By Uwem Essia
INTRODUCTION
In recent decades, the extant central banking model has faced significant scrutiny. The neo-liberal model, influenced mainly by institutions like the World Bank and the International Monetary Fund (IMF), prioritizes financial stability over active intervention in economic growth. However, critics argue that this approach contradicts the historical role of central banks, which once played pivotal roles in financing government activities, managing exchange rates, and supporting real sector growth in today’s developed nations during the early stages of their development.
This article explores the evolution of central banking from its early foundations in the United States, Europe, and Japan, where central banks were deeply integrated into state development strategies, to the modern neo-liberal paradigm emphasizing monetary stabilization. It examines how the historical focus on economic development has been sidelined and how central banks, particularly in developing countries, can reclaim their developmental role while navigating new challenges posed by globalization, technology, and the evolving financial landscape. Through this lens, the article makes a case for ‘unbundling’ central banking systems, a process of separating the various functions of a central bank, such as monetary policy and banking supervision, development financing, and investment facilitation into distinct entities. This is proposed as a way to enhance efficiency, foster economic growth, and better align monetary policy with national development goals, with a specific focus on the Central Bank of Nigeria (CBN).
CENTRAL BANKING THROUGH THE LENS OF MODERN MONETARY THEORY (MMT)
In recent decades, the received central banking model has come under severe criticism, especially from the modern monetary theory (MMT) prism, which prioritizes using monetary policies for growth promotion over the neo-liberal preoccupation with central bank independence and financial stabilization. The ‘neo-liberal’ approach to central banking, as widely canvassed by the World Bank and IMF and popularized by the Monetarist School of economic thought, emphasizes three main principles, namely, central bank independence, prioritizing inflation control (including formal ‘inflation targeting’), and employing indirect monetary policy tools such as adjusting short-term interest rates rather than direct methods like credit ceilings. This approach, while effective in some aspects, has been criticized for its lack of focus on economic development, particularly in developing countries.
Firstly, “central bank independence,” meant that the central bank should operate as an external ‘participant observer’ of the fiscal operations of the government and should at no time be compelled to finance public deficits. Secondly, a central bank should primarily control inflation and indirectly promote full employment or real sector growth via selective interventions. Thirdly, a central bank should not intervene directly in managing exchange rates or resort to capital flow controls. Also, a central bank should refrain from using methods like subsidized interest rates or credit ceilings to influence the quantity or distribution of credit.
Neo-Liberal Approach vs the Early Central Banking
Interestingly, the extant neo-liberal approach represents a significant departure from historical norms and practices in central banking in now-developed countries during the early stages of their development. Historically, central banks in the United States, England (and Europe generally), and Japan directly financed government activities, managed exchange rates, and supported economic sectors through direct interventions. The need to prioritize economic growth and development in less developed countries like Nigeria underscores the urgent need for a new perspective on central banking, one that does not remove the ladder today’s advanced countries climbed to industrialization or deny today’s less developed countries the theoretical basis for using their central banks as agents of development, which they ought to be given the resources at their disposal.
THE DEVELOPMENT OF CENTRAL BANKING IN THE U.S., U.K., EUROPE, AND JAPAN
Central banks directly provided financing for the development and growth of the private sector in today’s advanced countries. In particular, the state played paramount roles in the early development of the U.S., Western Europe generally, and Japan. Nearly all of today’s so-called advanced countries established particular banks through charters to meet these needs, granting them privileges like issuing currency in exchange for financing the state. These banks, in turn, distributed government debt to a network of lenders, facilitating borrowing and creating a “lender’s cartel” to ensure debt repayment, later transforming many of these banks into central banks.
Establishing the Bank of England in 1694 during a major war with France is a prime example of this role. The state obtained crucial loans at favorable rates by granting extensive privileges to a private banking corporation, which later evolved into the Bank of England. Indeed, the Bank of England’s financing of the crown significantly contributed to Britain’s success in the Napoleonic Wars. A similar situation applied to the early central banks in the United States, France, Belgium, Spain, and Germany. These early central banks played a crucial role in financing the state, demonstrating the profound historical link between central banking and government finance.
