Institute of Applied and Social Sciences
NEAR EAST UNIVERSITY
INSTITUTE OF APPLIED AND SOCIAL SCIENCES
‘THE APPROPRIATENESS OF CENTRAL BANK OF NORTHERN CYPRUS TO THE EUROPEAN SYSTEM OF CENTRAL BANKS’
HAKAN TOKGÖZ
Master Thesis
Supervisor: Assist. Prof. Dr. Erdal Güryay
Department of Economics
Nicosia – 2006
Hakan Tokgöz: ‘The Appropriateness of the Central Bank of Northern Cyprus to the European System of Central Banks’
Approval of Head of the Institute
Prof. Dr. Fakhraddin Mamedov
We certify that this thesis is satisfactory for the award of a degree in Master in Economics
Examining Committee in Charge
Chairman of the Committee
Assist. Prof. Dr. Hüseyin Özdeşer Chairman, Department of Economics – NEU
Assist. Prof. Dr. Erdal Güryay Chairman, Department of Business
Administration - NEU
(Supervisor)
Assist. Prof. Dr. Okan Şafaklı Department of Banking & Finance - NEU
i ACKNOWLEDGEMENT
I would like to thank to Assist. Prof. Dr. Erdal Güryay for supervising me in the preparation of this thesis and in all the studies leading to this thesis. I would also like to thank to Assist. Prof. Dr. Hüseyin Özdeşer for all the classes he teaching us about European Monetary Union.
ii
ABSTRACT
The purpose of this study is to produce appropriate suggestions to increase the appropriateness of the Central Bank and the local commercial banks of Turkish Republic of North Cyprus (TRNC) to the framework of Eurosystem. This study will therefore focus on the European System of Central Banks and the single monetary policy.
"The successful development of the “euro” is core to the realisation of a Europe in which people, services, capital and goods can move freely." The history of the EURO is the largest monetary changeover the world has ever seen. The Treaty of Rome (1957)[1] declared a Common European Market as a European objective with the aim of increasing economic prosperity and contributing to "an ever closer union among the peoples of Europe".Instigated by the German Chancellor Helmut Schmidt and the French President Valéry Giscard d'Estaing, the Brussels Summit of December 1978[2] decided to set up a European Monetary System (EMS). It aimed to create a zone of monetary stability in Europe by reducing fluctuations between the currencies of the participating countries. It was put into operation in March 1979.The Single European Act (1986)[3] and the Treaty on European Union (1992)[4] have built on this introducing "Economic and Monetary Union (EMU) "and laying the foundations for"single currency."
In April 1989 the report of the Delors Committee[5] envisaged the achievement of EMU in three stages:
1. The objective set for the first stage, between June 1990 and January 1992, was to step up cooperation between central banks;
2. The second stage included the establishment of a European System of Central Banks (ESCB) and the progressive transfer of decision-making on monetary policy to supranational institutions;
3. In the third stage,the national currencies would have their convergence rates irrevocably fixed and would be replaced by the European single currency.
The Economic and Monetary Union (EMU) is built on two foundations.
1. The Council of Economics and Finance Ministers (ECOFIN)
2. The European System of Central Banks (ESCB).
The former is responsible for determining the broad guidelines of the economic policy of the European Union (EU) and the latter is responsible for its monetary policy.ESCB was in charge of in the third stage of the Economic and Monetary Union (EMU). But it was built on the frame of the European Monetary Institude (EMI).
As recently as fifteen years ago the idea of merging the European Union’s national monetary systems seemed a fantacy. On January 4th 1999 this remarkable vision became a reality: the currencies of the 12 participating members of Europe’s Economic and Monetary Union were irrevocably fused. The institution at the very heart of European economic policy is now the European Central Bank.The European System of Central Banks (ESCB) comprises the European Central Bank (ECB) and the National Central Banks (NCB) of the Member States which have adopted the Euro.
In designing EMU, the architects laid great emphasis both on the independence of the European Central Bank and on the simplicity and severity of its anti-inflation objective. It undoubtedly has faced (even is facing) many challenges. These stem from institutional debates over policy direction and statistical methods, and from the diverse political standpoints of the cultures of the states that it represents.
