Updating the “Central Bank Law” will redefine the Central Bank’s governance

6th of 11, 2017

As part of enrolling in the Extended Fund Facility (EFF) program at the International Monetary Fund (IMF), Mongolia has been committed to carrying out some important economic reforms, including that of its banking sector. B.Tugsbilegt of The Mongolian Mining Journal spoke to O.Erdembileg, First Deputy Governor of Mongolbank, the Central Bank of Mongolia, to find out more about the proposed banking reforms, and its current progress.

It has already been established that we will have legal reforms in the banking sector. How will the role of the Central Bank be affected with the updated laws going into effect?
The plans for a legal reform in the banking sector were already in the works before we enrolled in the EFF program.  We had capable teams of people already working on drafting amendments to a set of 10 laws when Mongolia’s enrollment in the EFF program was approved.  The IMF decided to include our work in their program to synchronize all planned economic reform efforts for the best outcome.

The most important change to the Central Bank Law will be to make its role less ambiguous, especially relating to price stability. From the way the law is currently worded, it could be misconstrued that the Bank of Mongolia’s objective is to control the exchange rate.  We made it our mission to make sure the differences between these two vastly different concepts were realized. The central bank’s principal objective is and should always be price stability, first and financial sector stability, second.

Clearly stating and ranking our objectives will provide much needed clarity to the role of the central bank in the public’s mind. Right now it is widely misunderstood that the central bank is in charge of the exchange rate. In actuality, the exchange rate is influenced by the real economy and budget, which means it is directly influenced by policies and decisions implemented by the Government. When the Ministry of Industry and Trade still existed, it was in charge of maintaining Mongolia’s Balance of Payments (BoP). The BoP should tie in with the real economy and the budget and thereafter we can discuss how to finance the deficit, and how this will affect the exchange rate. Today, decisions on trade and industry are made by the Ministry of Foreign Relations, the Ministry of Food, Agriculture, and Light Industry, and the Ministry of Mining and Heavy Industry depending on their respective rights and responsibilities. The new laws will provide clarifications to the above issues.

Since the financial crisis of 2008, more emphasis has been placed on the importance of a stable financial sector. As mentioned before, the stability of the financial sector is our second most important objective. Other than clarifying these objectives in new Central Bank Law, we are also emphasizing the governance of the central bank At present, there is a global trend towards a central bank governance system that is similar to that of private banks. In other words, central banks are now using a system where they have a Board of Directors and a management team. Board members are appointed by Parliament, who are in turn representing the interests of the public, and the three Governors, who are also members of the Board, are nominated by the Speaker of Parliament. The Governor chairs the Board and nominates the rest of the members to Parliament for appointment.

The Management team includes the Governor, as head, and the First Deputy and Deputy Governors. The Management team is in charge of managing the bank but responsibilities such as audits and risk management are managed through separate committees chaired by members of the Board who have been nominated by the Governor. This is the current trend of governance that we are seeing with central banks around the world. In our case, we discussed this issue, taking into account our country’s characteristics before we decided to make changes to the decision-making process.

The issue of governance itself has to do with who is making what kind of decisions at what point in the process.  This will likely raise the accountability. According to the current law, the Governor of the central bank is the sole decision maker, and other governing and directing officials at the bank have advising roles only.  This is also true for my case; I advise the Governor within the areas that I am responsible for. This current scenario will be changed to a more collective decision-making process with either votes or unanimous decisions.

Our commercial banks are currently going through an asset quality review. This implies that there may be some operational risks. Is it that the IMF is not confident in the health of these banks? Will the proposed new laws aim at better oversight of banks and at better risk-control?
We are also currently working on amending the Banking Law. We are proposing the addition of clear regulatory procedures showing step-by-step measures the Bank of Mongolia will take to enforce disciplinary and corrective actions on commercial banks. It will also include our shift to a risk-based supervision method that will focus on identifying risks and taking remedial actions before actual problems arise. Our bank has already made an internal structure change in preparation for this shift. Another issue we are focusing on is the role of the Deposit Insurance Corporation of Mongolia (DICOM) in the banking sector.  DICOM has been collecting its insurance payments from commercial banks for a few years now and their deposit insurance fund has grown quite a bit.  We will be including new clauses in the update to the Deposit Insurance Law that will define an additional role for them that could have good outcomes for any problems that may arise at a commercial bank.

DICOM sets the insurance payment amount that will be paid by commercial banks each year. We would prefer the payment amount to be calculated on the basis of each bank’s risk levels, which is information that could then be optimized as a tool for macroprudential policy. To make this possible, detailed information about the banks’ operational mechanism and financial health should be available to DICOM. Under the present law, DICOM has limited access to such information. The amendments would seek to empower DICOM to demand data from banks so that it can make informed decisions for the depositors’ interest.

We plan to submit the drafted amendments to Parliament for discussion during its fall session, along with the General guidelines for Monetary Policy for 2018. Amendments to the Central Bank Law and the Banking Law have been submitted through Members of Parliament. The drafted amendment to the Law on Asset Management Company has been sent to the Ministry of Finance.

What is special about this IMF program (compared to earlier ones)?
The program implemented in 2009 did not fully address structural reform issues and, according to the IMF, this is the cause for the current issues we are dealing with. This time, they are taking this issue on board.  Structural reforms are time-consuming and are implemented. The current program focuses on three main areas: fiscal issues, the monetary and financial sector, and the structural reform covering the previously mentioned areas.

The ongoing asset quality review of banks is also a big part of banking sector reforms. How is the work progressing so far?
A comprehensive evaluation like this is very important to determine the health of the sector. The final report should be ready in late November. PwC Czech Republic was selected as the contractor for this review. Their report will indicate each bank’s capital adequacy to cover potential risks and also the risk management systems they follow, and collateral asset valuations.

What steps will be taken after the evaluation results are out?

After the evaluation, commercial banks will be asked to submit a sustainable business plan to see how they intend to operate until 2019. The Bank of Mongolia will run a stress test on these plans to determine their viability. Each bank also has to show how they plan to increase their capital if needed and improve risk management. The Bank of Mongolia will monitor and oversee the implementation of these plans.

Structural reform measures will be implemented in stages, regulated by legal provisions. The next batch of drafted laws will be submitted to Parliament for discussion during next year’s spring session. Once Parliament approves the amendments, the central bank will prepare and enforce the necessary regulations and policies on commercial banks. In addition, we are also working on new legal provisions for anti-money laundering, a practice that impacts the whole economy, not just the banking sector.

The IMF program will be effective for three years. The expected results have already been calculated but the banking sector reforms will not stop there. We will continue to improve our regulations.

My last question is a general one. How do you find the state of the Mongolian economy? The first half of the year has seen quite good growth, but is there a risk of a slowdown?
Risks are on the upside. The program numbers we have agreed with the Fund were quite conservative but of course there are things that do not depend on us. The policies of the U.S. Government and the decisions of the Federal Reserve impact global gold price and foreign direct investment in Mongolia. It is the same with China’s policies and decisions. China has been consistently executing its five-year plan since 2015. It includes plans to consolidate its coal sector, which could have significant effects on our economy. Even the type of coal we export should be thought out carefully. I am sure our government is not only addressing competitiveness through infrastructure issues, but is considering developments in the Chinese coal sector to make their policies.

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