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The bankers' bankers' bank: the Bank of International Settlements

Contemporary Review, July, 2004 by Keith Suter

'YOU mean to tell me that the success of the program and my re-election hinges on the Federal Reserve and a bunch of --ing bond traders?' This was the response of Bill Clinton, newly elected but not yet inaugurated as US President, when on 7 January 1993 he was briefed by his economics team on the limited financial power he would have as President. Other entities would guide his destiny.

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What is significant in this quotation (from Bob Woodward's book. The Agenda: Inside the Clinton White House) is that Clinton had spent two years talking about economics but had not learnt all that much about the real world of economics. In 1991, President George Bush won the Gulf War and seemed impossible to beat in the 1992 presidential election. Clinton, then an obscure politician from an obscure state, decided to campaign for the presidency. He avoided foreign policy (where the president was strong) and instead concentrated on the economy (where the president was weak). 'It's the economy, stupid' was the campaign slogan. But despite all the speeches and campaigning, he failed to grasp the power of the US Federal Reserve and the bond traders over any president.

In 1998, with Clinton in trouble over the Monica Lewinsky affair, financial commentators were happy with the lack of presidential power. Whatever happened to the President over his Congressional problems and the threat of impeachment, the economic boom would continue. The markets had confidence in Federal Reserve Chairman Alan Greenspan and Treasury Secretary Robert Rubin. The president's fate was irrelevant.

Standing behind the US Federal Reserve (which is the US bankers' bank) is yet another bank: the Bank of International Settlements (BIS). This is the bankers' bankers' bank. This is the least known part of the global banking system.

Once a month, the world's eleven most powerful central bankers gather in the Swiss city of Basle to discuss common problems. The meetings are not open to the public and are not publicized. This is not a sinister organization aimed at global financial domination (though some extreme left-wing and right-wing American political groups have argued that it is). But in the cosy world of banking, it is part of the final line of defence when there are runs on national banking systems. It is a bit like the International Monetary Fund--but it rarely receives the IMF's publicity.

Central Banks

The BIS is the central bankers' bank. Most national banking systems now have some form of a central bank or reserve bank to co-ordinate some of their activities (such as the Bank of England in the UK). A central bank is a banker to other banks. The final daily cash settlements within the banking system and between the banks and the central authority take place through a number of accounts held by the central bank. This means that the commercial banks involved must keep sufficient funds in the accounts held with the central bank.

A central bank also supervises the national banking system to ensure that banks do not operate fraudulently and that their customers' deposits are secure. The basic concept is 'capital adequacy': the need for enough realizable assets within a bank or other financial institution to enable it to absorb losses and thus avoid the risk of insolvency. Countries used to set their own capital adequacy levels. This has changed and a system was created by the BIS: the 1988 Basle Accord.

The BIS

The BIS was created in January 1930. It is the world's oldest international financial organization. Although based in Switzerland, the BIS is an international entity and Swiss officials have no right to enter the building without permission. It has immunity from Swiss criminal and administrative jurisdiction. The BIS is owned and controlled by the central banks. According to its charter, it is 'to promote the co-operation of central banks and to provide additional facilities for international financial co-operation'.

The BIS was originally created to handle the payment of German war debts. Following Germany's defeat in World War I, the Allies and the US (which regarded itself as separate from the European Allies) said that Germany had to pay for the war under a system of 'reparations'. The repayment system never functioned fully. In 1930, with yet another attempt to get the reparations system working, the BIS was created to handle what were supposed to be flows of money from Germany into the Allies and the US. When Hitler came to power in 1933 he stopped the system of repayments entirely.

However, the central bankers liked the BIS idea and kept it going. The need for such a bankers' bankers' bank had become clear a century ago, with the increased expansion of national economies and the important role of stable banking for those economies. With the similar increase in international trading, there had to be a system for co-ordinating the role of banks across borders.

Indeed, there had been the October 1929 Wall Street crash and there were fears (accurately as it turned out) that the world was heading for a major financial crisis. The Great Depression began in 1930 and was one of the major economic events of the twentieth century. These events reinforced in the minds of the central bankers the need for an international central bank to stand behind the national central bankers.

The bankers' bankers' bank: the Bank of International Settlements

Contemporary Review, July, 2004 by Keith Suter

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