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CONTENTS
Acknowledgement i
Abstract ii
Contents iii
Abbreviations v
List of Tables vi
List of Figures vii
List of Graphs viii
Introduction ix
Chapter I. The History Of The Euro,EMU and EMI
I.1 The History Of The Euro 1
I.1.1 The Historical Development Of Monetary Integration 2
I.1.2 The European Monetary System (EMS) 4
I.1.3 The Stages Of Economic And Monetary Union 9
I.1.4 The Process Of Introducing The Euro 29
I.2. The Impacts Of EMU 33
I.2.1 Possible Impacts of EURO As A Common Currency 34
I.2.2 The Economics of a Single Currency 65
I.2.3 Euro and The Banking System of TRNC 71
I.3 The European Monetary Institute (EMI) 73
I.3.1 Monetary Financial Institutions (MFIs) 76
Chapter II. The ESCB
II..1 The ESCB 80
II.1.1 The ECB 81
II.1.2 NCBs 84
II.1.3 Strategy Of the ESCB 85 II.2 An Outlook On Monetary Policy In General 93
iv
Chapter III. Institutional Framework and Legal Status of Central Banks In EU and In TRNC (a comparison)
III.1 The Obligatory Directives Of Legal Status Of ESCB According To The Union 105 Agreement
III.1.1 A Comparative Summary Of The European Uniıon’s Basic Banking Directives 106 And The Banking Law of TRNC
III.1.2 A General Outlook Of The Central Bank Of TRNC 113
III.1.3 The Independence Of Central Banks 121
III.2 As The City of London is one of the World’s Leading International Finance 129 Sector an eligible Governance Organization of The Bank of England
“The Framework Of The Bank Of England”
III.3 The Explicit Weakness of the Commercial Banks and Other 133
Financial Institutions of TRNC
III.4 The Ways To Strengthen the Banks In Unrestricted Competition Area (Mergers) 142
III.5 A Short Outlook to the Strong Structure of the Financial Institutions 151
In South Cyprus as Being the Nearest Rivals.
III.6 A Strategy for Strengthen the Central Bank and Banking Sector for TRNC. 155
Conclusion 161
v ABBREVIATIONS
CCBS: Centre For Central Banking Studies
CDP: Common Defense Policy
CFSP: Common Foreign And Security Policy
ECB: European Central Bank
ECOFIN: Economic And Financial Affairs Council
EMCF: Europen Monetary Cooperation Fund
EMI: European Monetary Institute
EMS II: New Exchange Rate Mechanism
EMS: European Monetary System
EMU: European Monetary Union
EP: European Parliament
ERM I: Exchange Rate Mechanism
ESCB: European System Of Central Bank
ESDI: European Defense And Security Idendity
EU: European Union
FSA: Financial Services Authority
FSC: Financial Stability Committee
GNP: Gross National Products
IMF: International Monetary Fund
LOLR: Lender Of Last Resort
MA: Monetary Analysis
MFIs: Monetary Financial Institutes
MMFs: Monetary Market Funds
MPC: Monetary Policy Committee
NATO: North Atlanthic Treaty Organization
OECD:Economic Organization Of Developing Countries
RTGS: Real Time Gross Settlement
TARGET: Trans-European Automated Real-Time Gross Settlement Express Transfer
TRNC: Turkish Republic Of Northern Cyprus
WEU: Western European Union
vi List of Tables
Table 1.1 The Capital Of ECB 23
Table I.2 Key Macroecenomic Polciy Parameters of Euro Are Between 2003-2006 41
Table 1.3 Share of National Currencies in Total Identified Official Holdings of 48 Foreign Exchange by Central Banks, End of Year (in percent)
Table 3.1 Institutional Framework Of The Central Banks Of EU Member States 109-112
Table 3.2 The Comparative Presentation Of The Balance Sheets 116
of the Central Bank of TRNC And The Bank Of Cyprus As Of 31.12.2003
Table 3.3 The Comparative Consolidated Active-Oassive Balance of All 118
Banks in TRNC and The Bank Of Cyprus As Of 31.12.2003
Table 3.4 The Political Independence Of The Central Banks In EU 125
Table 3.5 The Economic Independence Of The Central Banks In EU 127
Table 3.6 The Capitals of All Banks In TRNC As Of 31.12.2003 138
Table 3.7 The Deposits of All Banks In TRNC As Of 31.12.2003 139
Table 3.8 The Loans Given of All Banks In TRNC As Of 31.12.2003 140
Table 3.9 The Cash Values of All Banks In TRNC As Of 31.12.2003 141
Table 3.10 Horizontal Bank Mergers In EU Between 1988-1992 149
Table 3.11 Horizontal Bank Mergers Between Regions In EU Between 1988-1992 149
Table 3.12 The Number Of People Per Bank In Most Of EU States 157
vii
List Of Figures
Figure 1. European Monetary System 8
Figure 2. Stages Of Monetary Union 14
Figure 3. Managerial Organs Of ECB 18
Figure 4. European System Of Central Banks 26
Figure 5. Possible Impacts Of Euro 63
Figure 6. Key Areas of The Impacts Of Euro On Business 64
Figure 7. Adjustment Mechanisms For Non-Optimum Currency Areas 71
Figure 8. Monetary Financial Institutions 76
Figure 9. Four Basic Tasks For ESCB 83
Figure 10. Legal Reqirements For The NCBs 85
Figure 11. Guiding Principles 88
Figure 12 The Original Five Possible Strategies For ESCB 89
Figure 13. Organization Of The Central Bank Of TRNC 122
Figure 14. Organization of The Bank Of England 133
Figure 15. The Causes Of The Mergers Of Banks 147
Figure 16. The Types Of Euro Area Banking Instutitions 153
viii
List of Graphs
Graphic 1.1: Consumer Price Inflation in the Euro Zone between Jan-2000 40
and Jan 2004
Graphic 1.2: Euro Zone Interest Rates between Jan-99 and Jan-04 42
Comparative with Taylor Rate Coridor
Graphic 1.3: GDP Growth in the Euro Zone between 1999-2004 43
Graphic 1.4: Euro Are Household Saving Rate in Cyclical Downturns 44
in % of Disposable Income
Graphic 1.5: Euro Zone Houshold Actual and Simulated Consumption 45
(in billion of 1995 Euro)
ix INTRODUCTION
The Aim Of The Study:
The aim of this study is to analyse the appropriatness of the Central Bank and local commercial banks of Turkish Republic of Northern Cyprus (TRNC) to the framework of Eurosystem by focusing on the European System of Central Banks (ESCB) and the single monetary policy.
