Prudential regulation

An appropriate legal framework for financial operations is a significant contributor to preventing or minimising financial sector problems. Evidence shows that the absence of prudential regulations in some key areas can lead to bank failures and systemic instability, while establishing sound, clear and easily monitored rules for financial activities both encourages managers to run their institutions better and facilitates the work of supervisors. A major weakness of some financial systems is the fact that various financial institutions, especially cooperatives and intermediaries in rural areas, operate completely outside prudential regulations. Some countries have one single general banking law, which tries to assemble all regulations, but in many countries the operational issues are left to statutory notes, circulars or even simply the routine decisions of the supervisory institution. Various other laws can have an impact on the operation of financial institutions, e.g. company laws, securities laws, debt recovery laws and laws on liquidation and bankruptcy.

Library Resources

resource title type year resource
Money transfer operators in Nigeria: Regulation and licensing options Technical Note 2020

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Many people have had their 2020 plans ruined by COVID-19, but the cross-border remittance opportunity in Nigeria is even more enticing right now.

The World Bank expects cross-border remittances to drop dramatically in 2020, but many African players are experiencing a sharp increase in digital person-to-person flows as cash is becoming stigmatised. This may turn out to be an opportunity for pulling in the 50% of Nigerians who currently send cash informally.

This note outlines the market opportunity in Nigeria, the regulation to consider as well as the licensing options and requirements and the pros and cons of going solo or partnering up with a bank.

Key Facts Statements For Credit: Do They Work? The Experience of Armenia Case Study 2020

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This resource appears in: Policy Advice, Country studies, Prudential regulation

Rapidly developing digital credit products and aggressive credit sales have impelled financial authorities to help financial consumers make more informed and effective credit decisions. One of the tools many countries are using is Key Facts Statements (KFSs), which aim to improve financial decisions in the pre-contract stage of the credit process and to promote healthy competition among financial institutions.

However, many authorities want to know: do Key Facts Statements work?

This research shows that a KFS can have a significant positive effect on consumer credit choice and comprehension if the timing, content, design and delivery methods are appropriate and effective.

The study combines qualitative analyses from three experiments in Armenia and presents insights from international experience. The findings show both positive and negative effects of implementing credit KFSs and policy recommendations are made based on these findings.

Publisher AFI
Number of Pages 12
Primary Language English (en)
Region / Country Global
Keywords Key Facts Statement, Credit regulation
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Microfinance and COVID-19: Principles for Regulatory Response Brief 2020

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Governments across the globe have taken extraordinary steps to contain the COVID-19 outbreak. Although necessary, public health responses such as lockdowns have imposed serious costs on the real economy and the financial sector. As a result, further policy steps have proven necessary, both within and beyond the financial sector, to mitigate the impacts of the pandemic on businesses and ordinary people. This Briefing applies each principle to country contexts, and specifically addresses what each principle means for regulatory responses to the COVID-19 crisis.

Deposit Insurance Treatment of E-Money Brief 2019

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This resource appears in: ICT applications, Collateral regulation, Prudential regulation

The expansion of digital financial accounts among poor customers has raised the question of whether e-money should be covered by deposit insurance and if so, how. This Technical Note examines the options while arguing that deposit insurance should not be the first line of defense, for two primary reasons. In many emerging markets where authorities have limited resources, their first area of focus should be on strong prudential regulation and supervision to ensure safe and sound institutions. Second, electronic money issuers are engaged in a narrow set of activities and in most cases pose limited or no systemic risk, compared with financial institutions that intermediate deposits and issue credit.

Risk-Based Customer Due Diligence: Regulatory Approaches Technical Note 2019

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This resource appears in: Risk management, Prudential regulation

Regulators face a challenge in balancing policies on anti-money laundering and combating the financing of terrorism against placing the least burden on outreach to the poor and unbanked. This Technical Note provides guidance on using risk-based approaches to customer due diligence (CDD), supported by examples drawn from around the world. There are three regulatory options for employing risk-based CDD:

  1. Principles-based approach
  2. Single low-risk threshold
  3. Framework of multiple risk tiers.

Each requires regulators to determine the level of risk and then to decide the appropriate processes of simplified due diligence.

