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GOVERNANCE ASPECTS OF THE BANCO DE GUATEMALA UNDER ITS NEW ORGANIC LAW

BANCO DE GUATEMALA:

OPERATIONAL FRAMEWORK UNDER THE NEW CENTRAL BANK´S LAW 

Mario A. García-Lara [1]

 The new Organic Law of the Banco de Guatemala (the central bank of Guatemala) was approved by Congress on 23 April 2002, and came into force on 1 June 2002.  Among the key features of the new central bank legislation, it is worth mentioning that it:
  • makes price stability the main policy objective of the central bank;
  • gives the president of the bank a four-year term that does not coincide with the political cycle and sets limits on the causes for dismissal of the president;
  • requires the central government to cover all past and future losses of the central bank;
  • limits lender-of-last-resort facilities to short-term credit to banks with liquidity problems;  these credits should not amount to more than 50 percent of the bank’s net worth;
  • eliminates central bank role as implicit guarantor of clearing house settlements; requires reserves to serve as collateral for clearing; states that failure to meet these payments triggers liquidation;
  • requires an external audit of Banco de Guatemala’s financial statements; and,
  • creates an Executive Committee, separate from the board of directors, to implement monetary policy.
 Together with the central bank legislation, a new Banking law was enacted, establishing a framework for consolidated supervision of financial conglomerates; a new law of financial supervision was also enacted, clearly defining the Superintendecy of Banks as the supervisory agency of the central bank, banks and other financial institutions, including conglomerates.  The Banco de Guatemala and the Superintendency of Banks, although independent agencies, are both under the aegis of the same Board of Directors.
 


Monetary Policy Formulation and Implementation

 The new central bank law clearly establishes as a primary objective the maintenance of price stability; other responsibilities and functions of the central bank are subject to the prevalence of the primary objective.
A specific target (a given rate of inflation) is defined by the Board of Directors which, according to the new law, must formulate monetary policy for a twelve-month period.  It is understood that monetary policy formulation refers to the process of setting the main quantitative goals, among which there is not only the inflation target but also other intermediate goals or estimates (money issue, domestic credit, international reserves), as well as of establishing the main strategic guidelines (including the definition of the exchange rate regime) to be followed by the central bank for monetary and exchange rate policy implementation.  The approval of monetary policy by the Board must be based on its discussion of the proposals made by the Bank’s Governor and  staff [2] .
Besides monetary policy formulation, the Board is in charge of determining the central bank’s budget and strategy, as well as of ensuring the efficient use of the bank’s resources, reviewing the bank’s performance regarding its objectives and strategy, and monitoring its management.
The composition of the Board of Directors is defined in the Constitution of the Republic [3] .  Although the structure of  the Board, comprising representatives of the government and the corporate private sector, brings useful outside expertise and fresh views to the process of monetary policy discussion and approval, at the same time it may give rise to conflicts of interest and may lessen the operational autonomy of the central bank, thus affecting the timeliness of its decisions.
Therefore, in order to give more effectiveness to the operational autonomy of the central bank, the new law entrusts the implementation of monetary policy to a newly created Executive Committee.  Although the boundaries within which the Executive Committee can act are delimited by the monetary policy framework approved by the Board of Directors, the Committee is supposed to have, in practice, a great deal of instrument independence.  The law establishes that the Committee is composed by the Governor, the Vice-Governor, and by other members appointed by the Board; currently these other members are central bank staff  responsible for monetary analysis and for monetary operations [4] .  The by-law of the Committee, issued by the Board of Directors, says that the Committee must meet at least once a week and that it must report its activities to the Board (which must meet at least once a month), including the submission of its minutes.
The president of the Executive Committee is also the Governor of the central bank and the chairman of the Board of Directors.  Thus, the new central bank law also enhances the central bank’s operational autonomy by giving the governor of the bank (who is appointed by the President of the Republic) a four-year term that does not coincide with the political cycle and also by establishing that the grounds for his dismissal are strictly legal in nature and clearly defined, avoiding any political interference.
 



The Central Bank’s Finances

The Guatemalan Constitution explicitly prohibits central bank credit to the government.  Nevertheless, for fifteen years before the enactment of the new central bank law, Banco de Guatemala has incurred in financial losses resulting from its open market and exchange rate operations.  The new law clearly states the rules regarding the financial relations between the central bank and the government, including the absorption by the latter of past and future central bank losses/profits and its obligation to maintain the central bank capital.
The new law requires the central bank to keep proper accounts, compliant of international standards.  It also requires an external audit of the bank’s financial statements.  The central bank law and the Monetary law entrust Banco de Guatemala with the administration of its international reserves.