CENTRAL BANKING IN THE 19TH CENTURY GOLD STANDARD ERA
During the 19th century, most European countries adhered to the gold standard, necessitating central banks to maintain currency convertibility into gold at fixed rates. This entailed managing money, credit, and gold reserves to preserve convertibility and control price levels. The early central banks deliberately directed credit to specific sectors and stabilized capital and gold flows by implementing various “gold devices,” including interest-free loans to gold importers and impediments on gold exports, effectively serving as exchange controls. Thus, even under the gold standard framework, central banks utilized exchange and capital controls to pursue domestic objectives, contrasting sharply with the present neo-liberal World Bank and IMF-inspired obsession with price stability and central bank independence.
Lending to the Real Sector
Central banks in Europe, including France, the Netherlands, Italy, and Germany, actively provided subsidized credit and grants to industries and contributed directly to economic development. The Bank of England indirectly subsidized British financial institutions during the gold standard era to make them internationally competitive. Even during the classical liberal period, the Bank of England and the U.S. Federal Reserve provided generous credit to real sector corporations. These policies became more integral to central bank strategies after the Great Depression and WW II.
CENTRAL BANKS AS DEVELOPMENT AGENTS DURING THE “GOLDEN AGE OF CAPITALISM”
The period following the Great Depression and WWII was transformative for central banks worldwide. In the United States, the Federal Reserve came under tighter government control during the late 1930s and played a crucial role in financing WWII. The Federal Reserve, under the direction of the U.S. government, purchased government securities to finance the war effort, effectively increasing the money supply and stimulating economic activity. Even after the war, the Federal Reserve absolved government debt and pursued policies to support high employment while controlling inflation. This period saw the ascendancy of Keynesian policies aimed at economic stabilization and development. Additionally, the U.S. government utilized various financial institutions to achieve national goals, particularly in housing. The Federal Reserve’s monetary policy during this time was sensitive to the needs of the housing market, reflecting a coordinated effort to promote economic stability and growth.
France, in particular, implemented extensive credit controls as part of its industrial policy to modernize the economy and enhance international competitiveness. These controls, accompanied by capital and exchange controls, revived the post-WWII French economy. Similar policies were adopted in Italy and Belgium to achieve development goals.
POST-WORLD WAR II CENTRAL BANK POLICIES IN THE WEST: CREDIT ALLOCATION FOR SOCIAL GOALS
Following the upheavals of the Great Depression and WWII, governments in the U.K., Europe, Japan, and the U.S. exerted greater control over central banks and the banking sector. The Marshal Plan was primarily a cocktail of subsidies, grants, and low-interest loans. Central banks employed various credit allocation techniques for these purposes, often accompanied by capital and exchange controls on international capital movements.
Central Banks as Drivers of Development in Developing Countries
The post-WWII era witnessed a significant transformation in central banking worldwide, echoing changes in developed nations. Bloomfield observed that many newly established central banks, particularly those assisted by Federal Reserve advisors, were granted expansive authority and a diverse array of instruments for credit control. These powers aimed to empower central banks to pursue more purposeful monetary policies conducive to economic development and internal stability, in contrast to the constrained powers of central banks during the interwar period. Surprisingly, the Federal Reserve Bank of New York played a pivotal role in aiding developing countries’ central banks, advocating for a broader mandate encompassing monetary and credit policies. While stabilization and inflation control remained priorities, central banks were encouraged to adopt measures beyond traditional banking functions to promote overall economic development.
The historical accounts indicate that central banks have financed governments, sectoral policies, and foreign exchange management. Contrary to current orthodoxy, the central banking history emphasizes a developmental role, particularly in late-developing nations. The challenge lies not in abandoning developmental policies but in determining their nature and scope. Historically, central banks have been most effective when integrated into the government’s industrial policy frameworks instead of exercising independence. While tension exists between developmental and stabilization roles, evidence suggests that entirely forsaking the developmental role is not optimal, worse still, focusing solely on inflation targeting and exchange rate management as recommended by the IMF and World Bank. Thus, a balanced approach that leverages central banks’ developmental potential within a broader growth and development strategy is essential for sustainable economic growth and stability in developing countries.