Fair Play: Ensuring Competition in Digital Financial Services Paper 2019

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This resource appears in: Rural Financial Services, Rural Financial Services: General, Collateral regulation, Prudential regulation

Providing guidance to financial sector regulators for identifying anti-competitive behavior

In many emerging economies, digital financial services (DFS) markets are limited to one or two major providers, reducing innovation, customer choice and potentially facilitating monopolistic or cartelistic behavior. Why are DFS markets prone to concentration? Is this a problem?

This primer applies a framework to help answer these questions and demonstrate how regulation can have a substantial impact on competitive dynamics in the DFS marketplace. The paper also proposes regulatory levers that policy makers can use to promote more competition. Looking ahead, a competitive landscape becomes especially important given the rising importance of customer data and the entry of large, multinational technology companies into DFS markets.

Author Matthew Soursourian & Ariadne Plaitakis
Publisher CGAP
Number of Pages 32 pages
Primary Language English (en)
Region / Country Global
Keywords Competition, digital financial services, emerging economies, customer choice, multinational technology
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Consumer Protection Regulation in Low-Access Environments: Opportunities to Promote Responsible Finance Technical Note 2011

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This paper defines responsible finance as delivery of retail financial services in a transparent and equitable fashion. The focus is on products, processes, and policies that appropriately balance customers’ interests with those of providers’ and avoid harmful or unfair treatment. Responsible finance is promoted through measures that may include consumer protection regulation, industry or provider codes and standards, and improvements in consumer financial capability.

This Focus Note describes current practices and assesses options for design and implementation of basic consumer protection rules, focusing on low-access environments.

Legal and Regulatory Reform for Access to Finance: A Policy and Programming Tool Document 2006

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This comprehensive module sets out details for running a day-long training course, made up of 14 sessions, covering a policy and programming tool on the subject of legal and regulatory reform for access to finance. It is intended that at the end of the course, participants will:

  • understand the term “access to finance” and the possible policy interventions that correspond to this term.
  • know the basic of microfinance regulation best practice
  • be familiar with the Policy and Programming Tool and its use in analysing programme options
  • learn how to gather and analyse materials relevant to the tool
  • learn how to contract outside expertise

Each session guide sets out all the relevant steps for a facilitator to be able to run the session. This includes and indication of the time-period, an upfront summary of the key messages of the session and then a step-by-step guide to running the session. This guide is broken down by chunks of time so the facilitator can map out exactly all the logistics. Many of the sessions include handouts, flip chart activities and index card notes, all of which are set out in a clear guide found at the end of this training module.

The sessions to be conducted are broken down as follows:

  • Introduction
  • What is access to finance and why is it important?
  • How do we program “access to finance”?
  • What is microfinance regulation?
  • Can policy interventions always solve this issue?
  • Introducing the tool
  • Step one: assessing the situation
  • Step two: analyse conditions for reform
  • Using step two
  • Step two debrief
  • Step three: focus your efforts
  • Step four: decisions for the lorax republic
  • Debrief tool
  • Closing summary
Author Druschel, K, van Bastelaer, T and Meagher, P
Publisher USAID
Number of Pages 63 pp.
Primary Language English (en)
Region / Country Global
Keywords Regulation, Regulatory Reform, Legislation
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Regulating Microfinance in Ethiopia: Making it More Effective Case Study 2005

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The fact that the Ethiopian government has established the regulatory framework early-on in the development of the microfinance industry has helped to lay out the roadmap for the development of the sector. In particular, the provision allowing MFIs to mobilize small savings from the public has enabled them to finance a substantial portion of their portfolio from internally generated sources. Subsequent improvements in the regulatory framework include the revision of the loan size ceiling for individual borrowers, the revision of repayment periods on loans from one year to two years, and removal of the interest rate ceiling on credit. This removes some of the key regulatory problems faced by the industry. But more needs to be done.

