Risk Deloitte Key Challenges Facing Central Banks

8/10/2019 Risk Deloitte Key Challenges Facing Central Banks

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Key challenges facing central banks

Adapting to a new era


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Contents

Foreword 1

Key challenges facing central banks 2

Reputational risk 2

Accounting framework challenges and harmonization 3

Valuation challenges 5

Managing currency in circulation 7

Confidentiality versus transparency 9

Governance, risk management and compliance functions 10

Attracting and retaining people 12

Conclusion 13

Editors 15


3/20Key challenges facing central banks Adapting to a new era 1

Since the inception of the Bank of England in 1694, 1 a central banks core duty has been the sustainable

development of a nations economy. Over the years and across different geographies, the role of central banks

has evolved to cater to different socio-economic needs. Today, although there are numerous differences between

central banks around the world, they are commonly the lenders of last resort and lynchpins of economic stability.

In times of economic crisis, there is a heightened awareness and scrutiny of central banks and their accountability

to a nation at large, and the impact their decisions have on the stability of the global financial system.

Central banks face many challenges. Some of these issues include detailed operational and internal control matters,

preparation of financial reporting and disclosure statements, and continued action via monetary policy and financialstability measures to improve a nations economic health. These cross-organizational issues rank high on the

agendas of central banks governing committees.

This report is based on consultations with central banks around the world and highlights key challenges that are

faced by many central banks. Not every challenge will apply to every central bank and there are other challenges

not explored herein. In summary, the key challenges identified are:

1. Reputational risk

2. Accounting framework challenges and harmonization

3. Valuation challenges

4. Managing currency in circulation

5. Confidentiality versus transparency

6. Governance, risk management and compliance functions

7. Attracting and retaining people

Frank Dubas

Global Leader Sovereign Financial Institutions

Deloitte Touche Tohmatsu Limited

As used in this communication, Deloitte means Deloitte Touche Tohmatsu Limited and its member firms.

Foreword

1 About the Bank History

http://www.bankofengland

.co.uk/about/history/index.

htm, Bank of England,

2010


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Examples of non-financial risks that might affect a

central banks reputation are numerous. Some represent

prospective analytical weaknesses which might lead to

inappropriate policies being developed. Others could be

operational risks that are particularly potent in a central

bank context, such as weaknesses in security and/or

data protection, problems in key IT systems or poor

business continuity planning. Some will be more in

the nature of standard operational risks, such asdependence on key staff or errors in processing.

In all these areas, there is increasing focus on the

performance of public authorities in general, and

central banks in particular.

At the Bank of England, risks are managed under an

overarching framework designed to ensure consistency,

efficiency and transparency of risk management across

the organization. Within this framework three high-level

categories have been established: a) strategic, such as

policy risks, governance issues or external factors which

directly impact the Banks ability to meet its corepurposes; b) operational, such as risks from weaknesses

in business processes, systems, or through staff or third-

party actions which affect the delivery of the Banks key

business functions or its reputation; and c) financial.

For each category the intention is that decisions to

accept or mitigate risks are taken expediently and

transparently, with risk tolerance levels set, exceptions

monitored, risks and incidents reported and actions

taken where necessary. Underpinning this is a set of risk

standards that articulate how key categories of risk are

identified, assessed, controlled and monitored within

the Bank, and detailed governance arrangements.4

Key challenges facingcentral banks

2 Issues in the Governance

of Central Banks, Bank for

International Settlements,

May 2009

3 Reserve Bank of Australia

Annual Report 2008,Reserve Bank of Australia,

August 2008

4 Bank of England Annual

Report 2010, Bank of

England, June 2010

Reputational risk

The reputation of a central bank is possibly its most

important asset. Reputational risk may be the most

difficult risk to manage compared with other types of

risks. Central banks face significant reputational risk,

especially during times of crisis, and reputational

damage to a central bank could take decades to repair.

The Bank for International Settlements defines

reputational risk as occurring when there is amismatch between public perceptions and the actual

objectives and resources of the central bank.2

Reputational risk can arise from failure to effectively

manage any, or all, of the other risks. Other risks

include operational risk such as staff ethics and

misconduct, transactional processes and information

technology (IT) systems, portfolio risks, such as interest

rates and exchange rates, credit risk and liquidity risk. 3

Managing reputational risk is a vital component of a

sound risk management framework at any financial

institution. For commercial banks, risk managementtends to be more advanced for financial risks than

non-financial risks. The latter are important, however,

in that they can flow through into profit and loss.

Central banks too are not limited to financial risks.

