Abstract
Bosnians show little faith in their state-level institutions, and with good reason, as the country ranks poorly on measures of corruption, regulatory quality, and government efficacy. However, the Central Bank of Bosnia and Herzegovina (CBBH) is a notable exception. In a country where the state is still often paralyzed by ethnically aligned obstructionism, the Central Bank is widely lauded as an effective state-level institution, and it backstops, and oversees, a stable, trusted, pan-Bosnian banking system. To explain the Bank’s success, we draw on rational choice and institutionalist literature to propose and test a theory of the “CBBH as referee” in its three main functional areas: currency board maintenance, payment system operation, and the coordination of banking supervision. We find evidence for this mechanism in the context of currency board operations, and we also document a Haas-ian neofunctional process, in which the Bank has interacted cyclically with foreign banks to unintentionally de-ethnicize the Bosnian financial sector. Initial Bank reforms facilitated foreign banks’ market entry, and their subsequent lack of interest in hewing to prior ethnic divisions served to cement a unified Bosnian financial space. We substantiate this argument with data drawn from interactive interviews with Bosnian policymakers, financial sector experts, and banking sector participants, and in so doing, also show how the commercial behavior of transnational actors can have unexpected policy impacts.
The Curious Case of the CBBH
Bosnians do not trust their state-level institutions. Polling data are irregular, but results from a 2015 survey show that more than 50 percent of respondents have “no trust at all” in the state government and less than 7 percent of respondents have high levels of trust. 1 It is hard to blame Bosnians for holding this perspective; the country ranks 111th out of 180 in Transparency International’s Corruption Perceptions Index, while the World Bank’s Worldwide Governance Indicators place Bosnia in the bottom 50 percent of states on measurements of corruption control, government effectiveness, and regulatory quality. 2 However, the Central Bank of Bosnia and Herzegovina (CBBH) is a notable exception. Public opinion data on the Bank are elusive, but it is widely lauded in professional circles as a stable, trusted institution, and if one takes bank deposits as a proxy for the public’s overall faith in the banking system—which the CBBH is widely understood to backstop—their rapid growth over the last decade suggests a similar perspective. 3 Furthermore, when confidence in the banking system wobbled during the 2009 financial crisis, the CBBH successfully calmed depositors’ nerves. 4
The Dayton Accords, which ended the war in Bosnia in 1995, codified the Bank’s basic structure as an independent currency board, and it began operations in 1997. Since then, the Bosnian convertible mark (konvertibilna marka [KM]) has exchanged, by law, with the euro at a rate of 1.955830 to 1, all types of central bank open market operations are forbidden, and all KM in circulation are fully backed with foreign currency. Under this arrangement, the CBBH is, monetarily speaking, little more than an especially large foreign exchange office. Nevertheless, the Bank is also responsible for operating an efficient national-level payment system and for coordinating bank supervision (which is executed separately by Bosnia’s two constituent elements, the Republika Srpska and the Federation of Bosnia and Herzegovina [FBiH]). 5 While this limited mandate might reduce the Bank to a passing curiosity as an economic actor, its status as a well-functioning and trusted state-level organization, in a country where few are perceived as either, makes it worth studying as an institutional one. Why has the Bank succeeded as an institution, where other institutions have failed?
Our findings suggest the answer lies at the intersection of institutional design, trust, and technocracy. Drawing on rational choice and institutionalist literature, we propose a theory of the CBBH in which its status as an impartial third party, or referee, allows it to underwrite trust between Bosnia’s three main ethno-national groups. We test the theory using data from in-depth interviews with Bosnian policymakers, private-sector bankers, and representatives from international financial institutions and find that, while the “Bank as referee” concept applies to its currency board function, it does little to explain the Bank’s role in payment system operation and bank supervision. Here, we document a process characterized by elements of power dividing and Haas-ian neofunctionalism, in which the CBBH has leveraged the technocratic nature of bank supervision to assert itself as an effective state-level institution and has facilitated the market entry of transnational financial actors, who in turn de-ethnicized the Bosnian financial sector.
Before proceeding, a few notes on terminology: Bosnia, Bosnia and Herzegovina, and BiH all refer to the political entity of Bosnia and Herzegovina, either as an independent state or as a unit of Yugoslavia. The adjective Bosnian refers only to that political entity, and the noun Bosnians refers to its inhabitants, regardless of their ethnic background. Bosnian Croat and Bosnian Serb (or simply Croat and Serb) describe those residents of Bosnia who identify as members of the Croat or Serb ethno-national groups. The term Bosniak refers to Bosnia’s “ethnically Muslim” population, and the Central Bank of Bosnia and Herzegovina appears as the Central Bank, the Bank, or the CBBH.