The Ethiopian MFIs still have no way of learning new insights from foreign banks, yet indirect foreign ownership cannot be fully controlled, and not enough Ethiopian-owned MFIs are forthcoming. The poor still do not have enough microfinance service providers from which to choose. While the interest rate ceiling on credit has been removed, a minimum on interest to be paid for savings persists, hampering savings mobilization in remote rural areas. Existing microfinance institutions, while targeting to reach the poor, are serving mainly men. Thus, the regulatory framework not only needs to find ways and means of helping the industry become more competitive and efficient in delivering flexible financial services to the majority poor, the regulatory mechanism also needs to be better equipped to supervise and monitor the industry.

This paper is one of a series of studies commissioned by the CGAP / IRIS Microfinance Regulation and Supervision Resource Centre.

The Ultimate Balancing Act: Investor Confidence and Regulatory Considerations for Microfinance Paper 2005

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This paper states that behind the scenes of every investment transaction, investors, MFIs, local lawyers, and consultants navigate a sea of permits, restrictions, approvals, and potential obstacles in the local and regulatory environment. It asks – At what point do these hurdles become too costly to bear and actually deter commercial investment in microfinance? What regulatory practices promote investor confidence and provide impetus to increased private investment in microfinance? The paper seeks to answer these questions using fieldwork conducted in Uganda, Peru, and the Philippines, as well as international experience gained through desk research and interviews with leading experts.

The report notes that whilst it is rare that no regulatory oversight exists, the two ends of the spectrum can be classified by “light” regulatory oversight and “heavy” regulatory oversight. At the light end of the spectrum the paper points to:

  • No or nuclear legal status
  • Low level of oversight/monitoring
  • Secured lending: ability to pledge intangible assets
  • Lack of protection of minority investor rights

At the other end of the spectrum the paper highlights:

  • Restrictions due to legal status
  • Forms of capital allowed
  • Limit on loan size or term
  • Interest rates
  • Capital and reserve requirements
  • Cost of regulatory requirements
  • Restrictions on ownership
  • Tax burdens

The paper explores the specifics of the spectrum. It begins with an introduction to the Transitions to Private Capital project before turning to discussing the characteristics of regulatory practices along this spectrum. Topics such as MFI legal status, secured transactions law, investor protection, and tax considerations are discussed to show how an overall regulatory environment affects investor confidence. The paper ends with an examination of the lessons learned about balancing the two extremes and the process required to achieve this balance.

The paper concludes with the view that as external factors evolve (such as a change in government, economy, MFI market environment, investor interest, etc.), regulators and stakeholders must continually re-evaluate the balance required to promote investor confidence. The lessons noted in the paper are:

  • Transparent regulation of financial institutions provides security for both institutions and investors
  • Government attitude towards microfinance and investment is very important, particularly in creating a solid enabling environment
  • Clear communication about requirements is helpful for both MFIs and potential investors. Developing a consultative process when reappraising the regulatory environment results in increased investor confidence and better informed MFIs
Prudential Regulation Document 2002

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This short briefing paper notes that experience in emerging markets has demonstrated that financial crises can be highly damaging for economies, government budgets and living standards. This realisation, it argues, has reinforced interest in improving financial sector regulation and supervision. The objective of prudential regulation is to protect the stability of the financial system and protect deposits so its main focus is on the safety and soundness of the banking system and on non bank financial institutions that take deposits.

