HISTORICAL BACKGROUND OF THE UAE CENTRAL BANK
Origin of bank
The central bank is the institution that is responsible for monetary and banking regulation as well as managing currency of UAE. After the establishment of the independent state of UAE, the institution was established as the nation’s currency board in 19th May 1973. The purpose of creating the board was to create a new currency that would replace the currency which was in use before the establishment of the new state. UAE dirham replaced the Bahraini Dinar and Qatari riyal and the new currency started circulating immediately after that the board was created.
When the board was established it was not given equal power like a central bank. Though it had given the responsibilities of managing the countries currency, regulate foreign exchange, and controlling gold reserves it was not given the power to manage and control the monetary policy. But on December 10th, 1980 the Union Law No. (10) formed the modern central bank and replaced the currency board. Abu Dhabi and Dubai then deposited half of their revenue to the institution.
The bank was given powers to; act as a bankers bank, act as the bank of the government, manage the credit policy of UAE, to provide advisory and monetary support to the government, be a lends to commercial banks as the last resort, to control a countries monetary and gold reserves, to ensure stability of the country currency by regulating import and export policies , and to represent the government in other financial bodies across
Central Bank Leadership
The institutions are managed by a board of directors that is made up of seven members. Clear rules define the composition of the board of directors and are stated in the UEA Union Law No 10. The law requires that the board should be headed by a Chairman, who is assisted by a Vice Chairman and a governor. The above three have the same powers and rank as a minister and they are assisted by four other appointed members. Every member of the council servers for a period of four years. Members are chosen by Union Degree but subject to be approved by the council of ministers. For one to be appointed as a member he should not be an active board in any other bank, nor the federal council nor should they be a Ministers of Cabinet State.
Organization and Functions of the Bank
The head office of the bank is in Abu Dhabi. There are however other branches in a different state. That is; Sharjah, Ras Al Khaimah, Al Ain, Dubai, and Fujairah. Similarly, the bank has a various department that have various functions. Some of such departments are discussed below.
The Banking Supervision and Examination Department
This department has the mandate of regulating the banking industry in the UAE. The big part of this department is concentrated in Dubai since many banks are also concentrated in the city area. The department is very significant since its mandate is to regulate all domestic commercial banks, foreign commercial banks found in UEA, Financial Institutions, and Finance Houses. By the year 2013, the number of commercial banks in the UAE were 23 while the foreign banks were 28 banks.
Thus, the department has the mandate of issuing licenses to commercial banks, monitoring the bank’s compliance, setting standards that regulate the commercial banks, and cooperating with international Financial Institutions Like the Financial Action Task Force.
The UAE Fund Transfer System Department
This is the system that is used as a conversion of the central bank to other financial institutions, federal banks, and ministries. The exercise is done in six days except for Fridays and the bank’s charges a fee of 15 fils for every transaction.
Banking Operation Department
This is the department responsible for managing and issuing notes and currencies. It also manages the electronic method of payments in UAE. The printing of the currency was done by a UK firm De La Rue but from the year 2013, UAE established a mint that prints the currencies that meets the central bank requirements.
Research and Statistics Department
The department has the responsibility of collection Central Bank data and publishing the reports in series such as Central Bank’s Annual Reports. The department also partners with international institutions as well as other data agencies.
Monetary Reserve
The role of this department is investing the bank’s money reserves and securities. Central bank securities include federal government deposits as well as the minimum deposits that commercial banks are required to keep with the central bank.
Arguments Defending the Importance of Having Central Banks
With the ongoing open discussion on the importance of central banks, the first questions we should be addressing is whether the institution is doing UEA any good. Was the bank needed in the first place? According to research conducted by Smith (1936), it shows that the central banks were not developed to promote development in the banking sector but rather it was established as a government favor. Thus, what are some of the dangers posed by the absence of central banks? There are five arguments that will help us to make a conclusive case of whether the banks should be abolished. Let’s look at these arguments with the current state of the central bank in mind.
Excessive credit expansion and over- issuance of notes
This is the most important historical argument concerning the need to abolish central banks. the argument states that a free banking system provides greater incentives to commercial banks and they constantly lower their discount rates in order to expand their credit level and gain higher market share. Such banks will continue lending until they start to drain their gold reserves and this forces them to refrain from the habit so as to protect their own reserves. These acts would to economic crises.
Mutual check of central banks prevents commercial banks from taking actions that are meant to make the banks reap from the short-term benefits associated with excessive issuing of credit. Its argued that under the free banking systems there is a lot of economic instability resulting from fluctuations in money and credit supply. Thus, central banks servers as an interplay of inflationary and deflationary episodes. It also prevents commercial banks from issuing excessive notes and credit expansion.
Lender of the Last Result
Another argument is that the central banks mitigate the economics crises by acting as lenders of last resort because the public has strong confidence in the notes issued by the Central Banks. In cases where the public demands more money than what the commercial banks are able to give without affecting their reserves then the central banks can give credit and the public have higher confidence in their currencies. This will prevent a lot of economic downtowns as well as deflationary spirals.