A Theoretical Account of Institutions, Conflict, and Trust
In general, there is strong evidence that conflict reduces institutional trust, and trust in general, by increasing risk perceptions, changing individual and group-level reputations, and reducing institutional quality. 6 But among Bosnian state-level institutions, the CBBH is an outlier; Bosnians generally trust it to do its job, and by and large, it does it well. This surprising outcome—an institution that works in an environment where the empirical record, and most available points of immediate domestic comparison, says it should not—raises a broader theoretical question concerning when, and under what conditions, post-conflict institutions can facilitate trust. Research suggests wide cross-national variation, but Bosnia’s story shows there can be meaningful within-country variation, too, across different institutions. 7 Consequently, we propose a theory that focuses on institutional-level characteristics to explain when institutions do work to generate trust. Specifically, we hypothesize that post-conflict institutions will successfully facilitate trust when they have institutional characteristics that effectively position them as neutral arbiters, or referees, able to credibly enforce standards of behavior that are acceptable to all sides of the preceding conflict. 8
Definitions of trust have proliferated widely. 9 Here, we draw on rational choice and institutionalist perspectives, and describe trust as possible when two factors prevail. The first is the ability to make credible commitments—actors must believe that others can, and will, behave as promised and that they will not renege. The second concerns the content of those commitments—for actors to trust their interlocutors, they must believe that the risks of any given interaction are acceptable and that their counterparts will operate within mutually acceptable boundaries. Put more colloquially, trust happens when people can be expected to do what they say and when what they say they will do is acceptable to potential counterparties. These conditions may arise due to actors’ specific knowledge of each other, but institutions can also play a role in creating credible, and mutually acceptable, commitments. 10
In keeping with rational choice approaches, we posit a prisoner’s dilemma dynamic, in which both parties to an interaction may wish to extend trust, but ultimately decide not to for fear of being on the losing end if their interlocutor plays defect. Here, institutions can make it either more costly to defect, by punishing those who fail to cooperate, or less costly to trust, by bracketing the downside risk of getting cheated. In either case, extending trust becomes relatively more attractive. In a strict rationalist conception of this process, trust is cognitive, and the institution’s effect derives from the impact it has on the information available to each actor about how its counterpart is likely to behave, while historical institutionalist arguments suggest a psychological component, in which citizens’ encounters with, and observation of, (well-functioning) institutions influence their subsequent beliefs about the appropriate level of trust to extend in general. We argue that, in practice, these mechanisms are reinforcing and complementary—that as institutions affect actors’ case-specific calculus about the likely costs and benefits of extending trust, these same interactions, over time, shape pre-cognitive assumptions about the correct amount of trust to extend in the first place. In the absence of institutions, concerns about the trustworthiness of other actors are instead liable to spiral into a suboptimal equilibrium of constant defection. 11
This formulation is theoretically clean, but on its own, it is incomplete. First, it does not acknowledge the risk that the conflicts and trust deficits institutions are supposed to solve will simply be injected into the institutions themselves. 12 For an institution to operate effectively as a third-party enforcer, it needs to be credibly separate from the conflict it is supposed to be regulating and positioned as a neutral referee. Second, it does not explain which institutional characteristics might help achieve this positioning. As the Bosnian experience suggests, not every institution is well constructed to play the role of a neutral referee. To do it successfully, institutions must operate with procedures that actually engender perceptions of fairness and impartiality in their interlocutors—put another way, for institutions to serve effectively as referees and to sustain adherence to agreements, they need procedural fairness. Psychologists and behavioral economists have grounded procedural fairness in multiple elements, but generally speaking, “ . . . the theoretical literature on procedural [fairness] can be summarized using six broad procedural characteristics: voice, neutrality, consistency, accuracy, reversibility, and transparency.” 13 In practical terms, this means that institutions are more likely to succeed in a trust-building role when their operations produce consistent, accurate decisions that are perceived to be neutral by the parties they affect and that result from processes that are clearly understood from an external perspective.
Yet as the discussion in the section “A Neofunctional Interpretation of the CBBH” suggests, the data offer, at best, only partial support for the theory we propose above. Instead, the evidence tells a Haas-ian, neofunctional story. Seeking to explain cycles of European integration in the 1950s and 1960s, Ernst Haas developed a theory in which “. . . the creation of supranational authority leads to changes in the expectations and behavior of social actors, who in turn shift some of their resources and policy efforts to the supranational level.”
14
As the supranational authority begins to deliver policy solutions that serve the needs of these social actors, they demand additional policy outputs, creating a feedback loop that spurs further power transfer to the supranational entity. In the European context, this process has typically been thought of in economic terms:
Those who seek cross-border transactions experience the absence of European-level rules as a cost or an obstacle to the realization of greater gains. Increasing levels of cross-border transactions and communications by private actors increase the perceived need (or “functional demand”) for European-level rules and policies and for supranational capacity to supply them.
15
Neofunctionalism has been criticized for lacking theoretical specificity—it is not always clear how long it will take for transnational actors to develop policy preferences or for supranational policymakers to respond accordingly. For some, the fits, starts, and occasional setbacks that have characterized the really existing process of European integration have served as an empirical rebuke to the automaticity of ever further integration, which some see neofunctionalism as assuming. 16 In the Bosnian context, the relevant entities are sub-national units (Republika Srpska and the FBiH), not sovereign states, and it is not obvious whether Haas’ other scope conditions apply in full. 17 These critiques notwithstanding, we argue below that the general dynamic he describes is a helpful way to understand how private-sector actors in the banking sector interacted with the Bosnian state (here playing the role of the supranational authority vis-à-vis the country’s two constituent Entities) to drive Bosnia’s integration as a single economic space. In this analysis, the CBBH’s institutional success comes not from its ability to effectively referee between ethnic groups, but from its role in creating conditions that allowed non-ethnic third parties to enter the Bosnian market and to become sources of demand for a de-ethnicized banking industry.
A Brief Monetary History of Bosnia and Herzegovina
Prior focus on the CBBH as an economic actor notwithstanding, Bosnia offers a strong case for evaluating monetary institutions, as institutions, in the aftermath of ethnic conflict. First, monetary institutions played a deceptively important role in the dissolution of Yugoslavia, so the relevant actors in Bosnia are likely to have been especially aware of the structure and function of the central bank that was constructed in the war’s aftermath. Second, the CBBH was, in its basic structure, essentially forced on Bosnia’s warring parties by the United States and the international community. Third, Bosnia’s main ethnicities mapped almost perfectly onto their own separate wartime monetary institutions. Taken together, this means that Bosniaks, Croats, and Serbs all would have understood the Bank as an important, exogenously imposed national-level institution, which was replacing ones that had previously operated along ethnic lines and under direct ethnic control. In this context, the CBBH sits as an institution positioned in between Bosnia’s opposing sides, to adjudicate between them, in a way that aligns well with our prisoner’s dilemma theoretical framing. The following discussion of Bosnia’s wartime monetary institutions serves to make this clear.