The brief aims to answer the question – why have the prudential reforms already implemented in developing countries not been more effective in preventing banking crises and how can prudential systems be made more effective? In doing so, the following topics are covered:

  • Weak regulations and gaps in regulation
  • Weak enforcement of regulations
  • Supervisory capacity constraints
  • Strengthening prudential regulations
  • Better bank intervention policies
  • Improving the institutional environment for regulation
  • Risk based supervision
  • Market based approaches to regulation
  • Deposit insurance

In its analysis, the brief highlights the following as the main points:

  • Developing countries have made much progress in strengthening their prudential systems since the 1980s. Banking legislation has been upgraded and supervisory capacities expanded
  • Important weaknesses remaining include lax bank licensing, weaknesses in prudential regulations and poor enforcement of regulations
  • In most cases of bank insolvency, unless a systemic risk to the banking system is involved, the bank should be closed down
  • Bank regulators need stronger incentives to undertake effective regulation and supervision in the public interest. They need to be made more accountable to a body representing the public interest
  • Bank regulators also need proper protection from political interference
  • Risk based supervision can help make best use of scarce supervisory resources and help regulators deal with the increasingly complex financial services now evolving
  • Relying on market based supervision is unlikely to be feasible for many low income developing countries
Author Brownbridge, M, Kirkpatrick, C and Maimbo, SM
Publisher Finance and Development Research Programme
Number of Pages 4 pp.
Primary Language English (en)
Region / Country Global
Keywords Regulation, Financial System, Financial Services
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A framework for regulating microfinance institutions: the experience in Ghana and the Philippines Case Study 2002

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An earlier Policy Research Working Paper (Hennie van Greuning, Joselito Gallardo, and Bikki Randhawa, " A Framework for Regulating Microfinance Institutions, " WPS 2061, February 1999) presented a regulatory framework that identifies thresholds in financial intermediation activities that trigger a requirement for a microfinance institution to satisfy external or mandatory guidelines, thus creating a tiered approach to regulation and prudential supervision. The model focuses on the risk-taking activities of microfinance institutions that must be managed and prudentially regulated. This paper reports on the results of field testing the tiered approach in Ghana and the Philippines.

The two countries both have a wide range of informal, semi-formal and formal institutions providing financial services to the poor, but differ in how they regulate financial intermediation activities by microfinance providers. In this assessment and comparative analysis, the author focuses on the key issues in the regulatory and supervisory environment for microfinance, and in the legal system and judicial processes, that are being addressed by government authorities and microfinance stakeholders in both countries. He gives particular attention to the thresholds at which intermediation activities become subject to prudential regulation and regulatory standards for capitalization and capital adequacy, asset quality and provisioning for nonperforming loans, and liquidity management.

The paper seeks to identify the key elements and characteristics of the microfinance regulatory experience in Ghana and the Philippines and to identify lessons that may be useful for other countries interested in establishing a regulatory environment conducive to the development of sustainable microfinance institutions. One principal lesson is that a transparent, inclusive regulatory framework is indispensable for enabling microfinance institutions to maintain market specialization and to pursue institutional development that leads to sustainability. Clear pathways for institutional transformation facilitate the integration of microfinance institutions into the formal financial system.

Author Gallardo, J.
Publisher World Bank Group
Number of Pages 46 pp.
Primary Language English (en)
Region / Country Global
Keywords Regulation, Supervision, Microfinance Institutions
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Microfinance, Regulation and Uncollateralised Loans to Small Producers in Argentina Paper 2001 English (en)

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Microfinance is small loans and small deposits. The hope that microfinance can help small farmers and the self-employed has sparked much recent debate about how best to regulate microfinance organizations. However, changes to regulations do not make sense unless they create benefits from improved access to microfinance that exceed the costs created by those changes. In this paper the authors examine the role of collateral based regulation in Argentina and whether it is a constraint on increased lending to small rural producers.

During the Tequila crisis in 1995, the runs on banks led to a tightening of prudential regulation and supervision and the closure of smaller provincial and cooperative banks. Has this seriously damaged the access of small producers to loans? The authors do not think so – they argue that strong regulation is essential for attracting deposits and deposits are essential to provide funds for lending. As long as banks remain safe places to deposit savings, time will loosen constraints on access to loans.