Credibility, Transparency and Accountability

The effectiveness that Banco de Guatemala may have in achieving its objective of price stability depends very much on the degree of credibility that the society assigns to its actions.  Enhancing that credibility, in time, depends on how transparent and accountable the bank is perceived to be.  The new central bank law states that it must be held accountable and its governor has to appear twice a year before Congress to report on the conduct of monetary policy and the achievement of policy objectives.
The bank must also publish every six months a monetary policy report explaining the actions taken to achieve its objectives.  A summarized version of the bank’s financial statements must be published monthly and the externally audited statements must be published each year under international accounting standards.  The central bank must also publish and disseminate an annual study of the Guatemalan economy, its annual operations report and accounts, and the monetary policy and the monetary program approved by the Board of Directors.  The minutes of the Board involving monetary policy formulation must be published too.


Overseeing the Payment System Health
Under the new central bank law the Banco de Guatemala is obligated to oversee the payment system health and vitality.  Until now, efforts have concentrated on improving the clearing house functioning.  The new law eliminates the central bank role as implicit guarantor of settlements, requires that participant banks´ reserves serve as collateral for clearing and, together with the banking law, establishes that failure to meet clearing obligations triggers bank liquidation.
The responsibility for the overall stability of the financial system is shared by the Superintendency  of Banks, the Banco de Guatemala and their Board of Directors.  The Superintendency has the responsibility for supervising individual banks and other financial intermediaries that, together with a bank, are part of a conglomerate.  Thus, the central bank concentrates on analyzing systemic financial risk through continuous monitoring of the payment system.  For that purpose, Banco de Guatemala is in the initial steps of formally organizing its areas of risk assessment and risk administration.  With regards to financial risk, a newly crated Risk Analysis Unit is in charge of market risk evaluation concerning the bank’s international reserves, as well as credit risk assessment concerning the banking system.  With regards to operational risk, it is managed by the Risk Audit Unit at the Internal Audit Office, which activities are also incipient.
Fulfilling a standard central bank responsibility, the Banco de Guatemala is the lender of last resort for the banks operating in Guatemala [5] .  The new central bank law limits the lender-of-last-resort facilities to short-term credit to banks that prove to have only liquidity problems, as to limit the risk of such problems spreading to other parts of the banking system;  therefore these central bank credits are short-termed, with an interest rate penalty, and should not amount to more than 50 percent of the recipient bank’s net worth.


Challenges Ahead

The passage of the new central bank law has largely addressed many of the policy and governance issues related to the Banco de Guatemala’s monetary and administrative framework.  However, many significant tasks, details and vulnerabilities remain to be addressed.  Among these issues, the following deserve priority measures.
-         Inflation Targeting:  The central bank authorities are considering the adoption of an inflation-targeting framework, and plan to devote important resources (as well as to request technical assistance from foreign institutions) to fully assess the implications of an inflation targeting framework for Guatemala.  It has to be noted that the new legal framework sets price stability as the primary objective for the central bank and grants it instrument independence; therefore, an inflation targeting framework might provide the right environment to achieve log run price stability, though the central bank may need several years to put it in place.
-         Risk analysis and the payment system:  Although the Banco de Guatemala is obligated, by the new law, to oversee the payment system, it must move from the sidelines (where traditionally it has been acting) into the game to fulfill this obligation, and in advance, to prevent rather than react to a payment system crisis.  The challenges in this area include establishing and/or strengthening risk management and payment system units (or task forces); establishing a real-time gross-settlements system; and promulgating new regulations for the payment system.
-         Executive Committee Functioning: The Committee is a new institution whose strength and credibility are crucial for the central bank’s autonomy and for the effectiveness of monetary policy.  The Committee has to gain his place in the governance structure of the central bank, which implies that its technical capacity and muscle must be enhanced.


[1] Vice-governor of the Banco de Guatemala.  This paper was prepared for the seminar on Central Bank Corporate Governance at the Centre for Central Banking Studies, Bank of England, October 9 to 11, 2002.
[2] The proposals are prepared mainly the Department of Economic Studies.
[3] The Board is composed of the Governor and the Vice-Governor of the Banco de Guatemala and three ministers (Finance, Economy, and Agriculture), all appointed by the President of the Republic, two members (a titular and an alternate) appointed by the banks, two members (titular and alternate) appointed by the chambers of production of Guatemala, two members (titular and alternate) appointed by the (autonomous) State University, and two members (titular and alternate) appointed by the Congress of the Republic.  The Vice-Governor and all the alternates have voice, but have no vote.
[4] Currently these other members are the General Manager, the Economics Manager, the Financial Manager, the Director of the Economic Studies Department and the Director of the Open Market Operations Department.
[5] There are thirty-two private banks and one state-owned bank.