Central Banking in Low Income Countries

Central banks play a significant role in providing the macroeconomic context for development and poverty reduction. Promoting low inflation and currency stability is not just IMF mantra; economic growth suffers as a result of high inflation or currency instability, with the poor and vulnerable the worst affected. Central banking in most countries aims to achieve monetary stability – a sound currency, with a stable exchange rate and/or low inflation – and financial sector stability – sound banks which provide good services without undertaking excessive risk, and an effective non-cash payment system. Most central banks deal with their governments (principally the Ministry of Finance) and commercial banks. They rarely deal with individuals. But the whole population will benefit from good central banking: good quality bank notes and low inflation are important directly to everyone; and it is typically the case that failure to deliver these harms most the vulnerable in society. Relatively small but well-targeted inputs to strengthen these functions may be one of the most effective forms of aid provision. Millions can benefit very rapidly from a few months of well-targeted advice. Financial sector stability and financial market development will normally take longer to deliver results than improvements in the area of monetary stability. But they can support sustainable economic growth, to the benefit of all. It is probably harder to ensure that financial sector development will provide direct benefits to the poor and vulnerable, as they may not be users of the services; and microfinance development is normally led by the government and commercial providers rather than the by central bank. But there are important areas for central bank involvement: banking supervision, microfinance supervision, and the development of widely-available non-cash payment services. This paper aims to provide a broad understanding of what central banks are, focussing in particular on their functions in developing countries with a view to facilitating donors in targeting and monitoring effectively the provision of aid. It was written for the UK's Department for International Development, and is targeted at DFID – and other donor organisation – officials working with central banks. It aims to describe, in non-technical terms, what central banks are and what the appropriate role for them in developing countries might be. The final chapters look at institution and capacity building, and donor co-ordination.