Bank for International Settlements

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BIS Headquarters in Basel

The Bank for International Settlements (or BIS) is an international organization of central banks which exists to "foster cooperation among central banks and other agencies in pursuit of monetary and financial stability". It carries out its work through subcommittees, the secretariats it hosts, and through its annual General Meeting of all members. The BIS also provides banking services, but only to central banks, or to international organizations like itself. Based in Basel, Switzerland, the BIS was established by the Hague agreement of 1930.

1 Organization of central banks
- 1.1 Regulates capital adequacy
- 1.2 Encourages reserve transparency
2 Tier 1 vs. Total capital
3 Goal: a financial safety net
4 History
5 Role in banking supervision
- 5.1 Criticism
6 Management
7 See also
8 External links

[edit] Organization of central banks

As an organization of central banks, the BIS seeks to make monetary policy more predictable and transparent among its 55 member central banks. While monetary policy is determined by each sovereign nation, it is subject to central and private banking scrutiny and potentially to speculation that affects foreign exchange rates and especially the fate of export economies. Failures to keep monetary policy in line with reality and make monetary reforms in time, preferably as a simultaneous policy among all 55 member banks and also the International Monetary Fund, have historically led to losses in the billions as banks try to maintain a policy using open market methods that have proven to be unrealistic. Contrary to most economists' perceptions, central banks do not unilaterally "set" rates, they set goals and intervene using their massive financial resources and regulatory powers to achieve monetary targets they set. One reason to coordinate policy closely is to ensure that this does not become too expensive and that opportunities for private arbitrage exploiting shifts in policy or difference in policy, are rare and quickly removed.

Two aspects of monetary policy have proven to be particularly sensitive, and the BIS therefore has two specific goals: to regulate capital adequacy and make reserve requirements transparent.

[edit] Regulates capital adequacy

Capital adequacy policy applies to equity and capital assets. These can be overvalued in many circumstances. Accordingly the BIS requires bank capital/asset ratio to be above a prescribed minimum international standard, for the protection of all central banks involved. The BIS' main role is in setting capital adequacy requirements. From an international point of view, ensuring capital adequacy is the most important problem between central banks, as speculative lending based on inadequate underlying capital and widely varying liability rules causes economic crises as "bad money drives out good" (Gresham's Law). Specific policies are explained below.

[edit] Encourages reserve transparency

Reserve policy is also important, especially to consumers and the domestic economy. To insure liquidity and limit liability to the larger economy, banks cannot create money in specific industries or regions without limit. To make bank depositing and borrowing safer for customers and reduce risk of bank runs, banks are required to set aside or "reserve".

Reserve policy is harder to standardize as it depends on local conditions and is often fine-tuned to make industry-specific or region-specific changes, especially within large developing nations. For instance, the People's Bank of China requires urban banks to hold 7% reserves while letting rural banks continue to hold only 6%, and simultaneously telling all banks that reserve requirements on certain overheated industries would rise sharply or penalties would be laid if investments in them did not stop completely. The PBoC is thus unusual in acting as a national bank, focused on the country not on the currency, but its desire to control asset inflation is increasingly shared among BIS members who fear "bubbles", and among exporting countries that find it difficult to manage the diverse requirements of the domestic economy, especially rural agriculture, and an export economy, especially in manufactured goods. Effectively, the PBoC sets different reserve levels for domestic and export styles of development. Historically, the US also did this, by dividing federal monetary management into nine regions, in which the less-developed Western US had looser policies.

For various reasons it has become quite difficult to accurately assess reserves on more than simple loan instruments, and this plus the regional differences has tended to discourage standardizing any reserve rules at the global BIS scale. Historically, the BIS did set some standards which favoured lending money to private landowners (at about 5 to 1) and for-profit corporations (at about 2 to 1) over loans to individuals. These distinctions reflecting classical economics were superseded by policies relying on undifferentiated market values - more in line with neoclassical economics.

[edit] Tier 1 vs. Total capital

The BIS sets "requirements on two categories of capital, Tier 1 capital and Total capital. Tier 1 capital is the book value of its stock plus retained earnings. Tier 2 capital is loan-loss reserves plus subordinated debt. Total capital is the sum of Tier 1 and Tier 2 capital. Tier 1 capital must be at least 4% of total risk-weighted assets. Total capital must be at least 8% of total risk-weighted assets. When a bank creates a deposit to fund a loan, its assets and liabilities increase equally, with no increase in equity. That causes its capital ratio to drop. Thus the capital requirement limits the total amount of credit that a bank may issue. It is important to note that the capital requirement applies to assets while the bank reserve requirement applies to liabilities." - from an extremely detailed and robust account of the use of reserve policy and other central bank powers in China by Henry C.K. Liu.

[edit] Goal: a financial safety net

The relatively narrow role the BIS plays today does not reflect its ambitions or historical role.

A "well-designed financial safety net, supported by strong prudential regulation and supervision, effective laws that are enforced, and sound accounting and disclosure regimes," are among the Bank's goals. In fact they have been in its mandate since its founding in 1930 as a means to enforce the Treaty of Versailles. See history below.