Regulators in Argentina use the presence or absence of collateral as a low cost rule of thumb to judge the risk of portfolios. Uncollateralised loans have high requirements for capital and for loan loss provision. This ties up bank capital and so increases both costs for lenders and prices for borrowers. Other things being equal, this decreases access. However, access to microfinance for small producers in Argentina is constrained mostly by three factors unrelated to conservative regulation.

  • First, the financial system is still shallow. As long as deposits are small, short and swift to be withdrawn, loans will be small, short and scarce. The greatest constraint on loans in Argentina is lack of deposits. Strict regulation will continue to strengthen and consolidate the banking system and thus deepen the market and attract more deposits.
  • Second, most lenders who make uncollateralised loans can lend all they want and earn high profits from salaried consumers who are better clients than small producers. This is not a factor that justifies intervention.
  • Third, weak registries for liens on movable goods and incomplete credit bureaux reduce the value of chattel as a hostage and reduce the incentives for borrowers to preserve clean credit records. Public resources used to improve these public goods would improve access to uncollateralised loans for small producers in Argentina.
Paper  -  English (en)

Author Schreiner, M.; Colombet, H.H.
Number of Pages 30 pp.
Primary Language English (en)
Region / Country Global
Keywords Collateralized Debt Obligation (Cdo), Prudential Regulation, Bank Supervision
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New Tools for Assessing Financial System Soundness Article 2000

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This article which was published in Finance and Development explains that macro-prudential indicators (MPIs) — defined broadly as indicators of the health and stability of the financial system — can help countries assess their banking systems’ vulnerability to crisis. In recent years, an increasing amount of work has been done on such indicators as part of efforts to strengthen the international financial architecture.

MPIs comprise both aggregated micro-prudential indicators of the health of individual financial institutions and macroeconomic variables associated with financial system soundness. One commonly used framework for analyzing the health of individual institutions is the CAMELS framework, which looks at six major aspects of a financial institution: capital adequacy, asset quality, management soundness, earnings, liquidity, and sensitivity to market risk. Among the relevant macroeconomic indicators are data on aggregate and sectoral growth, trends in the balance of payments, the level and volatility of inflation, interest and exchange rates, the growth of credit, and changes in asset prices, especially stock and real estate prices.

In discussing how these indicators should be used, the authors say that the assessment of financial system soundness also requires an ability to couple the analysis of MPIs with informed judgments on the adequacy of the institutional and regulatory frameworks. These frameworks include the structure of the financial system and markets; accounting standards and disclosure requirements; loan classification, provisioning and other prudential regulations; the quality of supervision of financial institutions; the legal infrastructure (including those parts of it covering bankruptcy and foreclosure); incentive structures and safety nets; and liberalization and deregulation. The interpretation of MPIs is contingent on these institutional circumstances, and the monitoring of such indicators can only complement, not substitute for, institutional judgment.

The article goes on to discuss how these indicators can be measured and some of the statistical challenges that exist. The authors conclude that knowledge about MPIs is still limited. They believe we need to acquire a better understanding of what determines financial system soundness and to identify which signals might help policymakers prevent financial crises.


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The CAMEL methodology was originally adopted by North American bank regulators to evaluate the financial and managerial soundness of U.S. commercial lending institutions. The CAMEL reviews and rates five areas of financial and managerial performance: Capital Adequacy, Asset Quality, Management, Earnings, and Liquidity Management. As microfinance institutions (MFIs) increasingly reach out to formal financial markets to access capital, there is a need for a similar tool to gather and evaluate data on the performance of MFIs. Based on the conceptual framework of the original CAMEL, ACCION developed its own instrument. Although the ACCION CAMEL reviews the same five areas as the original CAMEL, the indicators and ratings used by ACCION reflect the unique challenges and conditions facing the microfinance industry. To date, ACCION has used its CAMEL primarily as an internal assessment tool, which has contributed to setting performance standards both for the ACCION Network and for the microfinance industry as a whole.

