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This book explores financial stability issues in the context of East Asia. In the East Asian region financial stability has been a major concern ever since the Asian crisis of 1997/98, which still looms large in the collective memory of the affected countries. The global crisis, which had its starting point in 2007, only served to exacerbate this concern. Safeguarding financial stability is therefore a major goal of any country in the region. Diverging cultural, political and economic backgrounds may however pose different stability challenges and necessary cooperation may be complicated by this diversity. Against this backdrop the contributions of this book by leading academics from the fields of economics and law as well as by practitioners from central banks shed light on various financial stability issues. The volume explores the legal environment of central banks as lenders of last resort and analyzes challenges to financial stability such as shadow banking and the choice of exchange rate regimes. Case studies from China, Japan and Indonesia are contrasted with experiences from Europe.



Introduction: Financial Stability in East Asia—A Tentative Assessment

The global financial crisis which began in 2007 has induced a wealth of research on financial stability. Many open issues remain, but a useful framework from which to draw lessons from the crisis has been developed by Stanley Fischer. It assesses the role of monetary policy at the zero interest lower bound, macroprudential supervision and exchange-rate management for the preservation of financial stability. It furthermore assigns important functions to central banks in dealing with bubbles and in fulfilling the role of lender of last resort.

This introduction takes up Fischer’s “lessons” in order to put the contributions in this volume into perspective and to draw tentative conclusions on the state of financial stability in East Asia: while there are no signs that a financial crisis is imminent, the task of preserving stability remains nonetheless arduous.

Frank Rövekamp, Moritz Bälz, Hanns Günther Hilpert

History and Legal Framework of the People’s Bank of China

This chapter gives a short overview on the history of the People’s Bank of China (PBoC), the central bank of the People’s Republic of China, and introduces its legal environment. Upon the basis of the Central Banking Law, promulgated in 1995 and amended in 2003, the chapter illustrates the following topics: the legal status of the PBoC, its objectives and tasks, its organisational structure, the independence of the Chinese central bank, the capital and instruments of the PBoC, and its reporting obligations and supervision. The PBoC developed in an environment which is most accurately described as one of managed transition, entailing the gradual transformation of the economic system and allowing a market-oriented framework slowly to grow out of the planned economy. The legal framework creates much flexibility or—from a more formal legal perspective—a particular uncertainty regarding the role of the PBoC, which advanced from a department of the Ministry of Finance to a state organ at ministerial level with growing authority within the hierarchy of the Chinese party-state. When it comes to the question of the independence of the PBoC, the prevailing opinion in the academic literature is that the Chinese central bank’s independence is in a critical situation, given its subordinate status to the State Council. Nevertheless, the rising authority of the PBoC in China has marked a significant change in Chinese monetary institutions and policy.

Knut Benjamin Pißler

The Independence of the Bank of Japan in the Light of Statutory Rules and Central Bank Independence Indices

This chapter undertakes to assess of the independence of the Bank of Japan (BoJ) in the light of statutory rules and central bank independence indices. It starts off by tracing the historical development of the BoJ which, from its establishment in 1882, was firmly put under government control. During World War II the so-called old Bank of Japan Act of 1942 even strengthened government authority, and despite some efforts to de-centralise the monetary policy process after the war, the BoJ remained subordinate to the Ministry of Finance (MoF) until 1997. At that time, in the wake of the “Big Bang” reforms for financial liberalisation, the Bank of Japan Act was fundamentally revised, and the MoF lost much of its wide-ranging authority over the Bank. Against this backdrop, in a second step this chapter examines the

de iure

independence of the BoJ with a view to the various dimensions of central bank independence—namely, institutional, personal, functional, and financial independence. In a third step quantitative approaches to measure the independence of the BoJ from a comparative perspective through central bank independence indices are assessed. Whilst methodological issues are identified with various of these indices, their results are roughly in line with the findings of the legal analysis that the 1997 reform has substantially strengthened the independence of the BoJ. On the other hand, as evidenced by recent developments under the second Abe government, weaknesses with regard to the personal independence of the BoJ and factors pertaining to Japan’s political economy seem to continue to render the Bank prone to political interference.

