LONDON, 22 October 2006 — The establishment in September 2006 of the Central Bank of Bahrain (CBB) to succeed the now-defunct Bahrain Monetary Agency (BMA), once again highlights the issue of the role of a central banking authority in an economy and financial market.

Should this central banking authority operate independently from its political masters, and should its functions be clearly divided between those of setting monetary policy including interest rate and inflation policies; and those of regulating, supervising and licensing financial services?

The Central Bank of Bahrain and Financial Institutions Law (CBB Law), issued under Royal Decree No. 64 of 2006, replaces the BMA Law of 1973 and the Insurance Law of 1987, and was enacted on Sept. 7, 2006.

“The new law consolidates into a single piece of legislation the full scope of CBB’s responsibilities as a central bank and regulator of Bahrain’s financial services industry. Legally the CBB, as the successor organization of the BMA, assumes all the rights and obligations of the now defunct BMA. As such, the existing currently in circulation also remains a legal tender. The new law modernizes and amalgamates the different laws, which previously governed the various segments of the financial services industry, into a single comprehensive document. It also marks the final stage in the creation of a single regulator for the financial services industry,” explained Anwar Khalifa Al-Sadah, deputy governor of the CBB. The CBB, more importantly, claims that it is endowed with strong operational independence and a wider range of enforcement powers. This would help the CBB to maintain clean markets.

However, under the CBB Law, the governor of the CBB will hold ministerial rank, with the assumption that he will participate in the council of ministers or the Cabinet. As such, the operational independence must come into question because of conflict of interest. Assuming CBB Governor Al-Maraj decides to raise interest rates for sound monetary and economic management reasons, and the government and fellow cabinet ministers see otherwise, who will have the final veto?

There are several instances in the Gulf Cooperative Council (GCC) countries where ministers of state are also chairmen of banks and other financial institutions and corporates. The issue of conflict of interest is shown scant regard. Dr. Mohammed Khirbash, for instance, is minister of state for the economy in the UAE. And yet he is also the chairman of Dubai Islamic Bank.

This would be unthinkable in any developed economy, which is what the Gulf economies are aspiring to be.

In the UK, when New Labour came to power in 1997, Chancellor of the Exchequer Gordon Brown, to his credit, in one of his first tasks as chancellor, made the Bank of England independent of the politicians. The Monetary Policy Committee sets British interest rate and inflation policies without the interference from the politicians for the supposed good of the economy and therefore the country, and not for the benefit of any particular party or government. It would indeed be naïve to think that governments are above manipulating monetary policy for political advantages.

More importantly, Britain also separated the functions of setting monetary policy from those of banking regulation and supervision. The Bank of England is now solely in charge of setting monetary policy and the Financial Services Authority (FSA) is now responsible for regulating and licensing financial services.

Many other countries have since gone down this route. Turkey has the Central Bank of Turkey and the Banking Regulation and Supervision Board.

One country which went the other way is Malaysia, where Bank Negara Malaysia used to be responsible for monetary policy and banking regulation. It was then asked to assume control of regulating the insurance market as well. Today Bank Negara is a huge regulatory entity responsible for monetary policy, banking regulation and licensing, insurance regulation and licensing, and indirectly for securities regulation through the Securities Commission.

With the restructuring of the Malaysian financial services market, Bank Negara may be overstretched and there are now calls from some politicians and bankers for Bank Negara’s powers be separated.

In the GCC context, operational independence is in danger of being a mere lip service policy, especially given the nature of political governance in the countries of the region. The CBB, which has an authorized capital of BD500 million, of which BD200 milion is paid up, comes into being at a time when Bahrain is determined to maintain its status as a major financial center of the region.

Dubai, Qatar and even Beirut all have aspirations to challenge Bahrain’s becoming the regional financial center.