Ardian Fullani: Monetary policy strategies for small economies
Speech by Mr Ardian Fullani, Governor of the Bank of Albania, at the VII Annual Conference
of the Bank of Albania "Monetary Policy Strategies for Small Economies", Tirana,
6 December 2007.
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Dear ladies and gentlemen,
It is a great pleasure to open the proceedings of the 7th Conference of the Bank of Albania.
On behalf of the institution and myself I take this opportunity to welcome all participants. I am
confident that the following two days will instigate debate and discussion on key central bank
issues.
This year's main topic will focus on the classical function of a central bank: "monetary policy".
Institutional framework, decision making process, monetary transmission efficiency and other
issues related with financial markets, macroeconomic and financial stability, will make
interesting topics of discussions from our esteemed speakers.
I am confident that our panellists are well-known senior experts; therefore, on behalf of the
institution I would like to thank them heartily for accepting to share with us their views and
findings.
Given that the proceedings of the Conference will extensively cover theoretical models and
countries experiences as well I would like to briefly present the evolution of our central bank
during the last three years.
To our pleasure the enhancement of analytical and modelling capacities of the Albanian
institutions has been widely recognized yielding a greater ownership in our medium run
economic and financial development programs.
Since the beginning of transition most of these programs have been designed and
implemented under the setup of IMF conditional support programs. Even the current policy
setup is designed under such program. We currently believe this is the final one which gets
IMF financial support, implying that our economy is matured and that Albania is on the right
track. After many hardships of transition, the Albanian authorities should have full ownership
in the medium-term development programs of our country. This is the reason why the Bank
of Albania has quite for long been engaged in a comprehensive process of scrutinizing and
choosing the best options.
The year which is coming to an end marked another important chapter in this context. In
contrast to the previous two years, the Bank of Albania has further deepened its cautious
research of all aspects characterizing the present and future of monetary policy.
It has been quite for a long time that the central bank has publicly announced its efforts in
assessing objectively and professionally the future of the Bank of Albania monetary policy.
These were not sporadic efforts but part of a process which initiated three years ago with the
only objective of finding the answers to the following questions:
Should we move to another monetary policy regime? What regime would be the most
appropriate one?
I believe you share the same opinion with me that finding the answers to the aforementioned
questions is not an easy thing. This is not a plain mechanical action.
In the last three years the Bank of Albania has been involved in an intensive process of
assessment, analysis and conclusions for the future of monetary policy. And we have not
been alone throughout this process.
Together with other Albanian institutions - first and foremost with fiscal authorities, different
European and regional central banks, other international financial institutions and academia,
we have tried to identify the most suitable monetary policy regime to be adopted.
During the last three years, we have been tossing ideas and scrupulously studying the
details of a fully fledged inflation targeting regime. Based on the current features and
expected developments of the financial markets, we believe the inflation targeting regime
provides the best policy choice for the future.
A relatively long history of low inflation, constant soundness of the macroeconomic situation,
stable and sound banking system, free floating exchange rate, a suitable institutional
framework, fiscal consolidation are important factors that have convinced us on the potential
success of inflation targeting regime. However, we are aware that there is still a lot to be
done in this context, in particular as far as monetary transmission mechanism and financial
market efficiency are concerned.
Furthermore, under a relatively rapid and considerable development of the Albanian
economy we are sure that the advantages a complete and independent monetary policy
framework provides are larger in size than the disadvantages. Therefore, the currency board
has not been considered a possible option for the future.
On the other hand, the current operational targets (quantitative limits on net assets of the
Bank of Albania and the banking system), or the so-called performance criteria, which are
part of today's decision-making, might not be able to preserve their binding power after the
expiration of the conditional agreement with the IMF in 2008. These intermediate objectives
may be replaced by a concrete and transparent objective such as the inflation rate, which
provides a more direct communication of monetary policy decisions in economy in order to
achieve the main target of the Bank of Albania. Consequently, summarizing what has been
previously said we have identified the inflation targeting regime as our best choice versus
currency board and monetary targeting. Another argument which supports our choice is that
various internationally recognized experts have compared the current setup of monetary
policy to an implicit inflation targeting framework.