Nineteen ninety was a critical year along Yugoslavia’s path to eventual collapse. Foreshadowing the concerns over monetary control which would shape decisions at the Dayton peace conference, Croatia and Slovenia’s moves to independence were impelled in part by Slobodan Milošević’s brazen looting of the Yugoslav central bank, an episode in which “. . . [O]n Dec. 28, [1990] the Parliament of [Yugoslavia]’s largest republic, Serbia, illegally and secretly approved a law requiring Serbian-controlled national banks to issue $1.8 billion worth of new money without any backing or federal Government approval.” 18
Bosnia declared independence as the Republic of Bosnia on 3 March 1992, with Bosniak Alija Izetbegović as president, and war followed shortly after. 19 Mass rape and ethnic cleansing were used as modes of combat, and civilians were indiscriminately targeted. Here it is enough to note that the Bosniak, Bosnian Croat, and Bosnian Serb communities were all subject to violence sufficient to inspire legitimate distrust of each other’s ethno-national grouping’s future intentions. 20
Bosnia’s wartime ethnic divisions extended to the monetary arena. Bosniak-controlled territory used the Bosnian dinar, Bosnian Croat regions first used the Croatian dinar and then the Croatian kuna, and the Republika Srpska adopted the Republika Srpska dinar (although the Yugoslav dinar also remained in widespread use). In all three regions, German Deutsche Marks circulated as the hard currency of choice. 21 In the Republic of Bosnia, central banking functions were eventually taken over by the National Bank of Bosnia and Herzegovina (NBBH), which was created on 15 January 1993. 22 The Republika Srpska established the National Bank of the Republika Srpska (NBRS), which issued the Republika Srpska dinar, but, in general, Bosnian Serb territory retained strong links with the banking system of the Federal Republic of Yugoslavia; the Republika Srpska dinar was pegged to the Yugoslav dinar, and Republika Srpska monetary authorities continued to process Yugoslav dinar payments. 23 Bosnian Croat areas monetarily merged with Croatia proper and did not establish a separate fully fledged central bank, relying instead on the slight repurposing of a Yugoslav-era monetary institution. Located in Mostar, the Mostar ZAP (Zavod za Platni Promet, or “payment bureau”) operated as a quasi-central bank, essentially serving as a large safe-deposit box into and from which funds could be deposited and withdrawn, but by which a fiat currency was not actively managed. “It held a one hundred percent cash reserve against [Deutsche Marks] deposited with it and required (informally) banks in its area to deposit a 45 percent cash reserve. . .against their kuna deposit liabilities.” 24 Until the CBBH was fully established, all three of its predecessors continued to function within their respective territories.
CBBH operations commenced on 11 August 1997, but the Bank’s direct roots lay in Dayton, where its basic contours had been enshrined in the country’s founding document. Dayton created a highly de-centralized country, but Richard Holbrooke, the United States’ lead negotiator, insisted that “certain government functions needed to be carried out under the direction of a singular state-level institution, and monetary policy was one of them.” 25 Dayton outlined the Bank’s basic character, but it also outsourced the delineation of its specific responsibilities and future composition to the Parliamentary Assembly, which did not pass the relevant legislation until June 1997. On 11 August 1997, the CBBH commenced operations in Sarajevo, and by December 1998, the CBBH was issuing bills and coins, and “a full range of monetary instruments was available to citizens and businesses . . . ” 26 Getting to this point alone had involved establishing Main Units in Mostar and Pale (the Pale Main Unit is now in Banja Luka), winding down the NBBH and NBRS, and relieving the Mostar ZAP of its quasi-central bank functions. 27 By October 1999, the CBBH was established as the sole monetary authority for Bosnia and Herzegovina and “all interbank payments were in KM.” 28 The financial system handling these payments was still constrained by its reliance on the Yugoslav-era payment bureaus, but at least it was constrained electronically; previous settlement procedures for interbank payments had involved periodic transfers of bundles of Deutsche Marks from one payment bureau to another in the trunk of a Mercedes-Benz. 29
It would be roughly another year until the payment bureaus were eliminated entirely from the Bosnian financial system. By January 2001, a comprehensive reform initiative had created a two-tiered system in which all payments are made by licensed commercial banks. Assessing the results of payment bureau reform in 2010, the U.S. Agency for International Development (USAID) reported that “Today, most transactions are facilitated through the banking system . . . Banking sector deposits are high, consumer loans have been growing rapidly, and foreign banks have entered into the sector to compete for BiH deposits and transactions.” 30 Perhaps most indicative of the reform’s success was the rapid growth in the number and value of the transactions the banking system handled. “In [its] first year of operation almost 12 million payment transactions were made . . . with a total value of almost 17 billion KM. In 2005 these had more than doubled to almost 25 million transactions, with a total value of almost 39 billion KM.” 31 By 2019, the payment system was handling 43.6 million annual transactions, for a total value of more than 123 billion KM, reflecting a growth of ~84 percent and 160 percent, respectively, compared with the 2005 figures. 32
As stated by the Law on CBBH, the FBiH and the Republika Srpska each maintain bank licensing and supervisory agencies, and the Central Bank is tasked with coordinating
the activities of [these agencies] in ways to be determined by the Governing Board of the Central Bank, including monthly meetings of the heads of such agencies with representatives of the Central Bank, and the submission of monthly reports by these agencies to the Central Bank on their activities and on developments at the financial institutions under their jurisdiction.