The BIS has historically had less power to enfore this "safety net" than it deems necessary. Recent head Andrew Crocket has bemoaned its inability to "hardwire the credit culture," characterizing many specific attempts to address specific concerns with growth of Offshore Financial Centres (OFCs), Highly Leveraged Institutions (HLIs), Large and Complex Financial Institutions (LCFIs), deposit insurance and especially the spread of money laundering and accounting scandals.

[edit] Dollar hegemony

Originally the BIS was intended to make sure that no one country could destabilize world currency. However, since the collapse of Bretton Woods in 1971, the US has effectively anchored the world's money with its own fiat currency, resulting in what is sometimes called dollar hegemony , a term coined by Henry C.K. Liu in 2002. In his 1975 book Money: Whence it came, where it went, John Kenneth Galbraith characterized one of the problems of the new arrangement being that the US became obligated to control inflation to a perhaps unreasonable degree, since other countries would suffer inflation whenever the US did. Alan Greenspan, who retired more or less coincident with the loss of the M3 indicator, was often criticized for focusing overmuch on inflation, but this tendency according to Galbraith was and is an inherent problem of the US dollar fiat economy.

Liu is even more critical of the problems it causes, notably distraction of domestic economic and social development efforts by constant unlimited exposure to the global financial markets and the export markets: without effective global capital adequacy and reserve requirements placed on the US, and without any mechanism to compensate for the effects of US inflation or asset bubbles on the rest of the world, a labour-exporting country will necessarily be subject to boom and bust and a permanent subordinate position in the global economy. The International Monetary Fund, more than the BIS, is implicated in this problem, as are of course most national governments which focus on export and GDP to the neglect of domestic demands, well-being and local resilience.

[edit] Natural capital

Aside from these technical concerns, the more fundamental problem of natural capital adequacy is not addressed at all by the bank, though some major international agreements have called for some such mechanism to address abuse of natural assets like the Earth's atmosphere or natural water filtration or pollination capacity. A 1995 study by Robert Costanza stated that 17 of nature's services to human society were in that year providing US$33T of value to human beings, mostly by making agriculture function at all. Valuations of agricultural assets or equipment in particular are extremely volatile when climate change, deforestation, pesticide runoff and other damage to underlying natural capital measures, remain invisible to the global financial system. Likewise, technologies with high liabilities but high cash payoffs are very attractive to banks, and there is no inhibition on their deployment in the current BIS regime.

One potential remedy to this problem would be to advise and reward a tiered reserve structure that would systematically encourage investment in sustainable development to reduce fundamental risk. Another would be to require explicit capital adequacy measures, as the United Nations ICLEI agency recommends for local governments: the ecoBudget measure.

[edit] Debt load

Many nations have a public debt load that they cannot possibly repay, and this too depresses the value of their labour and human capital by moving funds that could pay for local development to the creditor abroad. Reserve policy and capital adequacy requirements are two mechanisms that could be used to reward debt relief without directly requiring transfers of funds from debt-relieving governments to debt-holding banks. While there are some problems in guaranteeing that such methods are not abused for political purposes, the problems of debt-laden economies failing to feed, educate or fully employ their citizens tend to be substantially worse, and present risks to all investors.

The United Nations ICLEI triple bottom line reporting mechanism, though restricted to local government, has been proposed from time to time as a means of identifying regions that are systematically unable to cope with ecological and social problems due to debt repayment obligations. Concentrations of such communities would indicate a problem that was likely to spread to the whole national economy and possibly destabilize regions, suggesting some interventions including debt relief may be required. Using reserve requirements for this tends to be easier politically on the intervening nations than "printing money" to do so, and since relief is a global risk, an institution like the BIS could reasonably be expected to coordinate the action.

[edit] Export vs. domestic

Historically there have been many debates about the relative desirability of industrial development policies focused on exporting versus developing for local needs. The US, for instance, developed its giant economy almost entirely on domestic demand, benefitting from close coordination of supply and demand. Other developed nations did the same. Until 1970 this was considered the dominant and probably only proven model of development, and certainly was much more stable than relying on fickle export commodity markets. However, the collapse of Bretton Woods and the use of the US dollar as fiat currency made it systematically far easier to repay debts or raise capital in an export-focused economy. Even those nations focusing on domestic needs were competing globally for the capital and consumable inputs, and found these hard to acquire with anything other than US$.

Despite the inherent fundamental inefficiency of moving inputs vast distances to labour that had to be retrained to meet non-local needs, and then exporting to buyers again over vast distances, there was no easy way to participate in the global economy, and also no way to buy oil, without US$ - the shift to oil-based fleets thus likewise forced most economies into an overheated export market to acquire fiat dollars. This pattern continues even among nations that have no need to buy from the US. Nations that insisted on continuing a national development pattern tended to be isolated.