Uniform Distribution of Risks
Let’s take an argument where we have a free bank system and a bank undergoes through bankruptcy. This may occur if the bank has issued more note than their bank reserves. It is expected that the notes will not remain in the hands of the immediate client but rather they move from one person to another. By the time the bank is declared bankrupt, those will be possessing the notes will bear the worst loss. Thus, the risk will not be evenly distributed in the economy but rather it will hit the section of people in possession of the notes. The argument, therefore, is that the government creates uniformity in the economy by establishing the Central bank which distributes risks in the entire market.
Central Banks Promoting International Corporation
This argument shows that attempts have been made to bring harmony and cooperation of the international monetary institution. The establish of Bank of International Settlement (BIS) in the year 1930 is a good sign of the attempts already taken. They make such corporations in regard to making decisions about monetary policy. However, Central banks have to exist in the first place so as to make a corporation of monetary policy possible.
Rational Monetary Policy
This argument gained momentum after the world war. In the past, the monetary policy was implemented so as to create an automatic response in the financial system. But in the modern world, scientific criteria guide the Central Banks to have an active a rational monetary policy which will aid at controlling banks cash reserves and levels of credit. The introduction of fiat standard and the abolishment of gold standard gave the central banks the powers to control the money stock. One of the criteria that has been held is the stability of prices. To keep the general prices stable, money stock should be expanded the rate of economic growth. More argument has stated not only should there be price stability but rather there should be stable price inflation regulating the economy.
Some of the areas to be considered by the central banks include; challenges of moral hazards, improper distribution of wealth, unsustainable inflationary booms], and increased systematic risks. It is indeed necessary to have a rational monetary policy as no one can object to rationality. However, until now Central Banks have remained a platform for creating power politics and less of helping in economic issues.
Does Central Bank affect the business cycle
Business cycles are characterized by an economic boom in an economic period and economic collapse in the following period. The business cycles are used to compare the economic status between countries. Countries are measured in terms of wages, employment, production, total investment, and wages. There are different phases of the business cycle but the most important is depression and prosperity. The following are the phases of the business cycle and they move up and down the growth line.
Expansion stage
This is the period that the economy experiences a steady economic growth line. During this period then there is an increase in some factor in the economy such as; wages, employment, profits, production, and sales. Debtors have a high capacity to repay their debts as they are in a good financial condition. Thus, creditors charge a higher interest when lending and this increases the cash in circulation. More importantly, prices of the factors of production and the industries output rise. During this phase, there are many opportunities that are available and business invest the idle fund in the organization. Thus, cash outflows and cash inflows are equal during this period. The central bank has the mandate of moderating prices of commodities in the economy. Therefore, it will implement monetary policy that will regulate the prices of commodities and by so doing regulate inflation levels. Some of the instruments that the central bank can use to moderate price increase during the expansion stage is increasing lending rates which will discourage borrowing and thus reducing cash flows.
The Peak Stage
This is the maximum limit that growth in the expansion phase reach. It is the highest point of the business cycle and flows this point economy growth does not rise further. At this stage demand for various products gradually decrease due to the continuous increase in the prices of products. Prices of final products rise due to an increase in the prices of factors of production while the consumer’s income remains constant. Consumers are forced to constrain their spending habits so that they spend only on important commodities. Thus, luxurious commodities like perfume, pieces of jewelry, and automobiles reduce.
The Recession Stage
During this stage of the business cycle, the rise in the prices of inputs leads to a decrease in the demand for various products. A recession occurs when products demand decreases steadily. Producers are unaware of the reduction in demand for products during the recession stage the this creates an imbalance between demand and supply. But with time the producers become aware of the surplus in their industries and they also realize that they are spending more on producing commodities than the profit they are generating after selling the products. Few companies start experiencing this but later the effect is transferred to others in the industry. Such a situation seems to be a small fluctuation in the economy but when it persists it makes producers avoid any kind of investment in factors of production like machinery and stations. Prices for these factors reduce and this causes a reduction in the total demand of outputs.
Trough Stage
During this stage business growth decline more than normal and the economy is in a negative position. This implies that the national income and expenditure have gradually declined during this stage. Debtors find it difficult paying debts and commercial banks do not prefer lending thus rising the bank’s cash reserves. Therefore, the interest rate gradually decreases and economic output in the country reduces. During this stage, most businesses leave the industry.
Counter-attacks to functions of the central banks (possible threats of the existence of central banks)
It’s no doubt that central banks have many functions that are important to the economy of a country. But some arguments put forward criticize Central Banks by showing the possible threats of the existence of these institutions. Such an argument implies that even though the banks create the desired outcome, they have the potential of creating negative situations they are misused.
The researcher who has made such arguments include among others, Ludwig von Mises. Commercial banks consider the role of Central Banks been a leader of last resort as a datum when making their decisions. Thus, the role incentives the commercial banks to take higher risks as there is an assurance that Central will compensate and lend money if need be. This will lower their reserve ratios and thus raise fragility in the banking system.