Furthermore, we believe this regime will provide a better platform for harmonizing the
monetary policy with the fiscal one, implying that the fiscal authority will seriously commit to
support the proposed setup.
To this purpose, we invite the Albanian Government to reach a consensus on the key
objectives of both policies, monetary and fiscal, adopting the convergence criteria as a
strategic goal.
Success in this endeavour requires Albania, among other things, not only continuity on the
path of sound macro policies but even strengthening them further. This means a monetary
policy focused on maintaining price stability and a prudent fiscal policy which will ensure that
Albania's deficits and debt ratios are sustainable and at low levels to increase the
attractiveness to international investors. Put differently pursuing a monetary policy focused
on price stability and a prudent fiscal policy, will no doubt reduces Albania's risk premium.
The benefit of this achievement will be felt throughout the economy.
To support my idea I have to tell you one fresh news. Yesterday Albania succeeded to sell
internationally a seven year fixed rate bond in Lek. This was not a result of a toss of coin, but
a reflection of international confidence in the Albanian economy and its macro policies. This
confidence should increase in 2008, 2009 and beyond.
Regardless of the monetary policy regime it is to be said that the chances for this setup to be
successful are greater under a developed financial market, which understands properly the
monetary policy signals and transmits them adequately to the economy. Monetary policy
efficiency implies the financial market efficiency.
This issue has been part of my earlier discussions; however I would like to highlight that only
recently we have taken concrete steps which will improve certain financial market segments.
We have currently tried to adopt a set of measures which will facilitate the reformation
process of the financial market by further deepening it. In more concrete terms, the
Government securities market and the interbank market have been most particularly under
our special focus.
After several consultations with all actors in place we decided to come up with a package of
initiatives and priorities during 2008 whose purpose is to establish incentives and minimize
risks in the Albanian financial market:
- Broadening and deepening the base of participants in the Government
securities market
Starting from January 2008 we will increase the investors' base, eligible to directly invest in
the auctions of Government bonds. We believe it will increase the competition while so-far
this was a privilege enjoyed by the banking system.
- Reducing the interbank market risk
So far, the banking system has applied limits on the amounts it can lend in the interbank
market. Therefore, we are working on introducing a new law on repurchase agreements,
which will enable the risk-free conduct of repurchase agreements among commercial banks.
- Establishing the delivery versus payment system
In order to minimize the payment settlement risk and facilitate the intermediation in all types
of transactions involving collateralized loans, repurchase agreements and outright purchase
and sale of Government papers, we are working to put into practice the principle of delivery
versus payment system.
- Enhancing the interbank market efficiency
In collaboration with the Ministry of Finance we have agreed on less frequent Government
treasury bills auctions. Moreover the size to be issued in each auction schedule will increase.
This less frequent auction schedule will increase the number of transactions in the interbank
market for the period in-between the two auctions as banks will try to reduce the costs of
liquidity. On the other hand it will limit the opportunity of banks to be liquid based on
distributing their treasury bills investment and consequently, they will seek other market
options such as the interbank market.
- Introducing the prime rate
Being convinced that the monetary policy may be efficient through transparency the Bank of
Albania aims to introduce in the first half of 2008 the "prime rate" to the set of orientation
rates used by commercial banks.
Regardless of the measures to be adopted I would like to say that other financial market
segments need to come along with us in this challenge. I have to say that the financial
intermediation role of other financial institutions is weak and it has no substantial influence on
the intermediation and reallocation of financial funds in economy. I think today's reality
provides a lot of room for making the capital market reactive. According to our estimates, the
number of major companies certified by well-known international auditors is ever-increasingly
becoming larger.
Further to my speech I would like to focus on another priority of the Bank of Albania, that of
financial stability. It holds true that macroeconomic stability is crucial and precedes all other
important economic and financial developments. Without macroeconomic stability there is
neither growth, nor foreign investment or reallocation; consequently there is no development.
