Hence, the first choice which Exter had to make was whether to retain the currency board system or go for a central banking system. In a way, he did not have much choice in this regard, because his mandate was “to report on the organization and the functions of a Reserve Bank for Ceylon….” If he preferred a currency board, he should not have accepted the assignment. However, like a true professional, he compared and contrasted the two systems before he made his recommendation in favor of a central bank. The report demonstrates that his recommendation was out of conviction rather than the performance of a mere duty. His choice of a central bank for Ceylon in preference to the continuation of even a reformed currency board system was made on the basis of strong economic arguments. BIS Review 92/2007  1  1. The higher credit needs of a growing economy: Currency boards which are restrained by the need for maintaining a 100 % foreign reserve backing for the currency cannot supply enough liquidity to meet trade and other requirements unless the country continues to experience a huge balance of payments surplus year after year. Exter argued that it was not only impossible, but also undesirable to have such a surplus. Impossible because a country cannot continue to maintain a competitive edge over its competitors. Undesirable because freezing foreign reserves does not help the country to attain higher growth or welfare. 2.
Since the risk weights given to such unsecured advances exceed even 100 percent, it is necessary for the Central Bank to plan for a higher level of reserves than the minimum 15 percent. The Central Bank management, having taken this prudential requirement into account, has decided, as a part of the Bank’s modernization program, to raise the reserve level up to 100 percent of the domestic assets of the Bank. This is being continued by the Bank since 2003 and the reserve level today stands closer to 100 percent. However, it would be prudential to revisit even this percentage today in terms of its adequacy in view of the level of ever rising unsecured provisional advances and Exter’s warning that the profits earned by inflating the economy should not be distributed. The build up of reserves by the Central Bank to be equal to its domestic assets has another monetary dimension. On the liability side of Bank’s Balance Sheet, it has liabilities on account of currency issue and demand deposits maintained by commercial banks. These liabilities are known as monetary liabilities, since they constitute the reserve money of the system. All other liabilities, including the capital and reserves, are, therefore, called nonmonetary liabilities. When reserves are built-up to be equal to the Bank’s domestic liabilities, its monetary liabilities would vary exactly in accordance with the movement of the Bank’s net foreign assets.