While there are important political and technology transfer benefits from export economies, in general an export economy has radically different vulnerabilities and opportunities and cycles than domestic production. It is generally agreed that capital adequacy and reserve requirements should be higher for volatile export businesses, or those that are dependent on them. However most central banks have made no explicit provision for this. China (and historically the US) are key exceptions.

Asset inflation bubbles can also be quite localized, and can easily "boom and bust" if they rely overmuch on an export economy or foreign investment. This can affect neighbouring countries and can even, as in the case of Argentina and Mexico, require massive intervention by neighbours to "bail out" an economy. This rarely or never happens to a self-sufficient domestic economy, but this fundamental difference in risk profiles is very poorly reflected in monetary policy. The Chinese imposition of a 1% greater reserve requirement on the export-focused urban economy may be indicating that all vulnerable economies should be encouraged, or even required, to impose similar requirements.

[edit] History

Despite its recent history of taking a narrow central bank mediation role, the BIS was originally formed to facilitate money transfers arising from settling an obligation arising from a peace treaty. After World War I, the need for the bank was suggested in 1929 by the Young Committee, as a means of transfer for German reparations payments - see Treaty of Versailles. The plan was agreed in August of that year at a conference at the Hague, and a charter for the bank was drafted at the International Bankers Conference at Baden Baden in November. The charter was adopted at a second Hague Conference on January 20, 1930.

The BIS was originally owned by both the governments and private individuals, since the United States and France had decided to sell some of their shares to private investors. BIS shares traded on stock markets, which makes the bank a unique organisation: an international organisation (in the technical sense of public international law), yet with private shareholders. Many central banks had similarly started as such private institutions, for example the Bank of England was privately owned until 1946. In more recent years the BIS has forcibly bought back all shares held by private investors, and is now wholly owned by its member central banks.

Since 2004, the BIS has published its accounts in terms of Special Drawing Rights, or SDRs, replacing the Gold Franc as the bank's unit of account. As of March 31, 2005, the bank had total assets of U.S. $272 billion, given a dollar/SDR exchange rate of 1.51 for that date. Included in that total were gold reserves of 712 tonnes, assuming a SDR gold price of 283 units per ounce.

[edit] Role in banking supervision

The BIS provides the Basel Committee on Banking Supervision with its twelve-member secretariat, and with it has played a central role in establishing the Basel Capital Accords of 1988 and 2004. There remain significant differences between US, EU and UN officials regarding the degree of capital adequacy and reserve controls that global banking now requires. Put extremely simply, the US as of 2006 favoured strong strict central controls in the spirit of the original 1988 accords, the EU was more inclined to a distributed system managed collectively with a committee able to approve some exceptions. The UN agencies especially ICLEI are firmly committed to fundamental risk measures: the so-called triple bottom line and were becoming critical of central banking as an institutional structure for ignoring fundamental risks in favour of technical risk management.

[edit] Criticism

The UN agencies are echoing a broader complaint. Critics of capitalism as presently managed, including George Soros (who personally made billions exploiting the UK's clumsy attempts to prop up the pound sterling), argue that there is no will to enforce any significant regulation in the present competitive financial industry, where nations effectively compete to offer less regulation.

These critics often plead for a stronger role for the BIS in part as a hedge against the ideology prevailing at the International Monetary Fund, which has proven to be disastrous in quite a few cases. Strict reserve and capital discipline based on a non-ideological analysis of fundamental liabilities and rationally and scientifically expected risk would be far less likely, argue the critics, to be subordinated to a passing fashion in development policy.

For instance, regarding climate change, all of the living Nobel Prize scientists in the world signed a letter stating that the evidence for it was overwhelming and action was required. It is quite difficult to find any technical economic policy that has a similarly unanimous support, yet the IMF experts are often in a position to impose such fashions, while science is not reflected in central bank decision making.

Other doubts about the BIS's mandate, its program, its effectiveness, and the desirability of any existing institution taking the lead role in accounting reform, especially in light of serious failures of money-laundering law enforcement, major breaches of prudence and supervision in the United States (e.g. Enron), have led to some minor critique of the BIS in the anti-capitalism and anti-globalization movements. This is incidental usually to critiques of the IMF and World Bank, whose role is far more visible, and which have far more discretion in their policy.

The BIS is also a frequent target of allegations by conspiracy theorists, many of whom portray it as a front organisation through which a wealthy elite controls the world. Some argue that the bank has not helped matters through a culture of secretiveness, and that lack of information always encourages some people to imagine what they do not know.

"Another fly in the ointment has been the recent Nazi gold controversy, in which it was indicated that venerable Basel – and, more specifically, the little-known but extremely powerful Bank for International Settlements headquartered in the city – spent the 1930s and ’40s quietly laundering the Nazis’ ill-gotten gains under a cloak of neutrality. Evidence of such murky banking practice was received with shock, anger and disbelief in Basel and around the country, and has yet to be fully accepted. Unaccustomed to being faced with pointing fingers, Baslers may take some decades to assess and absorb the accusations." (quote: http://switzerland.isyours.com/e/guide/basel/index.html)