Stirring Trouble in The Georgian Banking Sector
Who should be supervising the activities of commercial banks in Georgia? Currently this responsibility lies with the country’s National Bank. However, the Georgian parliament will soon be deciding on a new legislation, which, if passed, could take away the supervisory role from NBG and transfer it to an independent agency reporting directly to the prime minister. At the same time, the President of Georgia, Giorgi Margvelashvili vowed to veto the bill, if it is passed by the Parliament, citing economic concerns.
So, why does this particular piece of legislation ignite political battles? And why does the Parliament want to shake up the country’s financial architecture now, when consumer and business confidence are at such low levels, and when there is so much uncertainty about the real economy?
THE POLITICAL CONTEXT
The proposed reforms must be seen in the context of the political “war of words” between the ruling Georgian Dream coalition and the National Bank’s leadership, which has been ongoing ever since the Georgian Lari started to slide against the US dollar in December 2014.
Since Georgia is still largely a dollarized economy, with more than half of all loans denominated in USD, the government came under huge popular pressure to “stop” the slide of the Lari against the dollar.
At the same time, taking full advantage of its independent status, the National Bank did not want to give in under pressure. NBG argued that a certain degree of currency devaluation was inevitable. On the one hand, the country is receiving less foreign cash from exports, caused by lower demand for Georgian goods in several partner countries – Azerbaijan, Armenia, Ukraine, and Russia. On the other hand, foreigners are investing less, and Georgians working abroad are sending less money back home. All of this naturally leads to a strengthening of all major currencies against the Lari.
There are several ways the Lari value could bounce back. The ideal scenario, requiring no sacrifices, would involve an increase in Georgia’s exports or a surge in investment and remittances from abroad. But the likelihood of this happening any time soon is quite low, given the broader picture of a region-wide economic slowdown. The other possibility is that Georgians (households, firms and the government) start buying less foreign goods, and thus reduce the demand for foreign currency on the market. This scenario is more painful, and can lead to lower growth or a recession.
The National Bank warned that an attempt to fight devaluation by any other means, namely by trying to supplement the lack of USD on the market with the country’s foreign exchange reserves, would have disastrous consequences, such as a Latin American-style currency crisis.
The NBG argued, in addition, that inflation is not picking up despite devaluation, remaining well below the rate that would require monetary policy intervention. In such a context any attempt to fix the exchange rate would only encourage speculators.
Indeed, Georgia’s foreign reserve levels are nearing the critical threshold of 3 months’ worth of imports, certainly not enough to allow frequent (or massive) interventions. If the National Bank tries to fix the exchange rate, the speculators will bet on depreciation by borrowing Lari and buying up the country’s stock of foreign currency reserves (at the low fixed rate). The National Bank will have to abandon the fixed rate once its foreign currency reserves run out, allowing the speculators to sell foreign currency at a price (in Lari terms) much higher than the fixed rate at which they have bought it initially, and thus make a nice profit.
While these arguments are well known to banking experts and macroeconomists worldwide, they failed to impress the majority of Georgian legislators. The allegations that commercial banks were manipulating the exchange rate for their own profit, while the NBG was turning a blind eye, started gaining momentum. Some legislators (e.g. Tamaz Mechiauri, chairman of the budget and finance committee) even criticized the National Bank on the grounds that NBG does not represent the interests of the ruling coalition.
The current proposal to take away the bank supervisory functions from NBG may therefore be interpreted as an ill advised attempt by the government to appease the public by gaining some control over foreign exchange transactions (and the value of the Lari).
Indeed, the actions of the National Bank may not be in line with the ruling coalition’s short-term political interests. But that is precisely the point - they should not be! The very reason the National Bank’s leadership has long term tenure, is to ensure its independence from the government. This is a long-standing international practice to safeguard against bad monetary policy decisions driven by purely political considerations. The main goal of the monetary policy should be to serve the country’s long terms interests, not to meet the short-term goals.
THE ECONOMIC FALLOUT
If the proposed legislation is passed, what are the likely economic consequences? It is a difficult question to answer, especially given the political context I outlined above.
On the one hand, the financial sector governing model, where the macro (monetary policy) and micro (bank supervision) functions are separated between institutions is not new. Introducing such a model need not have any “revolutionary” consequences at all.
On the other hand, in the current Georgian context these policy measures may have unintended and very unpleasant consequences.
Surely, in many OECD countries, such as Australia, Canada, Mexico, the supervision of a banking system, along with the securities market, is handled by a separate independent agency. Note, however, that all of these countries have a flexible exchange rate regime, and their choice of supervision model is not tied to an attempt to control the national currency value.
At the same time, many other OECD countries favor a “combined” or “mixed” system in bank supervision and monetary policy. Under these systems, bank supervision is the responsibility of a central bank either entirely, or shared between the central bank and other agencies. The United States is an example of such a “mixed” system, where supervisory functions are divided between as many as three separate agencies: the Federal Reserve (US central bank), FDIC (Federal Deposit Insurance Corporation), and the OCC, an office within the US Treasury Department.
The pros and cons of different supervisory systems have been the subject of debate within academic circles. Yet, the context of this debate is prevention of systemic bank failures, not currency stabilization measures. For example, some economists argue that a combined system (central bank supervises commercial banks) may lead to a conflict of interest– e.g. the central bank may be pressured to maintain low interest rates in order to save the country’s ailing banks. Others, however, argue that the combined system is better for ensuring financial stability, especially when the central bank plays the role of the “lender of last resort”, i.e. takes on the responsibility to rescue the banks that experience temporary difficulties.
In the Georgian case, even if the impact of the proposed legislation is likely to be minimal, the greatest concern about the proposal is that it may be a back door attempt to tighten control over commercial banks’ transactions, and to take some important monetary policy functions away from the National Bank.
If the primary objective of those behind the new legislation is to help stabilize the currency, then they have to understand that it will not help achieve this goal. Moreover, their actions might backfire and destabilize the financial system. Private banks may fear that the established “independent agency” may not in fact be independent, and that they will face more scrutiny and politically motivated restrictions.
Given the above considerations, the Parliament would be well advised to act in a responsible manner. Rather than trying to achieve any (uncertain) short-term political gains, it should give more weight to the country’s long-term economic policy objectives for the good of the Georgian people.
Yaroslava Babych