The Hypothesis of this study :
The hypothesis of this thesis is; the present economic and financial structure of North Cyprus needs to be restructured and re-organize to converge with the economic and financial norms of European Union (EU). In order to achieve this objective, institutional and legal infrastructure have to be changed according to the norms of EU as the primary goal and skilled and well educated personel has to be employeed. In TRNC the amount of the personel, who are expert on the economic norms and institutions of EU, are very limited. There are different (specially undeveloped) institutions, statistical methods, culture, economic, financial and governmental systems in TRNC. The Central Bank can only do the payments of the Treasure as a cashier of it.It has got a very single administration and decision making framework which is open all kinds of interventions. There are only limited number of financial institutions in TRNC. There are a few Local Commercial Banks (the majority shares of some of the biggest banks belong to the government and the rest of the biggest ones are the branches of the foreing banks), and very limited number of other credit institutions (already most of them are predominantly giving only hire-purchase credits and are subsidiaries of local commercial banks) and a few exchange offices.
Scope of the Study:
This study includes the story of the European Monetary Union (EMU) and of course the Euro as a natural result of it with the chronological development of the main financial institutions of the European Monetary System (EMS). The stages from the European Monetary Institute (EMI) to the ESCB , the main tasks and aims of these institutions and possible impacts of the Euro and EMU on the whole economy of the world were
x
introduced detailed and chronological. Institutional Framework of The Central Banks Of EU Member
States and TRNC with the financial structure of Central Bank and other local commercial banks in TRNC were presented.
The proposals for reorganize the Central Bank Of TRNC and the proposed mergers and reconstruction studies of Local Commercial Banks in TRNC, constitutes the last chapter of the thesis.
Method of the Study :
This presentation begins however with a short introduction to the EMI and its institutions which are known as “Monetary Financial Institutions (MFIs)”, its organization, tasks, decision-making bodies. Then, since it is presently the main decision-making o organ in the single monetary policy, the way to the establishment of the ESCB. Its tasks, its main decision-making organs, the strategy of the single monetary policy and the instruments and procedures used for market operations.
Follwing this introduction, the present organization of the Central Bank of TRNC, its competences and decision-making organs the existing financial structures of the local commercial banks were presented. Then it was tried to underline the disability of the Central Bank and other local retail banks to dominate and control the markets, monetary base and all kind of investments, which can be seen from the realized balance sheets of these institutions which were listed in the tables. On the other hand, according to the regulations of the releated rules of the Maastricht Agreement, re-organized structures of the central banks of some of the member states of EU (spesifically The Bank Of England ) were also explained with the helps of the tables and organization figures. By the help of the comparative tables it was tried to emphasize the necessity of restructuring on the frame-works of the banks and the central bank of TRNC. Finally the proposals to restructure and to appropriate the local financial institutions into EMU were presented.
Limitations :
The “capital adequacy ratio” is the most important indicator for the banks in determining the strength of them. Especially the amount of the warranted assets increase and/or decrease the capital ratio of a bank or any kind of a credit institution. But unfortunatly it
xi
couldn’t be possible to obtain such kind of data either from banks themselves or from the central bank.
Structure of Study
In Chapter I, the research begins with an introduction of the “Euro” and the stages of the EMU with its goals and ecocnomic and social impacts both on the euro area and on the world outside of the EU. Then follows an introducing about “European Monetary Institute and ıts Institutions”as the fundamental framework of European System Of Central Banks (ESCB)