33
Coordinating bank supervision is harder to measure than running a currency board, but the banking sector’s relative consolidation, and the strong presence of private capital and foreign banks, suggests broadly favorable performance. 34 In 2013, the European Union (EU) noted harmonized financial reporting between both entities, continuous execution of stress tests, “adequate” bank capitalization, and “satisfactory” overall inter-Entity coordination. 35 By 2020, there were signs of regression, with the EU reporting that “the efficiency of banking sector supervision is impeded by fragmented competences and insufficient coordination,” but system-level capital adequacy is high, non-performing loan ratios are low and declining, and the public continues to demonstrate confidence in the banking system, with deposits growing from ~3.8 billion KM in 2003 to ~24.6 billion KM in the first quarter of 2021. 36
On the Ground in Bosnia
To evaluate how theory compared with the reality on the ground in Bosnia, we dispatched one of the authors to Sarajevo in November 2014 to execute an exploratory institutional ethnography, with what amounted to a convenience sample made up of academics focused on the Bosnian financial sector, current and former bank officials, officials at international financial institutions, and private-sector bankers. 37 Conversations with these subjects (fifteen in total; see the appendix for a complete list) proceeded as interactive interviews, unfolding naturally within a structure informed by broader questions regarding the degree to which ethno-national concerns have affected decision-making in the Bosnian financial sector and the degree to which CBBH policies and actions have reduced their salience.
An institutional ethnographic approach made sense for three reasons. First, it was flexible—hypotheses generated in conversation with one source could be tested in discussions with others. Second, this was the most efficient way to build rich context; sources could, for example, provide direct knowledge of financial market conditions in the early 2000s in a way that reading newspaper articles or poring over banking sector statistics would not. Third, it was the best way to get direct insight into decision-makers’ thought processes and into the internal mechanics of observable outcomes.
Still, methodological limitations mean that the conclusions we suggest below should be taken as provisional. The most glaring issue is selection bias. We used Google searches, LinkedIn, newspaper articles, and government reports to identify potential sources, but this does not guarantee a comprehensive sample, and the fifteen sources we spoke with are simply those who agreed to do so. It could be the case that the people most likely to have unfavorable views of the CBBH are also those least likely to be interested in speaking with a foreigner. The source pool’s ethno-national composition could also be an issue—excluding foreign nationals, our contacts were predominantly Bosniak, which may have generated an unrepresentatively rosy picture of the Bank. Even if the sample were representative in its ethnic composition, it would still be very small. Over the years, the CBBH has employed hundreds of staffers, and thousands more people have interacted with it, or had their behavior shaped by it, as bankers and private-sector participants in the Bosnian financial sector. The fifteen sources we spoke with represent a small slice of that collective experience, and there is no guarantee their perspectives would be widely endorsed. This methodology also does not lend itself to precise measurement. It is one thing for sources to consistently observe that the CBBH’s currency board structure boosted trust in the Bosnian financial sector; it is another thing to be able to quantify that effect.
Nevertheless, qualitative evidence can still illuminate what makes the Bank work as a state-level Bosnian institution and whether it works in the referee capacity we specify above. Here, for each of the three main policy areas (currency board, payments, banking supervision), we outline the types of claims and feedback from primary sources that would constitute theory-affirming evidence. If data along these lines are lacking or absent entirely, then our theory is unlikely to hold.
In post-Dayton Bosnia, a currency board structure was appealing because it prevented the Central Bank from extending credit and creating money. Had it been able to do either, it would have been, in theory, an attractive target for ethno-national competition, for three main reasons. First, the group that could determine the availability of credit would also exercise substantial control over real economic activity and government finances. Second, in a crisis, it would be difficult to guarantee that emergency liquidity (extended by the central bank as the lender of last resort) would be made available impartially to banks associated with all ethnic groups. Third, the exchange rate itself could become an object of ethno-national contestation; if a particular group dominated the export trade, it might prefer a weaker currency. Commentary that indicates these were real fears, and that the Bank’s design and subsequent operations alleviated concerns about them, would support the claim that the referee model applies to its currency board operations.
In the payments domain, giving the CBBH responsibility for operating an efficient, market-based system represented a major shift from the politicized Yugoslav-era one. As post-Dayton politics have tended to instantiate ethnic divisions, the “Bank as referee” hypothesis suggests that moving to a system in which payments are executed by private market participants (licensed banks), on infrastructure overseen by an independent central bank, would decrease ethno-nationally derived transaction risk and allow interactions with a wider range of economic agents, independent of their ethno-national identity. With banks competing to offer reliable transaction services for a fair price, customers will prefer to optimize for performance, not ethnic alignment, and market incentives will militate against delivering irregular service quality on the basis of customer ethnicity. Here, confirmatory evidence would validate fears that the payment bureaus would not reliably execute transactions, or that they would execute them in ways that favored co-ethnics. In addition, it would also clearly identify the Bank’s role as payment system operator as an important factor in allowing for arms-length economic transactions that were not previously possible.
Finally, Dayton left banking regulation to be executed at the Entity level, by the Republika Srpska and the FBiH, respectively. Because tougher banking regulation could be a deterrent to attracting banking business, it is possible to imagine an ethnically tinged race to the bottom, in which each Entity enacts successively more lenient policies to attract banks to its territory. Against this backdrop, the “Bank as referee” hypothesis would posit that, by coordinating bank supervision, the CBBH has provided a medium through which the two Entities can avoid imposing regulations with asymmetrical effects. Supporting evidence here would indicate that the Entities have pursued, or have at least considered, meaningfully different regulatory strategies in an effort to win banking business. Furthermore, it would identify the CBBH, in its coordinating role, as an important actor in making sure this did not happen.
