Text by the CBBH Governor Senad Softić Ph.D. for "The Economist"

Central Bank of Bosnia and Herzegovina pillar of stability of BH economy and of society for almost quarter of century

Each crises, thus, this one, too, is excellent opportunity for reforms

We live in very turbulent times. The world was just recovering from the global financial crises when the Covid-19 pandemic hit it. Consequences of the global economy fall in 2020 have been unprecedented. The world's GDP even fell by 3.1%.   Fortunately, during 2021, it has the rising trend. The growth rate in 2021 is projected at 5.9%. Similar trends are recorded in BH, too. The most recent projections regularly made by the Central Bank of Bosnia and Herzegovina (CBBH) illustrate the growth of the GDP by 5.8% in 2021, and 3.9% in 2022. Being even more important, the date are corrected at higher level compared to the projections published by the CBBH on May 2021. Thus, high growth rates, partly caused by a 3.2% drop in GDP in 2020, are cause for optimism, since BH needs economic growth to achieve its main development goals.

It is often pointed out that since March 2020, BH, like the rest of the world, has been in crisis due to the Covid-19 pandemic, which is still ongoing, although economies are recovering. However, each crises, thus, this one, too, is excellent opportunity for reforms. This refers to structural reforms that should have long-term positive effects on economic growth and prosperity. The CBBH is aware of that, and has responded to the challenges of the crisis in time and with all available instruments, but at the same time, with internal reforms and reforms of existing instruments and functions, it is preparing for the times to come.

And the future is primarily related to the accelerated digitalization of finance with all the consequences it has for existing institutions. It is impossible to list everything that has changed due to the application of new technologies in finance. Let's start with numerous cryptocurrencies, where bitcoin is only the most popular and widespread, but the number of cryptocurrencies in the world is rising to ten thousand. Then, there is a strong trend in the development of decentralized finance, which allows direct lending of two parties without the mediation of a third party - a bank. Furthermore, there is the occurrence of these virtual so-called neo-banks, fast-growing. The number of their clients is measured in millions. Finally, there is a number of new forms of payment that are becoming a much faster and cheaper options. Major changes in financial systems will occur if, and when, digital money from central banks is used to a greater extent. What is physical cash today, will have the digital form tomorrow. In short, the world is on the verge of major changes in the world of finance. The CBBH seeks to monitor trends and analyse how and in what way these changes may affect the financial stability of the entire system.

By law, the CBBH is a currency board, meaning it does not have the instruments that other central banks have in crisis. It cannot lend to banks and the state, nor can it buy or sell securities. It also does not supervise or regulate commercial banks. The CBBH, through the coordination of two banking agencies and analysis performed, is extremely focused on the stability of the entire financial system in BH. By function, the Governor is the chairman of the Standing Committee for Financial Stability, the highest state body that coordinates the stability of the overall system and takes care of it.

The CBBH is pleased to point out that it has successfully performed all its legal functions in the crisis and will continue to do so. By internal regulations, the CBBH ensured that all its key processes are run smoothly, despite all the contacts restrictions due to the pandemic. Payment systems operated smoothly. The CBBH has significantly modernized its cash operations function, bringing it closer to the highest EU operational standards. Being aware of the importance of communication for any central bank, the CBBH significantly improved communication and communication channels during the crisis. With regular publishing of the Annual Report, the Financial Stability Report and numerous other statistics, we significantly contribute to better informing not only of the BH public, and of economic entities, but also of numerous international institutions, as well as, of potential investors in BH. Now the CBBH is present in the media much more often and not only through its website, or by being hosted by TV channels, but also via You tube channel, Facebook, Instagram and all forms of modern communication. As the Governor, I have often addressed to the public, especially in the early stages of the crisis, and we have successfully preserved the credibility of the currency board, in that way, too.

The CBBH has been working hard on improving and increasing the efficiency of the institution. Therefore, the function of control and management of non-financial risks in the CBBH has been quite improved, a very important compliance function has been introduced, scientific conferences with the participation of internationally recognized experts are held regularly (unfortunately, those have been held virtually since the beginning of the pandemic), we have been working hard on the strategic plan of the CBBH for the period ahead. To summarise, facing all external challenges, we have been focused on ongoing modernisation of the institution, as we are aware that a new environment asks us to provide new solutions to respond to all the challenges successfully.

It is particularly important that, during the crisis, the CBBH has started a long lasting process of modernisation of the only available monetary policy instrument, which is required reserve. With the assistance of the International Monetary Fund technical mission, modernisation of this instrument is underway, aimed at preserving the system stability and reducing potential risks. For example, from 01 January 2022, the rate on commercial banks’ excess reserves with the Central Bank is changed. Following the European Central Bank policy, such rate has been negative by now, with banks paying -0.5% for excess reserves. In next year, this will be -0.75%. This measure is a support to the currency board and an incentive for banks to use more actively the significant financial resources held in reserve accounts with the Central Bank for the support to the country's economic system. It is important to mention that throughout the crisis, the system liquidity has been very high.

During the crisis, the credit ratings assigned by two agencies Moody’s and S&P have been preserved, which was not easy. Even the outlook has remained stable. It is an important signal for potential investors in BH, to be aware of the risks.

Throughout the crisis, the CBBH has maintained intensive communication with the International Monetary Fund, which transferred additional funds through two channels, making the burden of the crisis easier. The help of the European Commission has also been very significant, as it transferred the macro-financial assistance funds on the basis of the Agreement on Credit Line between the European Union and Bosnia and Herzegovina. We have received the first tranche of that help by now. For the second tranche, significant reforms are needed, not for meeting the conditions of the second tranche but because we believe there is no significant progress in BH without such reforms.

After the fear of deflation in 2020, since mid 2021, the largest central banks in the world have been struggling to respond to inflation growth. Discussions whether the growth of inflation in the world, particularly in some developed countries is transitory or a long term trend will last for some time. We have not had problems with inflation in BH for years. We, as a small and open economy, share our destiny with larger ones, particularly with the euro area. Although a significant growth of prices is not expected in the years to come taking into account all the indicators, the CBBH is cautious. Our most recent projections include inflation rates of 1.7% in 2021 and 2.1% in 2022. We closely watch the growth of prices of raw materials in the world, not only oil, but also food and food products. We are aware of the fact that price stability is very important for the confidence of companies and citizens. Without confidence, there will be no additional investments. Without investments, there is no growth and prosperity which we all wish to have.

Finally, I would like to stress that as Governor of the Central Bank, I believe that we will continue to carry out our tasks successfully if we in the CBBH continue to work hard on modernization of the bank and facing all external and internal challenges. That is the only way to ensure stability in the future period, which we have done in the past quarter of the century.