A CASE FOR UNBUNDLING OF THE CENTRAL BANK OF NIGERIA
Recognizing the pivotal role of central banks for economic growth, exchange rate management, financial sector supervision, and payment system management, a case is made here for unbundling the Central Bank of Nigeria (CBN) into a group of institutions to manage the current functions of the CBN for better efficiency and effectiveness. In consideration of this, we propose the unbundling of the CBN into a conglomerate with four (4) sets of institutions, namely, a Nigerian Financial Regulatory Authority (NFRA), a set of Nigerian Reserve Banks (NRBs), and a set of Nigerian Investment Facilitation Corporations (NIFCs)
A Nigerian Financial Regulatory Authority (NFRA)
This entity should oversee all the banking and non-banking financial institutions and the payment systems in the country and be responsible for monetary/financial policies in liaison with the fiscal authorities. The NFRA would also set operational/prudential guidelines for the other members of the Central Banking Group and ensure compliance with the enabling legislation. The NFRA would equally oversee the capital market, the Debt Management Office, the Nigerian Deposit Insurance Corporation (NDIC), the Asset Management Company of Nigeria (AMCON), insurance, fintech, and big-tech companies, and other financial services providers. The NFRA would be headed by the Governor, who doubles equally as the Central Banking Group’s CEO and head of the Monetary Policy Committee. The research and training units of the present CBN would be domiciled in the NFRA. The NFRA keeps micro- and macroprudential policies in sync with fiscal authority and ensures value-for-money inspection of financed projects.
With the fintech and digital revolutions and globalization of finance, the CBN, as currently structured, cannot scrupulously provide the necessary regulation services alongside the other core activities of central banking. Having an overarching specialized financial regulatory authority for all bank and non-bank financial institutions will go a long way to strengthening the CBN’s regulatory and supervisory capacities. Specializing in this function will give the NFRA enough scope and depth to do regular system and policy evaluation of implementation outcomes to help chart future policies appropriately for achieving the desired goals.
A set of Nigerian Reserve Banks (NRBs)
The Nigerian Reserve Banks (NRBs) would be bankers of all financial institutions (bank and non-bank), all government ministries, departments, agencies, parastatals, and projects, and bankers of all large corporations with significant economic stakes (such as the Dangote Group, mobile communication providers, motor vehicle manufacturers, and other significant conglomerates). We recommend the creation of 10 distinct profit-making distinct NRBs at the first instance for competitiveness. Each NRB is expected to operate as a wholesale profit-making banking institution, able to establish branches within and outside Nigeria. Switching from one NRB to a more preferred one would be possible. The NRBs should be publicly quoted corporations, with the federal government retaining the majority shares (about 10-20 percent). States and local councils, individuals, and institutional investors can invest in the NRBs. The NFRA supervises the NRBs like other financial institutions and can sanction them for non-compliance.
A Set of Specialized Nigerian Investment Facilitation Corporations (NIFCs)
These specialized institutions are designed to serve as profit-making one-stop shops for investment facilitation, connecting funding, research findings/discoveries/inventions, financing, markets, and indigenous enterprises/startups. In particular, there should be NIFCs for renewable energy, recycling, crop cultivation, livestock, entertainment (music and film-making), tourism development, real estate, overseas job placement, etc. The NIFCs would support startup emergence growth and market-making for individuals, firms, and governments in Nigeria.
The specialized NIFCs would build and update databases on funding sources, inventions, innovative technologies, and market opportunities for use by prospective entrepreneurs. They would also have competencies for fundraising, project proposal writing, and arranging SPVs for project funding for their clients. The infrastructure of information and competencies they have should put them in a position to support prospective entrepreneurs/investors for stipulated charges. This approach deviates from the current approach, which assumes that prospective investors know what to do and that all they require is finance.
The proposed NIFCs compare with the Small and Medium Industries Development Corporation (SMIDEC) of Malaysia, the Small and Medium Industry Promotion Corporation (SMIPC) of South Korea, and the Ntsika Enterprise Promotion Agency of South Africa. The NIFCs should provide information, linkages, innovations, facilitation, and market-making necessary for indigenous firms’ growth, sustainability, and international competitiveness. The growth of indigenous businesses is essential for poverty alleviation and balanced industrial growth and development. Having the specialized NIFCs play the one-stop shop roles for accessing the required financial, logistic, training, and market-making support is a vital plus, as no such institutionalized investment facilitation institution exists in Nigeria.
