Lack of instruments to control an inflationary situation: If there is a continuous surplus in the balance of payments, a currency board has to necessarily monetize the surplus at the cost of building inflationary pressures. But it does not have instruments to contain it and is reduced to the status of a passive spectator. In view of the above shortcomings of a currency board system, Exter recommended that Ceylon should establish a central bank with wide powers. Exter could not be faulted for making this recommendation, since this was the accepted wisdom at that time. The frustration of the newly independent nations regarding their colonial past, the desire to attain economic independence soon to match the political independence and the obvious inflexibility of currency board systems to supply liquidity in a growing trade and payment era would have contributed to the popular belief at that time that the Currency board should be replaced by a central bank. However, about two and a half decades later when Singapore had to make the same choice, “Dr Goh and the Cabinet chose the path of prudence for Singapore and sought to preserve the Currency Board System for its in-built financial discipline” (Prudence at the Helm, 1992, p 15). Many nations since then, after devastating experiences with undisciplined monetary management, chose for currency board systems to institutionalize monetary discipline by legal means. Ironically, this virtue of a currency board system had not been dealt with in the Exter Report, possibly it would not have been foreseen at that time.
In a world with a core of diversified firms that are more similar, for example, cross-firm exams and horizontal analysis increase in value and supervisors might require broader skills. Moving beyond individual firms, there is the potential for microprudential risks to transform into macroprudential ones. If firms expand, diversify and become more similar, each might become safer individually. The industry as a whole, however, might not be any safer or more resilient. If all firms are effectively the same, they could become “systemic as a herd” and susceptible to the same shocks in a way that leaves the aggregate provision of financial services more volatile.9 The propagation mechanisms for an industry with a set of similar firms with a wider range of activities may be very different from one where firm heterogeneity can offset and smooth the impact of shocks. This suggests that supervisors and regulators should be concerned not just with the firm as an entity, but with the industry as a portfolio of firms where aggregate outcomes reflect both each firm’s individual contribution and correlation properties across firms. Finally, supervisors are concerned about the efficient provision of financial services and the ability of the financial industry to support the real economy. If firms’ mix of activities is overly determined by the regulatory environment, firms will have incentives to expand into activities where they do not have a comparative advantage. As a result, the potential gains of specialization would be lost. This could make the provision of financial services less efficient overall.