F INANCIAL LAW AND REGULATIONS Lecture 2

Required reading: Valdez, Introduction to Global Financial Markets (2003), Chapters 2 and 3 Cranston, Principles of Banking Law (2nd edition), Chapter 4

Reference: Bank of Mauritius Act

[A]

INTRODUCTION

Traditionally the core business activity for banks has been the taking of deposits and lending. Overtime there has been a move towards a model of universal banking where banks are not only engaged in core banking activities but in a range of other activities as well. We will consider this model of banking later, in light of the financial crisis and the lessons learned from it.

At this stage we will look at the Central Bank and its role generally. We will then turn to the internal organisation of banks, their inter relationship and banking regulation specifically. Banking regulation is only one aspect of what a central bank may or may not do (we will consider this in some detail later). The Central Bank may be considered as being at the heart of the banking system. This is because the Central Bank is the bankers bank and the banker to government.

So what does a Central Bank do? Typical activities are: Supervision of the banking system Acting as banker to the other banks Issuing banknotes Acting as banker to the government Raising money for the government Controlling the nations currency reserves Acting as lender of last resort Liaison with international bodies Advising the government on monetary policy

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[B]

SUPERVISION OF THE BANKING SYSTEM

We shall deal with this in greater detail later. A Central Bank may (but need not) be responsible for banking supervision. There may be a separate supervisory body. The Central Bank will however in practice collect a substantial amount of information from the banks. This information will be important in practice in order to support its other activities, in particular its role in relation to monetary policy. Where the Central Bank is responsible for banking supervision it will issue banking licences and conduct prudential regulation of banks.

[C]

ACTING AS BANKER TO THE OTHER BANKS

Banks, at least lending banks, need to have operational accounts with the Central Bank, because this is the only acceptable way of settling their obligations. E.g. If a bank needs to make payments to government (the payment of taxes by a customer of taxes) and the government has its account at the Central Bank. Major banks will hold working balances for day to day settlement for various activities with the Central Bank. Cheque Clearing will end each day with the net sum of money owed by one bank to another or due to it. Another example of the Central Bank acting as a banker to the banks is therefore if a bank, after netting payments due to other banks against those due to itself still owes other banks. Here again only settlement by adjustment to the accounts which banks have with the Central Bank is acceptable. The Banks also use the Central Bank as their source of notes and coins also.

[D]

ISSUING BANKNOTES

The Central Bank controls the issue of banknotes and, but not necessarily, coins. A Central Bank makes a profit (known as seignorage) on the issue of the currency because government deposits securities (or previously gold) with the bank to back the issue1.

[E]

ACTING AS BANKER TO THE GOVERNMENT

The Central bank is typically the governments banker. It performs the functions which a bank ordinarily performs for customers with a current account, notably receiving and making payments and advising and assisting in the operation of the account. Usually it will not lend to the government but will help the government to borrow money by the sales of its bills and bonds.

[F]
1

RAISING MONEY FOR THE GOVERNMENT

Hence the term fiduciary issue

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The Central Bank usually controls the issue by government of Treasury bill and bonds and settle payments in relation to these with the banks through accounts which the banks hold with the Central Bank. The cumulative sum of money owed by governments for all their borrowings is called the national debt. See further Valdez (op cit) at Pg 55.

[G]

CONTROLLING THE NATIONS CURRENCY RESERVES

Each nation has reserves of gold and foreign currencies held at the Central bank. If the Bank intervenes in the market to buy the domestic currency, it will do so using foreign exchange reserves. If it intervenes to sell the local currency it will acquire foreign currency. In so doing it controls the nations currency reserves and may influence the exchange rate of the currency.

[H]

ACTING AS LENDER OF LAST RESORT

One aspect of this role is by rescuing banks in trouble. Another aspect of this role is in relation to liquidity. If there is a cash flight and significant amounts of cash are withdrawn from the banks, the Central Bank will intervene by providing extra reserves to the Banks. Such interventions may be on a shorter term and smaller scale in relation to individual banks which face temporary lack of liquidity. This function of the Central Bank should be considered together with the function of Banking Supervision in the regulatory design architecture for financial services. We shall consider this further below.

