Agustín Carstens on fixing the global monetary system

Interview with Mr Agustín Carstens, General Manager of the BIS, in Central Banking, conducted by Mr Daniel Hinge on 1 July 2019.

BIS speech  | 
01 July 2019

The Bank for International Settlements (BIS) has said there is a need for a clearer framework for emerging market economy central banks to combine inflation  targeting, forex interventions and even capital controls. During your time at the Bank of Mexico, did you try to develop a coherent framework, or was it more a case of doing what worked?

As we described in chapter 2 of our annual economic report for 2019, this is an iterative process. We are in a situation where the framework that has been tremendously useful - the inflation targeting framework - has shown some limitations, given the circumstances.

In my time at Banco de México, we accumulated quite a bit of international reserves, especially from 2010-14. And that was mostly because we identified that there were quite substantial capital inflows, that under different circumstances would not be there, and that meant if things changed, they could leave the country. Therefore, the money that was   coming in, it was very likely to go out in the future, so why should we subject our economy to the adjustment process? It would mean allowing the real exchange rate to appreciate, which has both real consequences and financial sector consequences. The other issue that arises  is when those resources are repatriated.

It is fair to say that the situation has been more stable than we anticipated. We also accumulated some resources out of the windfall of oil gains. But clearly, some of these strategies had a macro-prudential orientation. Therefore I think, yes, in my time we experimented with this. There was a clear intention for us to systematise this more, and to better integrate the use of the different policy instruments.

Your point about the interventions being for the short term only seems significant. If you were to introduce capital controls for a long time, or make interventions over a long time, that presumably could create imbalances.

Yes, and you would establish a precedent that takes a long time to reverse. And the administrative burden of managing capital controls is very heavy, and you don't have a guarantee that it would be successful.

Emerging markets have built up quite large reserves. Is there such a thing as too big a reserve buffer?

As we say in our annual economic report, you have to do a cost-benefit analysis in accumulating reserves. It is not as easy, nor as straightforward, as comparing the financing cost of the accumulation of reserves versus the return on those assets. The adjustment of international reserves (in multiple possible ways) is a policy instrument - therefore, you have to incorporate the potential benefits of such policies. Sometimes those expected benefits are very difficult to measure, because you do not have enough observations. You do not have frequent outflows, or frequent pressures on your exchange rate, so that you could measure the stabilisation benefits that large reserves can bring. I guess my recommendation would  be, if a country is going to make a mistake, it is better to make it by accumulating excess reserves. But there is also the possibility of too much being too much!

One of the key issues around global liquidity that some are raising is that there is huge demand for dollar assets, but the US is shrinking as a share of global output. Some people say that could create a new 'Triffin dilemma'. Do you think that is a serious concern?

Something for me that is worth analysing and following very closely is the demand for dollars by non-US banking institutions. The clear advantage of the dollar is that it confers a  privileged status for international borrowing and lending. Therefore, that intermediation attracts different players, and some of these players are non-US institutions. As we have  seen in the great financial crisis, that was one of the weaknesses of the international   financial system, and therefore very complex arrangements needed to take place to provide adequate liquidity. So here I think it is very important to analyse and do adequate  surveillance of what is going on here, so that we prevent weak points or fragilities that would manifest themselves in risks of a run against a non-US institution in dollars.

For me, the most important aspect is precisely how this intermediation is done. It is intermediation that lacks a clear lender of last resort - and that vacuum could generate a problem. In the past, we have seen that it was in the interest of the US Federal Reserve, and other authorities, to jump in, and that is very commendable. Actually, I think they did a fabulous job there. But it is something that we cannot necessarily count on forever.

You were alluding to the swap lines there?

Yes.

Do you think that's the best way of achieving a form of global lender of last resort? Do you think there is a need to expand the swap lines?

My sense is that the activation of the swap lines was necessary, given the seriousness of the circumstances. But what is most important is to prevent getting into circumstances that  require such activation in the first place. That is pretty much the signal that the Fed and    other authorities have given - that is why they have been supportive of the very important reforms of bank regulation and supervision. I don't think the right response is to have a huge network of swap lines readily available.

Another option might be somehow to expand the resources of the International Monetary Fund.

Yes, that would be useful, but as we saw from the size of the swap arrangements, it is inconceivable that the fund could have resources of that amount.

The BIS has emphasised that a lot of these dollar mismatches are in emerging market non-banks, particularly non-financial firms. Is it problematic that the network of swap lines does not extend very far into emerging markets?

These are issues more related to the lending capacity of the IMF. I think, ideally, the lending capacity of the fund should be able to cover most of the large emerging market economies. But at present, there is a clear gap. I think the emphasis placed during the last few years on increasing the lending capacity of the fund, and also the reliability of that lending capacity, is very important. The more the lending capacity of the IMF is based on increased quotas and not on borrowing arrangements, the better. As a matter of fact, this is the initial conception of the IMF. My sense is that the IMF should be a solely quota-based institution.

There has obviously been quite a lot of political opposition to quota reforms.

Yes, but right now is not the right moment to discuss the issue.

What about the rise of market-based finance as a source of global liquidity - does  that create problems in terms of operating the backstop? Liquidity via the swap lines was distributed via the banking sector.