A Neofunctional Interpretation of the CBBH
We focus our empirical analysis on primary source data generated in discussions with bankers, Bank officials, academics, and international organizations involved with Bosnia’s financial sector. Moreover, mapping their commentary to the Bank’s three main policy areas (currency board operation, payment system operation and oversight, and the coordination of Entity-level banking supervision), we find only partial support for the “Bank as referee” hypothesis. While this dynamic does fairly characterize the Bank’s role as a currency board, it does not apply to its activities in payments or bank supervision. Here, reasoning inductively, we propose two alternative interpretations, focused on power-dividing and neofunctional processes. In the former case, public interactions were relegated to the private sphere, to allow for technocratic expertise and business interests to drive mutually acceptable outcomes, beyond totalizing ethnic concerns. In the latter, transnational actors in the form of multi-national banks were incentivized by CBBH reforms to enter the Bosnian market, and their disinterest in sustaining the country’s ethnic divides served to de-ethnicize the financial sector.
Currency Board Operation
The currency board structure could potentially alleviate three main issues—ethnically based availability of credit to finance government spending, ethnically biased access to emergency liquidity, and ethnically aligned exchange rate preferences. In reality, only the first two concerns appear to be relevant to the founding and continued operation of the CBBH; the possibility of a congruous ethno-national and economic sectoral alignment, such that the exchange rate would be an object of contention, was not even considered at Dayton.
38
Sources in Bosnia did credit the fear that a lender-of-last-resort capability would have been deployed with ethno-national favoritism, but at the time of the Bank’s inception, policymakers were most afraid of what might happen if the CBBH were able to extend discretionary credit more generally.
39
Negotiating at Dayton, David Lipton, Under Secretary of the Treasury for International Affairs and the CBBH’s chief architect, was well aware of the role monetary control had played in Yugoslavia’s dissolution and
. . . worried, frankly, just about monetization of budget deficits. I mean, say that the Bosniaks wanted to run a 5% budget deficit and print money, and so did the Serbs, and the central bank financed one and not the other . . . that would be causus belli essentially.
40
Bosnians, too, were cognizant of the ways in which control of central banks had been misused in the service of political projects. 41
Against this backdrop, the CBBH’s currency board structure has served to enhance the credibility of its commitment to take, and keep, credit extension off the table for Bosnian policymakers. The Bank could have simply pledged to peg the Bosnian mark to a foreign currency, but this arrangement would be unlikely to fully assuage fears that CBBH officials could be pressured into floating the currency or adjusting its exchange rate. In the counterfactual where this approach was taken, it is difficult to imagine Bosnian central bank officials holding fast against pressure to play fast and loose with exchange rates and credit rules when it suited their co-ethnics, or the Bank itself not becoming an object of fierce ethno-national contestation. Politically speaking, if the Central Bank can extend credit, then whoever controls it could unilaterally renegotiate agreements by creating money for programs only one Entity supported. Yet legally codifying a simple, clear, easily enforceable mandate for the CBBH, that blocks it from touching the exchange rate and from printing money to finance government spending, rendered these concerns moot. Amir Hadžiomeragić, head of the CBBH statistics department, emphasized the importance of the rules-based approach, saying,
. . . having a very narrow mandate for the central bank, and a very clear mandate . . . and having our policy based on rules—it was so, so crucial for building our credibility . . . since people have a very clear benchmark of what we need to do. So it is not just to issue money—[the mandate says] you can issue according to what you have on the other side of your balance sheet, you will stick to the fixed exchange rate, and . . . when people are faced with so many uncertainties in the economy, when everything is uncertain—what will be tomorrow’s political solution?—. . . this was one of the anchors for the economy.
That was the dominant view, expressed by academics, the International Monetary Fund (IMF), CBBH staff, and private-sector bankers—that the CBBH’s currency board status had been critical to underpinning stability, macroeconomic and otherwise, in Bosnia. 42 For many, it still was. In a country with a “rather dramatic political scene,” the currency board was seen as a crucial source of certainty and as an anchor for the country as a whole. 43
Payment System Operation and Oversight
In the payments domain, it turns out there was little scope or need for the Bank to play the role of independent arbiter that theory suggests. Even prior to payment system reform, there appears to have been reasonably high public faith in the general efficacy of the payment bureaus, and subjects suggested it was unlikely that individual Bosnians or businesses would have received differing levels of service based on ethno-national affiliation. According to Hadžiomeragić, prior to reform,
[The] payment system was reliable, efficient, but it was subject to some control by the government. So from the general public, I don’t think they recognized, what was the importance of that change . . . It was not that the day after [reform] everyone was happy and they felt that everything worked—it continued to work in the same way, but the private sector benefitted from that reform.
44
In the years immediately after Dayton, the physical and infrastructural barriers to traveling and doing business throughout Bosnia meant that a firm of one ethno-national group was highly unlikely to transact electronically with a firm of another. Ultimately, payment system reform did improve business conditions in Bosnia; previously, inter-Entity transactions often had to be routed via another country. And many saw the payment bureaus’ abolition as critical to improving banking sector performance. 45 Yet the clear message from Bank staff and private-sector banking participants was that the CBBH’s effectiveness in this area, at least for domestic actors, had little to do with setting rules of the game, providing impartial third-party enforcement, or serving as a backstop for credible commitments.
Banking Supervision
Charged as it is with coordinating bank supervision between the two Entity-level banking agencies, it is possible to imagine the CBBH as the impartial referee that has allowed the two Entities to avoid an ethno-nationally aligned regulatory race to the bottom. However, this has potential theoretical problems—after all, the Bank itself is also staffed by Bosniaks, Croats, and Serbs, so quis custodiet ipsos custodes?—and regardless, it is not how sources indicate the Bank has actually operated in the supervisory arena. Rather, its success stems from its ability to appeal to widely observed international standards and from its technocratic expertise.