[I]

LIAISON WITH INTERNATIONAL BODIES

Central Banks will liaise with international financial bodies like the International Monetary Fund (IMF) and the International Bank for Reconstruction and Development (the World Bank). They also liaise with and take part in discussions at the level of the Bank of International Settlements (BIS) in Basle. The BIS may be regarded as the central bankers central bank. It handles the payments made between world banks, sponsors cooperation, handles initiatives on key topics and hosts monthly meetings of the worlds bankers at its headquarters. It also holds about 10% of the reserves of major world central banks.

[J]

ADVISING THE GOVERNMENT ON MONETARY POLICY

The major role for the Central Bank remains that of advising government on monetary policy. Monetary policy relates to interest rates and to the money supply.

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The most important objective for monetary policy is seen as price stability. However, Central Banks are also concerned with other goals including financial stability. Without a sound financial system, the Banks monetary policy, such as price stability, will not be effective. The Central Bank has a number of instruments at its disposal in order to achieve its goal of price stability. These can be divided into regulatory and market instruments. The trend has been to make use of market instruments. Regulatory instruments can be characterised as direct and indirect. Direct regulation seeks to control directly the amount of money and credit provided through the banking system. E.g. by requiring the banks to adopt specific deposit-taking and lending policies, quantitative requirements being imposed (e.g. a banks rate of growth for interest-bearing deposits should not exceed a specific amount) or through qualitative directives (asking banks to lend to some sectors of the economy. Direct regulation although transparent usually rapidly leads to distortions. Reserve requirements are indirect regulatory instruments. The size of the reserves which banks are required to maintain with the Central Bank will determine the amount of money in circulation. These cannot be regularly varied however as this will cause disruption to the banks and could lead to distortions (e.g. booking deposits in branches outside the jurisdiction). Market operations are the more important means of intervention. E.g. by varying the rates for the purchasing (discounting) commercial bills, selling and repurchasing government securities (repos), or providing credit directly by way of an advance.

[K]

INDEPENDENCE

It is viewed as conventional wisdom that central-bank independence is a prerequisite to sound monetary policy. The IMF has pushed the cause for central bank independence worldwide.

There are different arguments which have been used to seek to justify the need for such independence. The common argument is that independence of the Central Bank is important to prevent politicians from using monetary expansion as a means of stimulating the economy in the interests of short-term electoral popularity. The evidence in support of this argument is not convincing. The other arguments are based in economic theory. 1. Evidence suggesting that in the medium to long term inflation does not contribute to positive economic performance. The Philips curve does hold however in the short term recessions have repeatedly followed tighter monetary policy and output has been stimulated by accelerating monetary growth. The recommendation which follows from this is therefore that to deliver

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economic growth monetary growth must be stable and the best way of ensuring this is through an independent central bank. 2. There is evidence that average rate of inflation has tended to be lower in countries with an independent central bank. (however correlation is not causation).

[L]

ACCOUNTABILITY

The other side to the argument for independence of Central Banks is the requirement for accountability. This may be in the form of: Narrow accountability (It should justify its policies to the public and the public should be able to monitor its performance and call it to account in the event of its failure to achieve its goals Broad accountability (a capacity on the part of the public to override existing monetary policy in the event that its consequences become unacceptable) Indirect accountability (through its structure, ensure that it is representative of different economic, social and regional interests)

[M]

THE BANK OF M AURITIUS ACT

Introduction

1.1.

The banking sector is licensed, regulated and supervised by the Bank of Mauritius which is the central bank for Mauritius.

1.2.

The Bank of Mauritius was set up by the enactment of the Bank of Mauritius Act 1966.

1.3.

Before the establishment of the Bank, the issuing of currency was managed by a Board of Commissioners of Currency once set up the Bank of Mauritius was also given the responsibility for monetary policy.

1.4.

The Bank of Mauritius started its operations in September 1967 as the Central Bank of the Country.

1.5.

