Conflicts of Interest at the National Bank: Why Supervision Must Be Separated

I was recently invited to a meeting with the National Bank of Kazakhstan as an expert. They explained why they had cut the base rate. But this post is not about that. Sitting in the National Bank, I realized that an organization with so many conflicts of interest simply cannot work effectively under any leadership, no matter who is put in charge.

Judge for yourself:

1. Economic growth vs. inflation

The National Bank is now responsible for economic growth, even though under current conditions this goal runs directly counter to the inflation goal. Boosting economic demand requires cheap money and nominal demand, which will fuel inflation. Containing inflation in the short term requires high rates and a reduction in nominal demand. Either way, something will suffer)

2. The UAPF (Unified Accumulative Pension Fund) is such a tangle that it is easy to get lost. First, the UAPF needs returns above inflation, so the lower inflation is, the easier it is to deliver that result. But there is a catch: the government compensates the difference between returns and inflation. That means the higher inflation is, the more the government pays out. So inflation is in your hands, and you can come up with something. But that is not the worst of it. The National Bank knows the quality of every bank, and with that knowledge no sensible manager would put money into a bank at a default-level risk. Yet the National Bank has nowhere to turn, and it can use pensioners' money to solve the liquidity problems of individual banks.

And then it gets worse. A bank is on its knees, and by all the rules of business it should be put into bankruptcy. But there is a problem: a huge amount of pensioners' money is sitting there, and if you bankrupt the bank now, you will face such criticism from all sides that it is better not to solve the bank's problem but to throw some more money at it, which makes the problem even harder to solve in the future. Moreover, providing short-term unsecured liquidity increases the money supply and puts renewed pressure on inflation, which then collides with the National Bank's role of keeping inflation in check.

3. Bank regulation. This is a separate story. The National Bank inspects second-tier banks and knows which of them have long had negative capital, which have zero capital, and which are more or less sound. But then it starts thinking about the systemic risks to the entire banking system and concludes that disclosing the facts to the market now would lead to a collapse. So it does not disclose them. If these were separate bodies, the picture would have been disclosed long ago and all the necessary decisions taken. Instead, because of pension assets and pressure from shareholders, the government and many other quarters, the real picture has to stay hidden, and yet there is no embarrassment about asking for KZT 2 trillion to resolve the banking sector's problems, while portraying problem assets as a mere KZT 1 trillion.

4. The Problem Loans Fund is also under the National Bank. In theory, this fund also comes into conflict with the National Bank, because it has to buy assets at a fair price, and that requires proper valuation and the right instruments. But here, too, pressure arises: if the Problem Loans Fund buys loans at fair value, all the banks will be exposed, and they will need recapitalization and/or bankruptcy, and so on.

And if the Fund buys from some banks on better terms and from others on worse terms, pressure on the National Bank will begin, along with reproaches that its decisions are unfair and that it is dependent on bank shareholders, and so on.

In short, the National Bank is not to be envied in the current situation, and the problem is not its staff. There are a great many capable people there, and the quality of its analysis is quite good. What is needed is reform of the National Bank itself, and it is obvious that without this reform, reforming the entire banking system is even more dangerous.

It is clear that the National Bank must lose the supervision function, the management of the UAPF and the management of the Problem Loans Fund.

That's about it)