Protecting What Matters: Reflections on a Central Bank's Role at Times of War.

• Author: Chiu, Iris H-Y.

TABLE OF CONTENTS I. INTRODUCTION: THE CENTRALITY OF A CENTRAL BANK AS A STATE INSTITUTION 876 A. War Finance 880 B. Bank Prudential Supervision and Maintaining the System for Inter-bank Payments and Settlement 881 C. The Central Bank's Role in Preserving and Helping to Rebuild Society and its Democratic Institutions 882 II. PROVISIONING WAR FINANCE 883 A. Central Bank Monetary Financing 884 B. External Debt Financing by Ukrainian Banks 888 C. External Debt Financing by External Investors 893 D. Donations 896 III. PROTECTING FINANCIAL STABILITY AND CITIZENS' WELFARE 898 A. Maintaining Resilience in Payment and Settlement Infrastructure in Ukraine and Partnerships Abroad 902 B. Addressing the Risk of Foreign Exchange Losses by Overseas Entities Servicing Ukrainian Refugees' Financial Needs 907 IV. Supporting Institutional Preservation 913 A. Institutional Basis for Peer-Level Shared/ Back-up Repositories 915 B. Concept of Technological Implementation by Means of Permissioned Blockchain........ 918 V. CONCLUSION 920 I. INTRODUCTION: THE CENTRALITY OF A CENTRAL BANK AS A STATE INSTITUTION

Since February 24, 2022, the sovereign state of Ukraine has been under Russian siege, (1) resulting in massive evacuation, dis-placement of its peoples, and the devastation of major cities. (2) Defence and humanitarian concerns are of foremost importance at the moment, but this Article reflects on an institution that is central in many respects to the protection and preservation of the Ukrainian state, its institutions, and the welfare of its peoples. We focus on the central bank's role at a time of exogenous shock and stress--invasion by a foreign power. Ukraine has declared martial law. This has been implemented by the National Bank of Ukraine (NBU) (3) in its various capacities since February 24, 2022, as the regulator for the banking system, the payment services settlement provider, and the central bank to the state. This Article considers all these aspects in the context of an existential threat.

Commentators have cautioned that martial law, although in response to the urgency of needs, should not be thought of as a state of "lawlessness" in favour of military primacy. Thought should be given to proportionality, (4) especially with regard to longer-term thinking for the restoration of order, governance, and the normal functioning of institutions. (5) This is important since institutions of the state--and of the government it supports--must strive to preserve their legitimacy and that of the state they serve. In this Article, we consider how the NBU as a young central bank (6) has stepped up, during a period of martial law, in a way that helps protect and preserve the independent state. Underlying Putin's invasion is the aim of undermining the legitimacy of the Ukrainian state:

Ukraine is viewed as belonging to... Russia... it is] a territory rather than an independent state. Ukraine and Belarus, as former Soviet Union states, are believed to form a single historic 'triune' nation with Russia. Putin started the war to destroy Ukraine's nation-building project, aiming to restore a 'historical Russia'. (7) In light of this, the NBU's roles should be viewed as contributing towards the support and reinforcement of the legitimacy of the independent state. The NBU is a pillar of Ukraine's right to exist as an independent, autonomous state. Besides its legal establishment, its legitimacy hinges on it being seen to be trustworthy, competent, transparent, and accountable, (8) ultimately sharing a community of interest with the state's citizens. Edmund Burke used similar words to describe the legitimacy of government: "[W]ithout any mutual relations, the cement is gone--cohesion lost--and everything hastens to decay and dissolution." (9) We argue that martial law should not erode the institutional distinctness of the young central bank. The legitimacy of institutions is key to state-building, and Ukraine's passage of statebuilding from 1990 has been challenging during the regimes prior to the Zelensky administration. (10) Even the Zelensky government has been criticised as insufficiently robust with reform. (11) Hence, the NBU's roles and exercise of powers during this extraordinary time are not only important for state preservation, but also its own institutional credibility and legitimacy, which in turn are key to such preservation.