The Bank of Mauritius Act 1966 was replaced in turn with modernised legislation in 1971, thereafter in 1988.

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1.6.

More recently, in 2004 Mauritius has enacted a new Bank of Mauritius Act as well as a new Banking Act to strengthen and modernise the regulation and supervision of the Banking sector and further implement national initiatives to bring banking supervision and regulation in line with international standards and practices.

1.7.

This has subsequently amended to provide for Islamic Banking.

Structure of the Bank of Mauritius

2.1

The Bank of Mauritius is headed by a Governor, who is also the Chairperson of its Board of Directors. The Governor is appointed by the President of the Republic, on the recommendation of the Prime Minister, as the principal representative of the Bank. The Bank also has two deputy Governors, who work under the general supervision of the Governor. They are responsible for the day to day administration of the Bank. The deputy Governors are appointed by the President of the Republic, on the advice of the Prime Minister (sections 13 an 14 of the Bank of Mauritius Act 2004)

2.2

The Bank of Mauritius is an independent institution with its own legal personality (section 3(2) of the Bank of Mauritius Act 2004). It tables its annual report before the National Assembly (sections 32 (3) and (4) of the Bank of Mauritius Act 2004). It is auto-financed with surplus funds, in excess of a certain specified amount, being transferred to the Consolidated Fund (section 11 of the Bank of Mauritius Act 2004).

2.3

The Bank of Mauritius may employ such persons as it deems necessary for the proper discharge of its functions. The terms and conditions of employment are those determined by the Bank (section 24 of the Bank of Mauritius Act 2004).

Objects of the Bank (section 4 of the Bank of Mauritius Act 2004)

3.1

The primary object of the Bank is to maintain price stability and to promote orderly and balanced economic development.

3.2

It is also required to (i) regulate credit and currency in the best interests of the economic development of Mauritius, (ii) to ensure the stability and

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soundness of the financial system in Mauritius as well as (iii) act as the central bank for Mauritius.

The central bank provides the nation's money supply. It controls interest rates, and acts as a lender of last resort to the banking sector (examples). It has supervisory powers. It is designed to be independent from political interference.

Functions of the Bank (section 5 of the Bank of Mauritius Act 2004)

Powers of the Bank (section 6 of the Bank of Mauritius Act 2004).

Currency (Part VI of the Bank of Mauritius Act 2004)

6.1

Section 34 sets out that the unit of currency in Mauritius shall be the rupee divided into 100 cents.

6.2

The Bank of Mauritius has the sole right to issue currency notes and coins.

6.3

The Bank of Mauritius determines the denomination, form, design, content, paper and authentication of such notes and coins.

6.4

Section 37 provides that the currency issued by the Bank of Mauritius shall be the legal tender in Mauritius

6.5

Sections 40, 41, 42, 43 and 44 provide for different offences which may be committed in relation to currency notes and coins.

Official Foreign reserves ( section 46 of Bank of Mauritius Act 2004): The Bank of Mauritius

maintains and manages the official foreign exchange reserves of Mauritius in the form set out in that section.

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Minimum cash balances (section 46 of Bank of Mauritius Act 2004) the Bank may require all

banks to maintain minimum cash balances up to a certain amount of each banks total deposit and other liabilities -

Credit information bureau (section 52 of Bank of Mauritius Act 2004)

For the purpose of ensuring the operation of a sound credit information system in Mauritius, the Bank has been given the power to establish, in conjunction with banks, a Credit Information Bureau and to require, on such terms and conditions as it may deem fit, any bank or other financial institution to furnish at such time and in such manner such credit information as it may require for the purpose of, inter alia, maintaining a data base on borrowers and guarantors.

10 Monetary Policy (sections 5(1)(a) and (2)(a) and 54 of Bank of Mauritius Act 2004) -

10.1

The Bank of Mauritius has the function of conducting monetary policy and managing the exchange rate of the rupee, taking into account the orderly and balanced economic development of Mauritius. It also has the power, with the concurrence of the Minister of Finance, to determine the accepted range of the rat of inflation during a given period consistent with the pursuit of the price stability objective.