However, macroeconomic stability without financial stability would be a utopia; it would be
like a non-standing bridge. This is the reason why we have been paying special attention to
financial stability throughout 2007. The recent developments in the sub-prime mortgage
loans must serve as an excellent reminder of the never ending surprises which from time to
time cause a lot of turmoil for the financial market stability. Moreover this episode once more
highlights the necessity for more harmony between monetary policy and financial stability. I
want to make clear that by financial stability I do not assume only the absence of a financial
crisis. First and foremost it implies a functional and efficient financial system in its
intermediation role.
I personally believe that too tight regulations truly minimize all the risks, but on the other
hand they might not always be conducive to sustained growth.
Therefore, the real challenge we are facing is to find an optimal balance between
deregulation, which promotes market forces and financial innovations, and negative
consequences of possible market failures and financial crises.
Obviously, this optimal balance is hard to be actualized in the daily practice. Therefore more
empirical studies need to be made, which I believe is one of the main priorities of the newly
established Financial Stability Department.
However, I would like to underline that as a supervisory authority we have been very prudent
during the present year, considering among others the rapid growth of credit portfolio in the
last 2-3 years. I take this opportunity to inform the banking system and the public at large that
starting from January 2008 the Credit Registry will begin to operate.
Special attention has been paid to strengthening banking supervision, in particular to that
part which relates to the governance of commercial banks. Moreover, we have required more
transparency from the banking system and a more accountable relationship with the public.
The continuous improvement of human capacities involved in internal control and risk
management has for a long time been a concern for the Bank of Albania. With reference to
the latter I would like to underscore that we have already identified three greatest risks
whose presence would have severe consequences on the financial stability. I have to say
that this group of risks characterizes the whole region; consequently there is a lot of room for
cooperation in this context.
1 Credit risk
Credit risk directly relates to the boom of credit to economy in the last years. Although the
statistics indicate that the share of non-performing loans is low, prudence is required. We all
do know that the rating and re-rating methods may be a tool in the hands of banks to keep
the reality away from the truth. The entrance of big international foreign groups puts upward
pressure on the other banking operators attempt to compete for borrowers which may often
deteriorate the credit portfolio quality. Moreover, let us not forget that the companies' balance
sheets lack transparency which makes another issue for this matter. To conclude I would like
to say that the current developments in the real estates market may potentially have a
negative impact. A considerable rise in prices when real estates account for about 80 per
cent of the collateral may have a negative impact in case there is a sudden fall of prices in
the fixed assets market.
2 Exchange rate risk
As of November 2007 outstanding credit is shared by 70 per cent of foreign currency credit
and 30 per cent in the local currency. It is my impression that the figures are similar to the
whole region. Extending credit in foreign currency to borrowers with income in national
currency means that a sudden exchange rate depreciation could threaten their capacity to
repay.
3 Contagion risk resulting from the presence of big banking groups throughout
the region
Currently we are all witnesses of a large-scale penetration of some big international banking
groups throughout our region. This development has obviously been welcome as it has
provided a better and more efficient allocation of free assets in economy. However, I believe
that more prudence is required in this context. A disturbing issue for the parent bank or a
concern of one of its branches in the region may cause turbulences for the fact that these
banking groups have large market shares. Moreover, host-host supervision-related concerns
have not been covered by the Basle standards which makes the whole situation even more
complex.
In conclusion, I would like to highlight that our work has been guided by a simple but
progressive philosophy which has aimed at:
- Establishing sound and operating structures;
- Concluding and improving the legal and regulatory base; and
- Absorbing qualified and professional human capacities to cope with the future
challenges.
I express my belief that the Bank of Albania is fully capable to have the full ownership of
designing and implementing the monetary policy.
Dear participants,
I tried to give a short overview of our work in the last years. I am sure than the speakers'
presentations and discussions in this conference will help us to better understand certain
issues and provide the answer to several questions.
I truly believe all the participants will be active by bringing and focusing on new aspects,
different experience and alternative perspectives to our viewpoints.
I wish you good proceedings.