By unbundling the CBN into these three specialized monetary and financing institutions, the reformed central banking group would productively align monetary regulation, financing, and investment facilitation with the country’s developmental goals, achieving optimal utilization of the vast resources and reserves at the disposal of the present central bank.
A NEED TO RECONSTRUCT THE MONETARY POLICY ARCHITECTURE OF THE CBN
Before the 2008/09 Global Financial Crisis (GFC), central banks were primarily preoccupied with achieving price stability. This shift was supported by rational expectations theory and policy consistency, advocating for transparency in forming expectations. Accordingly, many central banks adopted the Inflation Targeting Framework (ITF), which made price stability the primary objective of monetary policy. However, the GFC highlighted the limitations of a solely price-stability-focused approach. While ITF had successfully controlled inflation and stimulated economic growth, it also contributed to rapid credit expansion, asset price bubbles, and financial instability.
The crisis underscored the need for central banks to prioritize stimulating economic growth alongside pursuing price and financial system stability. This realization prompted mixing monetary policy with macroprudential and microprudential policies and foreign capital flow management, representing a new paradigm for central banks post-GFC. This approach acknowledges the interconnectedness of the financial system and the economy, aiming to insulate the economy from procyclicality and systemic risks that could lead to crises like the GFC. Moreover, central banks now face complex challenges, including the impact of digital technology on the economy. Digital transformation has disrupted traditional business models, including banking and financial services. It has also led to new forms of currency, such as cryptocurrencies, which present both opportunities and risks for central banks.
Central banks are facing new realities, particularly regarding rapidly developing technology trends. There is a solid need to be more innovative, especially in dealing with fintechs and big techs. Blockchain technology, known for cryptocurrencies and central bank digital currencies, will determine how much central banks can participate in a decentralized financial system. Cybersecurity is also crucial to protect against hacking attempts on FinTech companies. While digital technologies can boost productivity, create jobs, and improve public services, ensuring optimal benefits requires strong analog complements through robust regulations, skill development, and institutional strengthening. Central banks must develop tools and increase their supervision capacity to adapt to technological changes. They must take comprehensive actions to address challenges posed by new technologies, ensuring resilience and efficiency while prioritizing stimulating economic growth.
Lessons learned include the need for new monetary and financial policy instruments that do not sacrifice economic growth for monetary stability and maintaining strong alignment with fiscal authorities. Overall, the evolving economic landscape and technological advancements require central banks to adapt and innovate their policy frameworks to maintain stability and support economic growth in the digital era.
CONCLUSION
The evolution of central banking from its historical role as a critical driver of national development to its modern focus on monetary stabilization presents a paradox, particularly for developing countries. The neoliberal model, which emphasizes central bank independence, inflation control, and the use of indirect monetary tools, has constrained central banks’ ability to actively foster economic growth and development. While effective in maintaining financial stability, this approach often neglects the unique challenges less developed nations face that require more direct intervention in their economies.
The historical role of central banks in financing government projects, managing exchange rates, and supporting industrial sectors in now-advanced economies demonstrates that a more proactive, developmental role is both feasible and necessary. Developing countries, including Nigeria, must reassess their central banking models to integrate them better into national development strategies. By unbundling central banks into specialized institutions, as proposed here for the Central Bank of Nigeria, and adopting a balanced approach that combines monetary stability with developmental goals, less developed countries can harness the full potential of their central banking systems.
As technological advancements, such as fintech and digital currencies, continue to reshape the global financial landscape, central banks must adapt by innovating their policy frameworks to remain relevant. Ultimately, a renewed focus on developmental central banking, aligned with modern financial realities, offers a path toward sustainable economic growth and long-term stability for developing nations.
Extracted from: Essia, U (2024). Central banking unbundling: Central bank policy mix: Imperatives for thriving in a disrupted landscape https://www.amazon.com/author/uwemessia