The central bank should also establish and use an independent ‘lead nonexecutive director’ position and facilitate regular independent meetings of the nonexecutive directors (alone) so that the above is achieved in an objective manner. The key here is to push the central bank from being an individual led institution to one that is collectively governed by a set of responsible and independent persons, accountable to the society at large (within the respective countries).
   

The monetary policy function alone may be exempt from the purview of the central board and left to the monetary policy committee (MPC or equivalent)—a statutory committee with the highest levels of governance and with members appointed through due and proper process by a non-partisan committee of the highest legislative body in the respective countries.  The complete minutes of the MPC or equivalent have to be published within twenty four hours of its every meeting on the central bank website and be available for the larger general public. This transparency will ensure that the MPC functions with the highest levels of transparency, integrity and accountability. All of the procedural criteria suggested for appointing members to the central bank board (discussed briefly below and also in a subsequent article) would also apply for appointing members to the MPC. Of course, the MPC would also require additional qualifications, which the non-partisan committee of the highest legislature may stipulate in accordance with the context of the country and the prevailing economic situation and especially, given the on-going COVID-19 crisis.

1. Ensuring a transparent board appointment process: As noted above, competency-based processes must be used for the selection of people (who have the capacity, ethics, skills, and orientation) to serve on the central board. Filling up vacancies on the central bank board should thus be through a proper procedure, involving a search and selection committee (having the highest integrity without conflicts of interest) and with at least two to four names being proposed for each board vacancy.

While the finance ministry (or treasury department or equivalent) in the respective country can easily set up the search and selection committee, alternatively, the same can be performed by a high level non-partisan committee dealing with finance in the highest elected legislature of the respective countries. For example, it could be the parliamentary standing committee in India or the equivalent Senate committee on finance/treasury in the United States. This will set the highest standards of corporate governance in the selection of board members to the central bank as an institution.

If the appointment of board members is compromised, then corporate governance and accountability of the central bank as an institution (and, more importantly, as the country’s central bank) would suffer, as seems to have been the case in several situations. Proper attention must be paid to taking care of the reverse revolving door and revolving door phenomenon discussed in detail in a subsequent article in this series, and it is critical that they are stopped once and for all.   

Thus, the need of the hour is a transparent board appointment policy for the central bank and this policy must also ensure that directors have adequate skills and experience (apart from the availability of time to do their job effectively). The policy must also ensure that the overall composition of the central bank’s board of directors is suitably diverse—including more women, youth, and individuals with the requisite skills (and appropriate backgrounds) on the central bank board is perhaps a way to improve the board’s overall functioning and effectiveness. The policy must also ensure that conflict of interest issues are taken into account with regard to board appointments, so that the independence of the nonexecutive directors is not compromised under any circumstances (whatsoever). 

1. Establishing critical non-negotiables for board composition: People who have an ongoing direct commercial interest in the provision of financial services (through their direct/indirect involvement with DFIs, commercial and investment banking companies, NBFIs, FINTECH companies, MFIs including equity investments in such institutions and other related institutions) should not be appointed to the board of the central bank. This single step should go a long way to enhancing the accountability of the central bank as an institution and must be implemented forthwith. Likewise, relatives and/or very close friends of the central bank staff (including the governor or deputy governors and their equivalents, executive directors and other board members) should not be appointed to the central bank board. Similarly, it may be wise to keep politicians out of the central bank board. Let me make one thing clear here. This is not an exhaustive list of people who should not be appointed to the central bank board. Rather, it must be viewed as a starter set that provides examples of the kinds of relationships that are better avoided to enable effective functioning of the central bank board and, more importantly, facilitate public confidence with regard to the same.

Otherwise, serious conflicts of interests and related situations, as has happened in past crisis situations could happen here, much to the detriment of the reputation of the central bank. This is not to be construed that people with a background in economics, finance, business administration, and related areas should not be appointed to the central bank board. They can be, provided they meet the minimum non-negotiable criteria, such as those mentioned.

Look at it this way. The central bank is the regulator and supervisor of the financial sector in the respective countries and the board is involved in many critical deliberations related to the financial sector. What assurance can the central bank board provide that these important discussions and decisions will not be shared by nonexecutive directors with their parent (or related) organizations that have some form of commercial interest in the financial sector? Providing central bank board membership to anyone connected with institutions that have a strong commercial interest in the financial sector will, for the above-mentioned reasons, give undue advantage to these institutions as they will gain access to what economists often call superior information.

This is not to say that people who have in the past served in organizations with a commercial interest in the financial sector cannot become board members of the central bank. Maintaining a requisite cooling period of at least 2 or 3 years before they are appointed to the central bank board seems an advisable strategy. All in all, it would be prudent and appropriate if those with strong, ongoing commercial interests in the financial sector are not made board members of the central bank. And neither should people who are part of entities[4] that come under the regulation and/or supervision of the central bank be appointed to the central bank board. These norms must be enforced in real time, without fear or favor. In other words, there must be no exceptions to this under any circumstances what-so-ever. The board composition aspect, which is crucial to the accountability of a central bank, is discussed in detail in a subsequent article (as noted earlier).

1. Circumscribing the term of a central bank board member: Restricting board membership for people on the central bank board to a maximum of eight years or at the most, two terms—whichever is less—and ensuring regular induction of new members is critical. When board members get older than the furniture in the boardroom, experience suggests that they could be compromised in different ways, and therefore, ‘unrestricted board terms’ as practice, is better avoided. This needs to be implemented immediately at all central banks.