The ACCION CAMEL analyzes and rates 21 key indicators, with each indicator given an individual weighting. Eight quantitative indicators account for 47 percent of the rating, and 13 qualitative indicators make up the remaining 53 percent. The final CAMEL composite rating is a number on a scale of zero to five, with five as the measure of excellence. This numerical rating, in turn, corresponds to an alphabetical rating (AAA, AA, A; BBB, BB, B; C; D; and not rated).

This comprehensive guideline clearly explains the purpose and scope of CAMEL and goes into detail about how to apply the procedures necessary to generate the information required. It then discusses the financial statements and adjustments that are needed. Finally the CAMEL scoring system is explained in detail before providing examples and worksheets in the annexes.

Author Sonia B. Saltzman; Darcy Salinger
Publisher ACCION International
Number of Pages 106 pp.
Primary Language English (en)
Region / Country Global
Keywords Performance Standards, Capital Adequacy, Financial Management
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Basic Principles of Banking Supervision Document 1996 English (en)

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This handbook explores some of the basic principles of banking supervision. First of all, it addresses the general question of why banks need to be supervised, and sets out the basic aims of supervision. It notes that supervisors seek to ensure that banks are:

  • financially sound
  • well managed, and
  • not posing a threat to the interests of their depositors

And in pursuing these objectives supervisors are trying to form three judgements

  • how much risk is each bank undertaking?
  • what resources are available to manage that risk?
  • whether the identified level of resources is sufficient to balance the risk.

It then examines the nature of banking risk, focussing on credit risk, liquidity risk, yield risk, market risk, operational risk and ownership/management risk. Next, the key areas of prudential supervision are discussed – namely, capital adequacy, liquidity, asset quality, risk concentration, management, and systems and controls.

Furthermore, the need for an effective infrastructure for supervision, not least in respect of the legal and accounting environment, is noted. The legal framework must deal with:

  • business organisation – the formation, ownership, rights and obligations of privately owned enterprise
  • the ownership of property – and in particular the means by which banks to whom collateral is pledged by a borrower can register and, in extremis, enforce their claims
  • insolvency – the circumstances and manner in which an unpaid creditor of an enterprise may call for it liquidation, the process by which that liquidation is to be effected and the priority to be accorded to different classes of creditor

Accounting systems should encompass:

  • an agreed set of accounting standards to be followed by all enterprises in the preparation of their accounts, facilitating the resource allocation process – for example, by enabling banks to undertake informed credit assessments
  • independent review and certification of the accounts prepared by enterprises, undertaken by external auditors
  • public disclosure of audited financial statements

Finally, the relative contributions of off-site and on-site supervision are briefly discussed.

The author notes that the handbook does not seek to prescribe what any country should do, or to promote particular national practices (which maybe mentioned by way of illustration). Rather, it seeks to introduce the nature and concepts of supervision to those for whom the subject may be comparatively unfamiliar.

Basic Principles of Banking Supervision  -  English (en)

Basel Committee on Banking Supervision Website English (en)

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Basel Committee on Banking Supervision  -  English (en)

Centre for Central Banking Studies - Handbooks Website English (en)

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The website offers a series of Handbooks in Central Banking, which has grown out of the activities of the Bank of England’s Centre for Central Banking Studies in arranging and delivering training courses, conferences and expert advice for central banks and central bankers of countries across the globe.

Drawing upon that experience, the Handbooks are therefore targeted primarily at central bankers. The aim is to present particular topics which concern them in a concise, balanced and accessible manner, and in a practical context. This should, enable someone taking up new responsibilities within a central bank, whether at senior or junior level, and whether transferring from other duties within the bank or arriving fresh from outside, quickly to assimilate the key aspects of a subject, although the depth of treatment may vary from one Handbook to another. While acknowledging that a sound analytical framework must be the basis for any thorough discussion of central banking policies or operations, the authors have generally tried to avoid too theoretical an approach. Moreover, the Handbooks are not intended as a channel for new research.

Centre for Central Banking Studies - Handbooks  -  English (en)

Publisher Bank of England
Primary Language English (en)
Region / Country Global
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