What we found about market-based finance is that, in some cases, it can generate problems, and that is why at critical points access to central bank money was granted to non-banking institutions. But I think clearly that was an exception, and a lot of effort has been made during the last few years to tackle those circumstances that could induce an exception. I think that's the right way of doing it.

A lot of market-based finance implied huge undertaking of risks - risks that went overboard

- and my sense is that to rein in that type of risk-taking is vital. Now, usually what we see is that if you contain risk-taking in some particular sector of the financial market, it goes to another one. Oftentimes, it falls outside the regulatory and supervisory perimeter. At the same time, it is very likely that once intermediation is done under those practices, it may not pose a systemic risk. My sense is that as long as we keep that risk-taking under control and surveillance, we will be better off.

Is there a need for more regulation on the market-based side?

The real issue is: "Does this represent a systemic risk or not?"

If we are talking about systemic risk, yes, I would venture more into regulation. If it is not systemic, I would think the risks are borne by agents that know what they are exposed to, and will be able to sustain the consequences of different scenarios.

Is that something that will need to be investigated in the next year or two?

It is a permanent job. It is not that we are right now in a situation where we urgently need to do that - we need to do that today, tomorrow and the day after tomorrow.

There are various new types of fintech firms and products - including Facebook's 'stablecoin', libra. What should the response be?

I subscribe to what many very distinguished public officials have mentioned. First, we don't have all the information. A stable currency, as it is presented - it is hard to see what the value-added of it is. The value-added probably has to do with the intentions that Facebook has to use it for different forms of financial services and how these would be integrated into their business model. My sense is we need to wait for what additional information Facebook comes up with. Certainly, it should not be a vehicle to avoid clear regulations, like know your customer [KYC], anti-money laundering and countering the financing of terrorism   [AML/CFT]. We need to make sure that doesn't happen. We need to see what other alternatives are out there, and then really assess if there is value-added. My sense is that, as it is presented, there is not much value-added.

Is it maybe a sign central banks should be doing more to improve the efficiency of cross-border payments?

That is the final objective. We need to look at why remittances are not that efficient today: a lot of it has to do with KYC and AML/CFT. Yes, there might be high commissions from the formal financial sector, or from other operators today - thus, we would welcome any type of financial innovation that would reduce those commissions. I think competition, and new entrants, should try to reduce those costs. Now, do you need to come up with a whole new currency to avoid those costs? I don't think that is a sine qua non. It might not necessarily attack the margins that are relevant to reduce those transaction costs.

Do you think there is a case for giving members of the public access to accounts at the central bank - whether that is via a distributed ledger or something else?

Central bank digital currencies at the retail level have very serious consequences, and  they are not easily tackled. Therefore, for me, a model where you have wholesale digital currencies might be feasible, and then rely on the second tier that is necessary for   payments, which would be provided by the private sector. The second-tier could be operated through the banks or through other innovators, provided that a level playing field is established - for the sake of the incumbents, but also for the sake of the newcomers. I am in favour of that. Thus, central bank digital currencies might not be necessary at the retail level.

It sounds like you may be in favour of giving some fintech firms access to the central bank's balance sheet?

It depends. There are different ways of doing it. Some central banks have decided to take those steps in a very careful way, and I would support that.

I also wanted to touch on the BIS's strategy and outlook. You recently unveiled the BIS Innovation 2025 plan. Can you give an idea of the thinking that went into that? Why do it now?

The BIS is a very determined, very high-performing institution, and it is here to serve central banks in the best possible way. In the years after the great financial crisis, the best contribution we could make was to support central banks in combating the consequences of the crisis, and building an environment in which the incidence of those types of crises would be minimised. I think we did a very good job in that respect.

However, sometimes, the urgent blurs the things that are important. I think that, on some important issues, we just didn't have the capacity to deal with them at that time. Some of these aspects have to do with technology, and that is why a cross-cutting theme in BIS 2025 is to upgrade the capacity of institutions to handle technological changes. It became an  urgent matter, and that is why we are upgrading our technological capabilities in-house, to improve our services to banking clients, also through our economic research. At the same time, we are broadening the focus of our engagement through the innovation hubs. These will scout technologies that could be important for central banks, and make more efficient the accumulation of this type of knowledge, the application of this knowledge, and, through time, try to mix this with the collaborative efforts that go on here in the BIS. They will contribute to the creation of global public goods that would make for a more efficient global financial system.

The other aspect is that, during the past 10 years or so, we have seen many developments in monetary policy frameworks. There is a feeling that practice has gone ahead of theory, and I think we need to close that gap. That is what we will emphasise in our research in the years to come.

What was the thinking behind the innovation hubs?

That is a very important step that the central banking community and the BIS have taken.  For the first time, we are going to partner with some host central banks in multiple locations to catalyse collaborative efforts. The motivation for this setup comes from two key aspects. One is that technological development is progressing at a tremendous speed. And number two, it has no borders. Therefore it is very complicated for each individual central bank to be sitting in their own nation, seeing what is going on in their own environment, but being subject to the influences of what is going on in other locations, where they do not have full and timely knowledge. I think it makes sense to have a collaborative effort. There are economies of scale in that process, and the BIS is in the best position to capture these economies of scale for the benefit of all central banks.