1. Facilitating evaluation of board member performance: Having a compulsory formal evaluation of the functioning of the central bank’s board of directors by an external independent evaluator is necessary. The results of this evaluation should be made available to the public—officially publishing the evaluation (on their website) is an aspect that could also be considered by the concerned central bank. Independent evaluators—individuals and/or institutions—must not have had a material relationship (as defined in common parlance) with the central bank and or their financial sector. They could be specialized governance experts with sufficient exposure to laws of the land and various sectors of the economy in general.

1. Ensuring that central bank board members do not get involved in non-board activities: Ensuring that board members do not head or serve on other central bank committees (outside of the board) concurrently is a very important issue. The central bank board’s primary task, as noted earlier, is very clear—to monitor the central bank’s performance and that of its executives, including the governor and deputy governor (or equivalents), and act as the first stage of defence in the multi-layered accountability mechanism. That being the case, they cannot and should not serve on any committees other than board subcommittees as they would, as part of the board duties, have a role in evaluating the functioning of these (non-board) committees.

1. Reducing key person dependence: Key person dependence at central banks is especially common. This is bad practice of corporate governance and it reduces the accountability of the central bank as an institution. I am not sure that any central bank is acting with accountability, when it puts a single board member on many non-board committees and panels, which the board {of which (s)he is part} will ultimately have to evaluate! And matters get worse if the person concerned has links with commercial entities involved with the financial services sector, as undue conflicts of interest will (then) arise.

1. Emphasizing procedural accountability: If you look at the lessons from past crisis situations (whether the U.S. subprime crisis of 2007/8, or the 2010 Indian microfinance crisis in AP or 2018 Indian financial sector crisis encompassing the IL&FS case as well as the PNB scam), a key aspect to consider is procedural accountability, whereby professionals with an active commercial interest in the financial sector are neither made part of the central bank board, nor committees recommending regulatory and supervisory norms for the larger financial sector.

1. Adopting an official formal code of conduct publicly: Lastly, an official code of conduct needs to be formally and publicly adopted by the central bank board with regard to various aspects, including activities and roles that board members can engage in (as board members of the central bank) and disclosures to be made to them with regard to conflicts of interest and several other issues.

Overall, what needs to be emphasized here is that central banks have fair practice and other such codes for various stakeholders including DFIs and FIs like commercial and investment banks, NBFIs, FINTECH companies, MFIs and others. Is it not fair that the central bank has an official code adopted formally for its board and staff? And once adopted formally, it should be available publicly and board members would have to make appropriate disclosures as per the code. This is a very simple task to set the ball rolling for greater institutional accountability, and central bank heads must push hard to get this done quickly so that the central bank becomes the change it wants to ultimately see on the ground in its financial sector. 

Regarding long-term accountability, the head of the central bank and his/her key deputies and/or senior personnel must be required to depose once in every three months before a select special high powered non-partisan committee of the highest legislature of the country concerned. It could be a committee of the parliament as in India or a committee of the U.S. Congress or likewise in other countries. And the minutes of this disposition must be made available to the public at large through the websites of the highest legislative body as well as that of the central bank. This transparency is critical and will bring in the much needed accountability.

Thus, accountability and ethics are crucial to the survival of the financial sector and there is no doubt that there has been a systemic breakdown in accountability and ethics globally across the financial sector in the past few years, leading to various forms of economic crises, the effects of which we are still experiencing.

As all of you would agree, the integrity and credibility of financial markets and peoples’ trust in these markets are of paramount importance to the economic health of countries—there is no exception to this basic dictum and more so today, than ever, because COVID-19 is ravaging our economies. The stability, soundness, safety, inclusiveness and sustained prosperity of each and every country’s financial system and larger economy rely fundamentally on the notions of fairness, transparency, and accountability. In other words, central banks must ensure this happens consistently at all levels in the financial sector, whereby the concerned stakeholders (be it regulators, supervisors, DFIs, commercial and investment banks, NBFIs, new age FIs, FinTech firms, MFIs, and others) produce services of high quality and conduct themselves fairly and with a high degree of integrity, transparency and accountability.

The central bank in each respective country must start to facilitate this process of metamorphosis, which is required now, more than ever before—again because of the devastating short- and medium-term impact of COVID-19, which is still on-going. Unless the central bank and other financial service regulators become the change they want to see in the financial sector, I am afraid there will be very little action on the ground in terms of accountability. Without accountability and ethics among financial service regulators and supervisors, ensuring financial stability and achieving universal inclusion would become a very onerous task indeed.

To achieve this in real time implementation, appropriate composition of the board of regulatory bodies including central banks becomes a crucial aspect, along with the need to stop the unacceptable practice of revolving and reverse revolving door phenomenon—both of these are discussed in greater detail in subsequent articles in this ‘central bank accountability’ series.

[1] RAMESH SRIVATSAVA ARUNACHALAM is a board member of the Financial Inclusion Advocacy Centre (FIAC), Ghana and UK. He is also a partner in ASCENSION ADVISORY (India), under incorporation. He is the author of 14 critically acclaimed books. Ramesh also provides strategic advice on a wide variety of Financial Sector, Financial Inclusion and Economic Development issues. He has worked in over 314 assignments with multi-laterals, governments, private sector, Banks, NBFCs, DFIs, regulators, supervisors, MFIs and other stakeholders in 31 countries across 5 continents and 680 districts of India during the last 32 years. He can be contacted at [email protected] and +919962815615.

[2] The evaluation of performance would exclude monetary policy, which would be dealt with separately by a monetary policy committee and/or equivalent.

[3] Or whatever, the head of the central bank is called.

[4] The entities could come under direct supervision of the central bank or in many instances, they come under what is typically called the category of ‘third parties’ who also need close supervision. An example of this would be information technology service providers.