10.2

For this purpose the Bank of Mauritius has a Monetary Committee set up under section 54 of the Bank of Mauritius Act. The Committee is responsible for the formulation of the monetary policy and for submitting it to the Board of the Bank of Mauritius with recommendations and findings for decision by the Board of the Bank of Mauritius.

11 Government Banker and financial adviser (section 56 of Bank of Mauritius Act 2004)

The Bank of Mauritius is the banker of the government, its adviser on monetary and financial matters and the depository of the official foreign exchange reserves of Mauritius and of Government funds.

12 Confidentiality (section 26 and the third schedule of Bank of Mauritius Act 2004) -

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[N]

Banking Business (section 2 of the Banking Act 2004) and other licensed activities

BANK means a company incorporated under the Companies Act, or a branch of a company incorporated abroad, which is licensed by the central bank to carry on any or all of the following (a) banking business; banking business (a) means (i) the business of accepting sums of money, in the form of deposits or other funds, whether or not such deposits or funds involve the issue of securities or other obligations howsoever described, withdrawable or repayable on demand or after a fixed period or after notice; and (ii) the use of such deposits of funds, either in whole or in part, for (A) loans, advances or investments, on the own account and at the risk of the person carrying on such business; (B) the business of acquiring, under an agreement with a person, an asset from a supplier for the purpose of letting out the asset to the person, subject to payment of instalments together with an option to retain ownership of the asset at the end of the contractual period; and (b) (b) includes such services as are incidental and necessary to banking;

Islamic banking business; Islamic banking business means any financial business, the aims and operations of which are, in addition to the conventional good governance and risk management rules, in consonance with the ethos and value system of Islam;

(c) (d)

private banking business; investment banking business;

deposit means a sum of money paid on terms (a) that it is to be repaid in full, with or without interest or premium of any kind, and either on demand or at a time agreed by or on behalf of the person making the payment and the person receiving it; and (b) that are not referable to the provision of property or services or the giving of security, whether or not evidenced by any entry in a record of the person receiving the sum, or by any receipt, certificate, note or other document;

DEPOSIT TAKING BUSINESS means the business of accepting (a) deposits of money for the purpose of -

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(i)

financing the specific activities of the non-bank deposit taking institution receiving such deposits or such other activities as may be approved by the central bank; and

(ii)

investment in Government securities, Bank of Mauritius Bills issued under the Bank of Mauritius Act 2004 or such other investment as may be approved by the central bank; or

(b)

Islamic deposits for the purposes of financing the activities of the non-bank deposit taking institution receiving such deposits or such other activities as may be approved by the central bank, the aims and operations of which are, in addition to the conventional good governance and risk management rules, Islamic deposit means a sum of money or monies worth received by or paid to any person, under which the receipt and repayment shall be in accordance with the terms of an agreement made on any basis including custody or profit sharing;in consonance with the ethos and value system of Islam;

CASH DEALER means a body corporate licensed by the central bank to carry on the business of foreign exchange dealer or money-changer;

FOREIGN EXCHANGE DEALER means any body corporate licensed as such by the central bank to carry on the business of (a) buying and selling foreign currency, including spot and forward exchange transactions and wholesale money market dealings; and (b) (c) a money-changer*; money or value transfer services. money or value transfer service means a financial service that accepts cash, cheques, other monetary instruments or other stores of value in one location and pays a corresponding sum in cash or other form to a beneficiary in another location, by means of a communication, message, transfer or through a clearing network to which the money or value transfer service belongs, and where the transaction performed by such service can involve one or more intermediaries and a third party, final payment;

MONEY-CHANGER* means any body corporate licensed as such under this Act to carry on solely the business of (a) (b) (c) buying and selling of foreign currency notes, coins and travellers cheques; replacement of lost or stolen travellers cheques; and encashment under credit cards;

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NON-BANK DEPOSIT TAKING INSTITUTION means an institution other than a bank that has been authorised by the central bank to conduct deposit taking business;

financial institution means any bank, non-bank deposit taking institution or cash dealer licensed by the central bank

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