Sead KRESO, Selena BEGOVIĆ

1. FINANCIAL DEVELOPMENT AND THE PROCESS OF MONEY MULTIPLICATION IN THE EUROPEAN TRANSITION COUNTRIES Sead KRESO, Selena BEGOVIĆ

2. Content • The main goals of the presentation • Money multipliers • Determinants of (and limitations to) the money multiplication process • Type of monetary/exchange rate regime • Level of financial development • Financial sitem BiH-perspective from foreign capital flows • Presence of foreign banks • Conclusions and suggestions

3. The main goals of the presentation • To investigate the effect of the type of monetary regime and the depth of financial development on the dynamics of money multipliers • To demonstrate the limitations and obstacles to process of money multiplication process in the European transition countries, with a focus on countries with currency board arrangement • To suggest improvements for better utilisation of national resources in European transition countries, with a special focus on Bosnia and Herzegovina

4. Money multipliers • After the creation of the high powered money (reserve money, monetary base - MB) it is further being “technically processed”within the money flows between the financial institutions and clients/customers (forming M1, M2 and broader monetary aggregates) • Consequently, progress and development of a whole financial mechanism can be observed through money multipliers (m1, m2, m3), which show the increase of the “financial pyramid” with regards to the monetary base (m1=M1/MB; m2=M2/MB; m3=M3/MB) • (Short/Long-term) Capital (as high-powered money) (In)Flows into an economy (can) generate additional money supply or bank credit

5. Money multipliersfor the selected transition and developed countries Source: Based upon the calculation of money multipliers according to the data for the monetary aggregated from IMF's International Financial Statistics and WB's World Development Indicator databases *Note: The broad money is different monetary aggregate in different countries (see IFS Documentation at http://esds80.mcc.ac.uk/wds_ifs/TableViewer/document.aspx?ReportId=47036)

6. Money multipliers for the European transition countries Source: Based upon the calculation of money multipliers according to the data for the monetary aggregated from IMF's International Financial Statistics and WB's World Development Indicator databases

7. The main determinants of the money multiplication process • Level of discretion of monetary/exchange rate regime (ability to affect money multiplication process) • Level of development of financial markets and institutions • An asset share of foreign-owned banksand the dependence of money multiplication process on foreign financial markets

8. “De facto” exchange rate regimes Source: Ilzetski et al. (2010) and authors’ additions (in blue)

9. Financial market development indicator (FMDI) Source: WEF data platform (available at http://www.weforum.org/issues/competitiveness-0/gci2012-data-platform/)

10. Money multiplier and FMDI (2010) Source: STATA12 printout based on the data on money multipliers and FMDI investigated above

11. Financial sitem BiH, perspective from foreign capital flows • FitzGerald (QEHWPS08) • „Short-term capital flow instability arises from the desire of investors to hold liquid assets in the face of uncertainty“ • „The volatility of short-term capital flows (or ‘capital surges’) is now recognized as a major problem for macroeconomic management in developing countries“ • Firat Demir (2007) • „..the volatility of short term capital inflows such that increasing volatility by disrupting market activities, domestic investment and growth increases socio-political risk, which further feeds into the volatility of such flows“

12. Firat Demir (2007) • „Between 1990 and 2003, gross inflows increased 50 times in Argentina, 21 times in Mexico and 42 times in Turkey compared to the 1984-1989 period... While gross inflows stand around $592, $553 and $188 billion in AMT, the net inflows remained at $5, $27 and $7 billion respectively between 1990 and 2003“ • Chee-Keong Choong, Siew-Yong Lam, Zulkornain Yusop (2010) • “... private capital flows have a positive impact on growth in low-income countries with well-developed financial sector“

13. Bosnia and Herzegovina/region - Financial system strongly dominated by commercial banks established by foreign capital • The Development strategy for BiH (Internetional comunity, WB) - to build the economic structure based on SMEs • Rodric (1999) • “Small enterprises ... are vulnerable to the business cycle because they rely on sub-contracts from larger firms or the expenditure of wages by their employees”

14. Assets share of foreign-owned banks Source: EBRD

15. T11: Consolidated Balance of Commercial Banks in BH • - end of period, in KM million– (an excerpt of selected items) • ASSETSLIABILITIES Source: CBBH Bulletin 4, 2012.

16. T15: Total Deposits and Loans of Commercial Banks • end of period, in KM million – • DEPOSITS LOANS Source: CBBH Bulletin 4, 2012.

17. T18 & T19: Short & Long -terms Loans Structure by Sectorof Commercial Banks- end of period, in KM million– • (an excerpt of selected items) • Short -terms Loans Long -terms Loans Source: CBBH Bulletin 4, 2012.

18. Maturity matching process in Bosnia and Herzegovina „Export“ of short-term funds M2 • m2 Foreign financial market M1 MB • m1 „Import“ of long-term funds

19. Conclusions and suggestions • The level of financial market development is rather low in European transition countries(particularly in Bosnia and Herzegovina) • A high asset share of foreign-owned banks and the dependence of money multiplication process on foreign financial markets • This foreign dependence does not allow complete utilisation of national resources and is rather expensive • Even though money multipliers are lower in countries with the most restrictive monetary policies - this is also consequence of low level of financial development and the dependence on foreign markets

20. Conclusions and suggestions • Since the restrictive monetary policies are increasing credibility and stability in a transition countries available financial resources should be increased through other channels • The introduction of new channels of money multiplication through domestic finacial markets, which could use scarce financial resources more effectively for developing national economies and could be utilised as a buffer against the shocks • creation and development of the appropriate debt-securities market for investment of short (and longer) term funds • establishment of, for example, the development bank, which could be used by government to: initiate and attract development funding; implement a selective credit policy for some strategic area of development, affect the interest rate and to buffer shocks