Central bank independence has over time become a cherished tenet for central bank legitimacy. (12) This is a form of agency independence based on a clear mandate, usually price stability, administered by technocratic expertise. (13) We have, however, witnessed expansions in the realms and variety of central bank actions, (14) during crises such as the global financial crisis of 2007-09 and the COVID-19 pandemic, especially in the West where mature central banks embrace clear mandates and technocratic independence. (15) These central bank actions are often justified by "output legitimacy," (16) providing relief from financial pressures in crises that are both financial and nonfinancial (such as the COVID-19 pandemic) in nature. However, the expansionary nature of central bank actions raises questions as to its independence, (17) and its actions need to be grounded in legitimacy. The role of the NBU at wartime raises challenges not only for the effective exercise of its powers to preserve the state but also in relation to the preservation of its independence, technocratic credibility, and legitimacy.

We discuss three key roles for the NBU at this time: provisioning war finance that is crucial to defence, preserving the economic institutions of the banking and financial sector, and catering for the financial welfare of citizens. These three priorities present conflicting objectives for the NBU, and balancing these conflicting objectives will be important for the NBU's institutional preservation, legitimacy, and credibility, which ultimately contribute to the state's preservation. Further, we argue that the international support of peer-level central banks and of the International Monetary Fund (IMF) and Bank for International Settlements (BIS) will be important for some of the NBU's objectives and ultimately, state preservation. The NBU's institutional preservation will also be a precondition for mobilizing such peer-level international support. In this manner, despite martial law, we argue that the NBU needs to navigate multiple goals as a distinct and expert institution, towards the purposes of output efficacy and legitimacy.

A. War Finance

First, a central bank is often positioned as the government's bank, especially at times of crisis such as war. That was indeed the rationale of some of the early central banks. (18) The Bank of England, for example, was historically formed for the purpose of financing war and managing the government's budget and finances. (19) The NBU is now placed in a similar position of providing for war finance (20) as well as fund-raising war finance for the government. (21) This role is immediately important, but as Part II discusses, there are challenging choices that need to be made in relation to inflation-targeting goals and the mobilisation of state-owned banks. (22) We discuss these through the lens of the need for the NBU to preserve itself as a credible national institution, as such institutional preservation is itself a key condition for the ultimate preservation and restoration of the democratic state, its institutions, and its people's welfare.

B. Bank Prudential Supervision and Maintaining the System for Inter-bank Payments and Settlement

Second, the NBU, like many central banks, (23) is the bank regulator and supervisor for banks authorised to operate and provide services in Ukraine. (24) Further, the NBU is also the provider of payment and settlement services that cover 97 percent of the Ukrainian market. (25) This role supplies a public good, complementary to many central banks' role as bank regulators. The central bank acts as the bankers' bank and the settlement asset of central bank reserves is regarded as the "safest" asset for inter-bank settlement for payment transactions. (26) Central banks have evolved to provide bank-to-bank settlement for payment transactions, reinforcing their central role in the economy with the legitimacy this confers. (27) In providing bank regulation and over-sight, as well as the public good of inter-bank settlement for payment services, the NBU is central to protecting the financial stability of the financial system in Ukraine. (28)

The provision of war finance raises potentially conflicting objectives for the NBU in relation to its financial stability roles. Societal demands and the need to meet citizen welfare requirements further exacerbate the conflicts of objectives. These are discussed in Parts II and III. We consider the NBU's balancing acts and argue that two important tenets should be preserved. The first is the preservation of payment and settlement certainty, which can be increasingly threatened as a ceasefire continues to be elusive at the time of writing. Unconventional approaches to protect financial stability and maintain the resilience of the payment and settlement infrastructure may need to be considered. (29) The second is the need to ensure an appropriate degree of financial soundness in Ukrainian banks, despite immediate pressures to meet citizens' welfare needs. Martial law should not be regarded as a licence to "throw caution to the wind" in relation to the strength and credibility of the banking sector, which would be important for purposes of restoration and rebuilding in due course. Underpinning these is, however, the NBU's own capacity to respond to stretched mandates, which we flesh out in Parts II and III.

Important support is arguably needed from the international network of central banks, and at this time, European central banks and the European Central Bank (ECB). Part III discusses...