Moritz Bälz, Markus Heckel

The Legal Framework for the European System of Central Banks

The Treaty of Maastricht imposed the strict obligation to establish an economic and monetary union as an integral part of the EU. The single currency was to become the currency of the EU and the legal tender in all Member States unless an exemption was explicitly granted.

Consequently, the primary law systematically only speaks of economic policy or monetary policy which is the task of the Eurosystem, consisting of the ECB and the central banks of the Member States whose currency is the euro. Although the national central banks of all the Member States together with the ECB constitute the European System of Central Banks, only the ECB is granted legal personality.

General economic policy is not a task of the EU, but has been retained by the Member States. Exceptions have to be provided explicitly in the primary law. EU law, however, contains a host of rules to prevent excessive debt and deficits on the part of the Member States.

Price stability has been set as the “primary objective”. The term has to be interpreted as close to zero per cent inflation. To safeguard the primary objective, a comprehensive guarantee of the independence of the ESCB, the ECB, and the members of its organs has been provided for.

Exit from the Monetary Union while remaining a EU Member State is not possible. The introduction of a parallel currency is prohibited. If a new currency in substitution of the euro or parallel to it is introduced, all claims denominated in euro will remain in euro and, economically, the burden will most likely even increase.

Helmut Siekmann

Central Bank Independence in Times of High Fiscal Risk: The Case of Japan

The Bank of Japan Act of 1997/1998 grants the Bank of Japan (BoJ) operational independence regarding the conduct of monetary policy. This independence is legally constrained and has also been questioned politically by the Abe administration’s recent usurpation of monetary policy as part of its overall economic policy. The deflationary environment characteristic of the Japanese economy over the last 20 years has, to date, avoided fiscal and monetary policy goals coming into conflict. The real test for central bank independence in Japan will come once deflation has been overcome and the harmonious relation between price stability and fiscal, as well as financial system, stability comes to an end. Price stability may still be maintained as long as fiscal consolidation is synchronised with the reduction in the non-public sector’s saving-investment balance.

Franz Waldenberger

The Legality of Outright Monetary Transactions of the European System of Central Banks

On 6 September 2012, the Governing Council of the ECB took decisions on a number of technical features regarding the Eurosystem’s outright transactions in secondary sovereign bond markets (OMT). This decision was challenged in the German Federal Constitutional Court (GFCC). In its seminal judgment of 14 January 2014, the GFCC expressed serious doubts about the compatibility of the ECB’s decision with EU law.

It admitted the complaints and petitions even though actual purchases had not been executed and the control of the acts of an organ of the EU is, in principle, not the task of the GFCC. As justification for this procedure, the court resorted to its judicature on a reserved “ultra vires” control and the defence of the “constitutional identity” of Germany. In the end, however, the court referred the case to the European Court of Justice (ECJ/CJEU) for preliminary rulings on several questions of EU law. In substance, the German court assessed OMT as an act of economic policy beyond the competences of the ECB. Furthermore, it judged OMT as a monetary financing of sovereign debt prohibited by EU primary law. The defence of the ECB (the disruption of the monetary policy transmission mechanism) was dismissed as “irrelevant”. Finally, the court presented a way for a compromise by an interpretation of OMT which was in conformity with EU.

Both the procedure and the findings of this judgment were harshly criticised not only by many economists but also by the majority of legal scholars. This criticism is, by and large, convincing in view of the admissibility of the complaints. It is also questionable whether the referral to the ECJ/CJEU was indicated. The arguments of the court are, however, conclusive with regard to the transgression of competences by the ECB, and—to somewhat lesser extent—with regard to the monetary debt financing.