In the world of banking regulation, the Basel Committee on Banking Supervision (hosted by the Bank for International Settlements—essentially the world’s bank for central banks) is widely viewed as the global authority on best practices. Its recommendations (referred to as numbered rounds—for example, Basel II, Basel III) carry no legal force, but it is understood that member states will shape domestic regulatory regimes to align with them, and they serve as an obvious reference point for banking regulators in non-member states that hope to remain viable markets for international banks.
46
Bosnia’s Basel implementation lags behind (Basel IV has already been agreed upon, while Bosnia is yet to achieve full compliance with Basel III), but the standards are an obvious focal point for harmonizing bank regulations between the Entities.
47
According to Ruben Atoyan, the local IMF representative, the two Entities
would exactly [harmonize towards Basel standards anyway], and they would move in [that] direction driven by the work of the banking agencies themselves, because these are financial sector experts—they’re very much aware of the requirements of Basel II and Basel III . . .
48
While Atoyan is referencing the Entity-level banking agencies, and not the CBBH, his point nevertheless underlines the Basel standards’ influence and the likelihood that they will be mutually understood in Bosnia in technocratic terms.
CBBH Chief Economist, Belma Čolaković, does not refer to Basel directly in her description of the Bank’s activities in harmonizing regulations, but they would have clearly shaped the regulatory practices she was trying to implement. In her telling,
. . . at the very beginning—[the Entity supervisors] did not see the need for a systemic approach . . . So what the Central Bank started doing was . . . well, I was the person who prepared the first macro stress testing framework for the banking system. . . We for the first time actually said, “this is what is happening, this is how the financial system links, these are the inter-linkages between banks, and this is what you should monitor.” What we also did was, we came up with—it’s not the banking agencies—we came up with criteria for establishing a list of systemically important banks for the country at the state level . . . and then [we prepared] a document, a list of banks, and [gave] this report to the coordination meeting between the Central Bank and the banking agencies. . . [The] Central Bank is conducting stress tests for the system as a whole and then giving the results and the whole file to the banking agencies, and then they talk to banks. . .
49
She also emphasized the Bank’s role in the early 2000s, in ensuring that the Entity-level banking agencies were not only codifying harmonized regulations (apparently ca. 2004 the two Entities still did not have similar capital reporting requirements) but also implementing them in a way that generated comparable results:
It was really amazing to see at that time—it was 2004—they were actually sitting around the same table and they would say, “We’re doing it this way, and we’re doing it that way” . . . they would for instance report on capital in totally different ways—that’s another step where we said, “Fine—the first step would be to build a framework that is going to guarantee the same rules of the game across the whole nation”—that’s when foreign banks are coming in—and then we said, ‘ok, fine, we’re attracting foreign banks, now we’re having risk which is being built at different levels in different places . . . so now we have to start monitoring that,’ and that was another step.
50
In the eyes of one private-sector observer, these efforts paid off, with Slaviša Raković, former Deputy CEO of Nova Banka AD Banja Luka, noting,
. . . banking regulation was also reformed in 1998, and it’s practically on the same grounds—there were little differences in tax regulation . . . but I don’t know, I know these guys very well, and it seems they could be united under the Central Bank . . . you don’t have a major difference, even the supervisory process includes both agencies for the same bank if they are operating in both Entities.
51
Nevertheless, this assessment was not universal, with an anonymous senior banking executive claiming that while banking regulations in the Republika Srpska might have equivalent legal stringency, supervisory standards were in practice much lower than in the FBiH. 52
In addition to these more general accounts of the Bank’s activities in the regulatory space, the specific example of its response to the 2008 global financial crisis shows how the Bank has leveraged its technical expertise to bolster its position as a functional state-level institution.
53
As Atoyan described it,
. . . in 2009, in the crisis, when some of the banks in the country did face increasing pressures, the decision to lower reserve requirements was done very quickly, very promptly, and . . . the decision . . . was made by the Central Bank. And that really helped to calm the liquidity pressures . . . in the financial sector . . . . That was not the only intervention of the Central Bank, the other intervention was . . . verbal . . . . and again, given the weight and the credibility of the institution, that calmed down the depositors . . .
54
Power Dividing and Neofunctionalism
As the earlier parts of this section suggest, there is evidence that the Bank performed according to theoretical expectations in the monetary domain. Its currency board structure allowed it to credibly commit to maintaining a fixed exchange rate and, more importantly, to not extending credit under any circumstances. In doing so, the Bank has underwritten a baseline level of political stability and inter-ethnic cooperation, by foreclosing on the possibility of one ethno-national group using control of the CBBH to selectively finance government programs or to selectively rescue illiquid financial institutions. And interviewees’ perceptions of how the currency board has successfully operated indicate widespread recognition that it has done so by leveraging characteristics that align well with the procedural fairness concepts of neutrality, consistency, and transparency. With respect to the Bank’s monetary activities, the theory we outlined above appears to hold some explanatory power. However, the same cannot be said regarding its role in payments and banking supervision. Instead, our research suggests that the outcomes we observe with the CBBH, and in the Bosnian financial sector more broadly, can best be explained by elements of Philip Roeder’s power dividing and Haas-ian neofunctionalism.
Evaluating ways to structure political institutions in the wake of conflicts in ethnically divided societies, Roeder suggests a power-dividing approach, which
. . . empowers individual citizens at the expense of the state, empowers multiple majorities within a common-state government to address diverse policy issues, and makes it more difficult for any one majority to take rights away from minorities by balancing the powers of one governmental organ (and its majority) against other organs (and their majorities) within a common-state.
55
Here, a “high wall” separates areas of government control from those where individual decision rights dominate, and government power itself is brought to bear only through multiple, separate, cross-cutting institutions. This is an apt description of the Bosnian financial sector. The CBBH and the financial system it anchors have taken the state out of finance and allowed it to become a largely private activity, undertaken on an economic basis. The currency board structure means the government cannot control interest rates or exchange rates, there is no political access to the payment infrastructure, and banking supervision is executed by entities separate from the CBBH entirely, but checked by the presence of robust, technocratic, international standards.
