Monetary Policy and the Future of Central Banking

The chapter highlights the state of monetary policy in Africa and explores the challenges that central banks face as they address the increasingly complex forces at work in the global economy. It sequences the evolution of monetary policy from the time of World War II under the Bretton Woods system to the more recent forward-looking monetary policy in advanced economies and relates it to influencing the evolution of monetary policy frameworks in Africa. Some challenges affecting African countries are identified, including the collapse of commodity prices, persistent high interest rates spreads, and limitations of high frequency data that constrain monetary authorities’ abilities to take corrective actions in a timely manner. The chapter concludes by providing seven principles towards increasing the effectiveness of monetary policy for countries seeking to move towards forward-looking monetary policy frameworks.

Powering Financial Inclusion through Innovative Payment Systems

Over the past 50 years, Kenya’s payments and banking systems have undergone both incremental and revolutionary modifications that have transformed Kenya’s financial landscape, from cash transactions to digital finance ecosystems. M-PESA, rolled out in 2007, undoubtedly has earned its place in Kenya’s Hall of Fame. The developments in the payments system have culminated in a more accessible, effective and efficient Kenyan payment system. This chapter tells the M-PESA story from the lens of a regulator, from conception to the eventual launch in March 2007. More importantly, the chapter tells other understated stories of payments and related banking sector innovations that have seen the level of financial inclusion in Kenya triple from 26 per cent in 2006 to over 75 per cent in 2016. The chapter provides lessons learnt in this transformational journey, one being the need for regulators to understand the business models underpinning innovations, risks thereon, and their mitigating factors.

Central Bank Independence

The chapter covers central bank independence broadly and makes use of rich literature to bring out key issues on central bank independence from the inception of central banking in 1668 to the twenty-first century. The chapter identifies four measures of central bank independence mainly focusing on legal characteristics. The findings of the study point to benefits associated with independence of central banks, including management of inflation. Also, it is found that delegating monetary policy to an independent central bank increases debt sustainability and fosters fiscal discipline. It is noted that central bank independence needs to be reconciled with the requirements of institutional and personal accountability of the governors. Further, the financial regulation role should be strengthened in the mandates of central banks as the objective of price stability does not necessarily foster financial stability.

Central Banking in Kenya

The history of the Central Bank of Kenya (CBK) dates back to the pre-colonial period when the East African Currency Board performed central banking functions before CBK was established in 1966. Over the first 20 years of its formation, the Bank focused on maintaining the external and internal value of the currency and financial stability. Liberalization reforms followed in early 1990s that led to a market-based economy and a shift in conduct of monetary policy from direct to indirect monetary policy instruments. Legislative amendments granted CBK operational independence and set out clear objective of price stability. The legal and regulatory framework has continued to evolve to reflect the changing domestic and global dynamics. Going forward, the future of central banking in Kenya will largely be shaped by the emerging financial and technological developments, regional integration initiatives, and the evolving global dynamics.

Dynamics of Monetary Policy in Kenya

This chapter provides a chronicle of monetary policy phases and outcomes in Kenya since the establishment of the Central Bank of Kenya in 1966. After detailed analysis of historical events and data spanning 50 years, it is found that monetary policy has evolved from an era of rudimentary monetary policy practice, a backward-looking monetary policy to a regime that is forward-looking, best characterized as transitioning to inflation targeting. During the 50 year journey, the Bank has made major milestones in the formulation of monetary policy. However, the interest rate capping law that came into force in September 2016, as the Bank celebrated its 50th anniversary, posed a threat to the achievements. The Central Bank was keen on having it repealed and this was attained in November 2019.

Evolution of Central Banking

This chapter provides some observations regarding the evolution of central banking. It is noted that the practice of monetary policy and the scope of central banks have changed over time. The chapter reflects on the path to East African Economic and Monetary Union (EA-EMU). First, how does East Africa stand in terms of economic and financial convergence? Second, what are the milestones of central banking that all central banks of the EA-EMU should master? Third, which monetary lessons could the euro area offer? Fourth, what worked, and has not, in the euro area, what is being fixed? It is noted that East African countries have differences in income per capita, exchange rate volatility, domestic prices, and fiscal discipline. To support sustainable convergence, they should align their monetary policy frameworks and have solid fiscal arrangement.

Financial Stability and Bank Supervision in the Twenty-First Century

This chapter addresses the challenges and opportunities for financial stability and bank supervision in the twenty-first century. It is argued that one of the major challenges to the vision of achieving a world where the financial systems are stable, reliable, and accessible was the 2008 global financial crisis. The G20 took up an agenda to improve regulation and supervision regimes globally through initiatives such as higher capital requirements and new liquidity regulations. However, challenges have emerged due to advances in technology, financial innovations, climate change, legislative or regulatory barriers and money laundering, organized crime, corruption, and the financing of terrorism. In particular, supervisors in developing economies face the challenge of how to ensure financial stability while at the same time promoting the development of the financial system to sustainable economic growth for poverty reduction and greater equality.

Introduction

The introductory chapter provides the motivation of the book and a summary content of all the chapters. The main aim of the book is to document key milestones traversed by the Central Bank of Kenya over the last 50 years, in line with evolution of central banking globally and within the East African region, and, reflects on the future prospects and challenges. The chapter also outlines the contents of the book, which is structured into two parts. Part 1 provides a background of international issues, including theory as well as evidence, relating to central banking in general. Part II builds on this background and provides specific insight into central banking in Kenya. The book is envisaged to be a useful resource to many readers interested in understanding the role and evolution of monetary and financial policy, globally and its influence on Kenya for the past 50 years.

Mobile Money

The chapter focuses on mobile money—one of the most celebrated innovations in the developing economies, that adds service over the mobile phone. The chapter highlights the economics behind the product, what may have driven to the wide adoption of mobile money in developing countries and the impacts it has had on the users of the financial product. The focus is mainly on the Kenya-based M-PESA given its success, but also discusses more recent innovations that build on mobile money systems to deliver additional financial services and value. It is noted that although these innovations exist, they have not given rise to a thriving Fintech sector. The chapter therefore also discusses the constraints to the growth of mobile money and what this implies for the future of mobile money in developing economies, and where the most exciting opportunities for research may be.

Do Central Banks Have a Role in Financial Inclusion?

The chapter focuses on the role of central banks in fostering financial inclusion and specifically on the potential impact of financial inclusion on financial stability and economic growth. It examines the expansion of financial inclusion, from the reliance on informal solutions to the availability of formal services, through the engagement of policy-makers who have impacted on the way the financial sector has developed to be increasingly networked, driven by digitization, and supported by digital mobile networks. It highlights Kenya’s global success in financial inclusion; Kenya is used as a case study in central bank management, financial inclusion, and its contribution to economic development. It concludes by pointing out the risks associated with the absence of countervailing policies by financial institutions which may lead to unexpected losses to the financial system, and ultimately a banking crisis.