Helmut Siekmann

Externally Imposed Financial Repression, Conflicted Internationalisation of the Renminbi and External Balancing via Wage Adjustment

China has made several important steps to liberalise its domestic financial markets and to open up its capital markets internationally in order to promote the renminbi as an international currency. To make the renminbi a convertible, freely floating international currency is a pre-requisite for the renminbi to challenge the dollar as an international currency. The chapter shows, however, that the very benign liquidity conditions in the US, combined with very large foreign currency denominated assets, constitute an insurmountable impediment for the floating and the internationalisation of the renminbi. With exchange-rate stability being seen as an important determinant of macroeconomic stability and growth in China (and East Asia), domestic-wage increases are proposed in order to reduce the appreciation pressure on the Chinese currency.

Gunther Schnabl

Demand and Supply of Shadow Banking in China

Shadow banking is a major financial risk faced by Chinese policy-makers today. Instead of assessing, as others do, its size and impact, this chapter examines the demand and supply side of China’s shadow-banking system. This distinction increases, on the one hand, the understanding of the drivers of the rapid growth of shadow banking in recent years. On the other hand, the distinction allows to derive targeted policy measures to contain the size and risks of shadow-banking activities in the future. The chapter looks into the definition of shadow banking (Sect. 2), puts Chinese shadow banking into perspective by assessing its structure, causes and risks (Sect. 3), and analyses, in greater detail, its demand and supply sides (Sects. 4 and 5 respectively). It finds a high degree of inter-connectedness of China’s biggest challenges (shadow banking, public and corporate debt, financial repression and real estate issues), something which has to be taken into account when designing policy measures. The chapter concludes (Sect. 6) that, on the demand side, further fiscal reforms are needed to sort out the relationship between central and local government, so that local governments can secure the funding needed for urbanisation. On the supply side, interest rates should be further liberalised to avoid “bad money” driving out “good money”.

Xuechun Zhang, Patrick Hess

Navigating the Trilemma: Central Banking in East Asia Between Inflation Targeting, Exchange-Rate Management and Guarding Financial Stability

Inflation targeting (IT) arrangements rose to prominence in the early 1990s, when a couple of advanced countries adopted IT as their formal monetary policy framework. Over the years, IT arrangements have also been implement by a growing number of emerging economies, including Korea, Indonesia, Thailand and the Philippines, all of which adopted IT frameworks soon after the Asian crisis. Although formally following IT regimes, the central banks of these four countries have continued to manage their exchange rates against the dollar. While generally low inflation rates during the period of “great moderation” made inflation targeting a relatively easy job and gave central banks leeway to manage exchange rates without compromising their inflation targets, there have been episodes during which conflicts arose between explicit internal inflation targets and informal external exchange rate targets. Conflict, however, may not only arise between inflation and exchange-rate targeting, but also when taking into account the nexus between monetary policy and financial stability. After the Global Financial Crisis clearly exposed the problems that can arise for financial stability when central banks focus too narrowly on inflation rates, a consensus is currently emerging that central banks ought to include financial stability in their policy reaction functions. Against this backdrop, the chapter discusses the trilemma faced by East Asian central banks in targeting inflation rates while at the same time guarding financial market stability and managing exchange rates. It reviews the experience of East Asian countries with inflation targeting to date and discusses the challenges for incorporating macroprudential regulation into monetary policy frameworks while keeping an eye on the exchange rate.

Ulrich Volz

Concern About Financial Stability Following the Recent US Legal Expansionism: International Law and East Asian Perspectives

This chapter looks into the effects of the extra-territorial application of US economic laws on financial institutions. It undertakes to do so both from the perspective of international law in general, and from an East Asian perspective in particular. It is argued that the expansionist approach applied by US governmental agencies is not only questionable under the principles of international law, but may actually also create risks for the financial stability of East Asia. This is because the banks in the region increasingly feel the impact of US law compliance costs, which may induce them systematically to decrease their use of US dollars in international transactions. This, in turn, may foster the development of payment systems in East Asia that avoid the US dollar or the United States, and thus harm financial stability in the global US dollar market. A solution to this problem may lie in the conclusion of a multilateral agreement on economic sanctions similar to the “Basel Concordat” framework, or of a bilateral treaty like the US-Japan “Agreement Concerning Cooperation on Anticompetitive Activities” or to the US-Japan “Income Tax Convention”.

Takashi Kubota


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