Roeder also argues that “ . . . by creating independent organs with specialized decision authority, power dividing balances efficient decisionmaking in specific areas against the dangers of tyranny by a single majority across issue areas,” and it is hard not to see elements of this at play in the CBBH’s ability to carve out meaningful independent capabilities in bank supervision. 56 It has asserted itself in this arena as a policy expert and delivered capable crisis management with a unified voice. The CBBH’s status as an institution with clearly bracketed responsibilities in a highly technical area that targets private-sector actors has allowed it to work with an effectiveness rarely seen elsewhere at the state level in Bosnia. Viewing the banking sector’s technocratic character (and especially the Basel standards’ relevance) from a procedural fairness perspective suggests a mechanism for this success. Banking regulation’s technocratic nature isolates the domain from day-to-day political concerns, while for participating actors, the prominence of international standards, and their ability to serve as a clear point of convergence, provides neutrality, consistency, and transparency. Insofar as the CBBH, in its coordinating role, is able to position itself as a conduit for international best practices, it may be able to piggyback on their credibility.
However, the most compelling interpretation for how the CBBH’s formal and regulatory evolution interacted with foreign bank preferences to create a feedback loop that ultimately served to de-ethnicize the country’s financial sector is a neofunctional one. Postwar Bosnia was not an obviously attractive market for foreign banks. Implementing a currency board eliminated at least one major risk (the exchange rate) and essentially obviated the question of whether foreign businesses could trust the macroeconomic policy outputs of Bosnian politicians and bureaucrats. But in the late 1990s, prospective market entrants would still have found a payments system operated by Yugoslav-era, communist-designed institutions (the payment bureaus) that occasionally found it necessary to execute interbank clearing by schlepping Deutsche Marks around in the trunk of a Mercedes-Benz. Consequently, replacing the (fairly effective) payment bureaus with a market-based system, in which commercial banks execute payments via a network overseen and administered by the CBBH, was widely understood to be “marketing for international banks.” 57 Indeed, multiple sources cited payment system reform as a crucial condition of foreign banks’ decision to enter the Bosnian market. 58
If it was the Bank’s initial role as a currency board and in payments reform that paved the way for foreign banks to enter the Bosnian market, it was those banks’ demand for a unitary regulatory space that drove the first rounds of inter-Entity harmonization in bank supervisory standards. As Čolaković tells it,
. . . when foreign banks started entering, I think the Entity governments thought that they would control their share of the banking sector and [that] they’re going to be the bosses in their own small little yard. And then they realized that foreign banks are not going to operate like that, and that’s when they started harmonizing regulation, and that’s when the central bank was given a coordinating role in banking supervision. It was not so at the beginning, it was only two banking agencies, and then they would behave as if [the two Entities] are different states . . .and just imagine having a commercial bank that has subsidiaries in both Entities, and they have to report to the mother bank, and they’re reporting from a single country totally different things, which was absolutely insane. And that’s when the central bank was given this coordinating role . . . When I came to the central bank in 2003, I think that’s when the major efforts were done in unifying . . . banking supervision, and then in 2005 another step was made—we started building . . . credible financial soundness indicators for the system as a whole . . .
59
And there is also evidence that the emergence of the Basel standards as a clear focal point for regulatory harmonization, independent of any CBBH activity, has, at least in part, been driven by foreign banks. As a risk management professional at the Bosnian subsidiary of a leading regional bank described it, since most Bosnian banks are owned by European bank holding companies, they are obligated to implement Basel II standards, regardless of what local regulators require. In this telling, the Entity-level banking agencies have been essentially playing catch-up to supply a regulatory framework that aligns with the actual practices of the banks they oversee. 60
Ultimately, then, there is support for the idea that initial CBBH reforms facilitated foreign banks’ entrance to the Bosnian financial sector, and that these banks’ subsequent demands for a unified Bosnian market served as a critical catalyst for regulatory reform and harmonization between the two Entities. In turn, this created an opportunity for foreign banks to de-ethnicize the Bosnian financial sector by treating it as a unitary market. Čolaković again puts it best, saying,
When it comes to . . . whether the financial sector is fragmented in a sense that there are [ethnic] concerns, I don’t think so . . . the majority of our banking system is foreign owned, so people are not going to pay too much attention to that.
61
At the time of the interview (2014), four of Bosnia’s five largest banks by assets, covering almost 60 percent of the total market, were foreign-owned (UniCredit, Raiffeisen, Addiko, and NLB), and foreign-owned banks held more than 80 percent of all Bosnian banking assets. 62 At the end of 2020, 80 percent of the banking system’s total capital was in foreign hands, and banks such as Raiffeisen (Austrian-owned) and UniCredit (Italian) operate freely throughout the country, with branches in the FBiH and Republika Srpska. 63 This bears out her assertion and lends credence to the suggestion that, having been successfully enticed to enter the Bosnian market, foreign banks are now the dominant players and unlikely to be operating in ways that reinforce the valence of ethno-national considerations in the banking sector.
What the CBBH Tells Us and Why It Matters
Whatever problems Bosnia may have, the stability of its financial system and the efficacy of its financial institutions are, generally speaking, not among them. The banking sector is dominated by well-capitalized, foreign-owned banks, and the CBBH is one of the most well-regarded state-level institutions. In a country where appeals to ethno-national solidarity can easily serve to undermine cooperation and trust, the CBBH stands as a compelling counterexample. By legally forbidding the CBBH from extending credit or adjusting the exchange rate, its currency board structure credibly committed the Bank to sustaining significant constraints on the range of available policy outcomes. This created a backdrop for ethno-national cooperation by taking the worst possible outcomes off the table and by eliminating the possibility that the Bank’s powers could be deployed to the benefit of some ethno-national groups, and not others. But the Bank’s role with payment system reform and coordinating bank supervision does not conform to what the “Bank as referee” theory implies. In both areas, there is little evidence that market participants or financial sector policymakers understood the CBBH as acting to facilitate inter-ethnic cooperation that would not have happened otherwise. Banks and financial actors largely trusted the payment bureaus to execute their responsibilities fairly and efficiently, and Entity-level harmonization of banking regulation was instead driven by convergence on international regulatory standards and by private-sector banks.
Indeed, the CBBH’s key output in the payments space and with banking supervision was to make Bosnia safe for transnational financial institutions. The payment bureaus might have provided relatively effective service, but foreign banks evaluating the Bosnian market would have been understandably spooked by a system that so closely linked payments and the state. The Central Bank’s coordinating role for banking supervision served a similar function: it demonstrated to foreign banks that they would in fact be operating in a single economic space in Bosnia. The resulting influx of foreign banks in the early 2000s, which, as non-Bosnian financial entities, had no interest in operating within the constraints of either Entity or ethnicity, served to de-ethnicize the Bosnian financial system.
The timing of the CBBH’s formation does illustrate the historical contingency of its present-day success. In the years immediately after Dayton, (re)constructing a unified Bosnian state seemed possible, and the international community was heavily invested in doing so. By the mid-2000s, that was a debatable proposition, and it is reasonable to question whether the CBBH could have been established in the Bosnian political environment that has prevailed since then. “Move fast and break things” may be an irresponsible way to approach state-building, but the experience of the CBBH does suggest that, in a post-conflict environment, speed can be critical.
This contingency notwithstanding, the Bosnian case does produce an important generalizable implication. Practitioners emphasize the value of homegrown institutions, and in the regulatory arena, the risks of relying on transnational private-sector firms are well documented, but Bosnia’s experience suggests that exogenously imposed domestic institutions and external actors can also combine to achieve positive outcomes. 64 In the monetary domain, the Bank succeeded as a referee by piggybacking on the credibility of first the Deutsche Mark and then the Euro; in payments and bank regulation, it succeeded by importing foreign banks’ lack of interest in ethnic divisions. In short, even when coming from external sources, post-conflict institutions can help generate trust when they empower private-sector actors whose interests run orthogonally to those defining the preceding conflict. However, this depends on a critical scope condition—physical security. Until it was safe for basic economic activity to take place across the inter-Entity boundary line (and in between ethnic groups), anything the Bank was doing to create a unified economic space was irrelevant—no multi-national was interested in the Bosnian market, and interethnic economic activity was a pipe dream.
The CBBH’s story also suggests that central bank independence is not the panacea it is often positioned as. A standard Lijphartian view of central bank independence assumes an institutional predilection for ruthlessly fighting inflation, but the CBBH’s formation as a currency board indicates that independence itself is not enough and that the goals of that independence are liable to themselves being contested. 65 More work is necessary to evaluate, more systematically, how and when central bank independence itself can be a locus of contestation in the aftermath of ethnic conflict.
Footnotes
Appendix
Summary of Primary Research
| Date | Name | Relevant experience | Location | Mode of Collection |
|---|---|---|---|---|
| 26 July 2014 | Anonymous | ~20 years of experience in credit analysis, risk management, and Basel implementation | Tempe, AZ/BiH | Email correspondence |
| 20 November 2014 | Slaviša Raković | Deputy Minister for Foreign Economic Affairs, Republika Srpska (1996–1997); Deputy chief executive officer, Nova Banka AD Banja Luka (1999–2009) | Sarajevo, BiH | Recorded and transcribed |
| 21 November 2014 | Adnan Efendić | Associate Professor of Economics, University of Sarajevo | Sarajevo, BiH | Recorded and transcribed |
| 21 November 2014 | Anonymous (2) | 20 + years of experience as a senior executive with domestic and foreign banks in the Bosnian financial sector | Sarajevo, BiH | Handwritten notes |
| 23 November 2014 | James Lyon | Analyst in Bosnia, 1996–2001 (U.S. Agency for International Development subcontractors, International Crisis Group) | Belgrade, Serbia | Recorded and transcribed |
| 24 November 2014 | Sead Kreso and Selena Begović | Professor of Finance, University of Sarajevo; Doctoral Candidate, University of Sarajevo | Sarajevo, BiH | Handwritten notes |
| 26 November 2014 | Mirko Sajić | Executive Director of Privatization Department in Payment Bureau of RS, 2000–2002 | Banja Luka, BiH | Recorded and transcribed |
| 27 November 14 | Belma Čolaković | Chief Economist, CBBH | Sarajevo, BiH | Recorded and transcribed |
| 27 November 14 | Saša Lemez | IT Support Service Coordinator | Sarajevo, BiH | Recorded and transcribed |
| 27 November 14 | Amir Hadžiomeragić | Head of Department for Statistics, CBBH | Sarajevo, BiH | Recorded and transcribed |
| 27 November 14 | Sabina Silajdžić | Assistant Professor of Economics, University of Sarajevo | Sarajevo, BiH | Recorded and transcribed |
| 28 November 2014 | Ruben Atoyan | Resident Representative, IMF | Sarajevo, BiH | Recorded and transcribed |
| 28 November 2014 | Fikret Hadžić | Professor of Banking, University of Sarajevo | Sarajevo, BiH | Recorded and transcribed |
| 17 February 15 | David Lipton | Under Secretary of the Treasury for Intl. Affairs, 1993–1998; economic advisor to the governments of Russia, Poland, and Slovenia 1989–1992 | Ann Arbor, MI/Washington, DC | Recorded and transcribed |