Indeed, given the increasing importance of a central

banks credibility in todays world, it is reputation that is

key. Financial loss is important in that it can impinge on

how the central bank is regarded, and hence on its

ability to achieve its remit, but non-financial risks may

more directly affect reputation. While financial risk

management has typically been more formalized than

that of other risks, safeguards over the latter have been

extensive, and are increasingly being brought within a

more structured framework. Many central banks are

integrating risk management frameworks to ensure

consistency across all levels of the bank.

Central banks face significant reputational risk, especiallyduring times of crisis, and reputational damage to a centralbank could take decades to repair.



Accounting framework challenges and

harmonization

Central banks are required to comply with their nations

Central Banking Act or equivalent act (hereafter Central

Banking Act). A Central Banking Act typically defines

the role of a central bank in managing monetary policy,

controlling inflation, facilitating payment systems

(e.g., wire, securities settlement), and supervising

financial institutions. Generally, the Central Banking Actdoes not address the specific financial reporting or

internal control reporting frameworks to be adopted.

Many central banks are permitted by their Central

Banking Act to adopt a national or global accounting

standard, or to develop their own specific financial

reporting rules to accommodate the unique

circumstances of central banks. Consequently, there is a

divergence in accounting frameworks that have been

adopted by central banks globally. The divergence in

accounting frameworks for central banks creates

challenges around comparability of financial reporting

across central banks, and challenges for central bankmanagement, governing committees and their external

auditors.

In addition, a Central Banking Act may include very

prescriptive accounting rules, which are not consistent

with generally accepted accounting principles (GAAP).

An example may be the treatment of unrealized foreign

currency gains. A Central Banking Act may require these

currency gains to be recorded directly in equity and not

be subjected to distribution. This treatment potentially

differs from International Financial Reporting Standards

(IFRS) where unrealized foreign currency gains are

recognized in the income statement. Where a Central

Banking Act includes rules that diverge from GAAP, this

creates additional challenges for central banks

management for benchmarking between central banks

as well as creating challenges during the external audit.

Central banks external auditors may struggle to opine

on financial statements that are based on a unique

financial reporting framework.

One impact the global financial crisis had on central

banks concerned the application of appropriate

professional judgment (in accordance with the relevant

accounting rules) to situations where rescue packagesand programs created a variety of atypical investments

and other unique financing structures. These

investments raised consolidation and control issues that

required significant discussions between management,

governing committees and external auditors to

determine the appropriate accounting, reporting and

disclosures for the programs and related investments, as

well as the unwinding of the programs.

Another financial reporting challenge is where a central

bank functions as administrators or agents for its localMinistry of Finance. For example, Banque de France acts

as France's fiscal agency for World Bank Group and

regional development banks and aid organizations.5

Several central banks may have certain assets and

classes of transactions with international agencies,

such as aid agencies and development banks, which

result in assets being held by the central banks.

However, the central banks may not enjoy the benefits

of those assets nor are they susceptible to the risks of

ownership. It is important to apply appropriate

professional judgment in accordance with the relevant

accounting framework in assessing the accounting

treatment for these transactions, which are unique and

likely not addressed in typical accounting frameworks.

The global financial crisis has led central banks to want

to be able to compare themselves to their peers on a

global scale through harmonization of accounting

methodologies. Central banks are increasingly moving

towards the adoption of IFRS. Although this may improve

the comparability of central bank financial statements,

the adoption of IFRS accounting principles developed for

commercial entities may create other challenges for

central banks management and stakeholders.

Many central banks are permitted by theirCentral Banking Act to adopt a national orglobal accounting standard, or to developtheir own specific financial reporting rulesto accommodate the unique circumstances ofcentral banks.

5 Organisation and

activities Foreignexchange policy and

international relations

http://www.banque-

france.fr/gb/instit/sebc/4a.

htm, Banque de France,

2004


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One measure that may address harmonization concerns

is for the sector to develop a Statement of Recommended

Practices (SORP) to supplement IFRS. SORPs augment

existing accounting, legal and regulatory regimes when

unique situations or transactions are undertaken by a

particular industry or sector. A SORP could act as a

compendium of guidance for central banks that want

to adopt IFRS but also want to maintain some level of

comparability with other institutions. This would allow

central banks to benchmark their performance against

their peers. However, a one size fits all approach may

not work due to the special characteristics of the

operations and functions of central banks around the

world. Without a global coordinated effort to address

central banks special characteristics, inconsistencies in

central bank accounting frameworks will develop due to

valid socio-economic and local requirements.

The European System of Central Banks (ESCB) has

harmonized some of the divergent financial reporting

practices across Europe through the European Central

Bank (ECB) Guideline.6 The ECB Guideline is a legally

binding instrument in the European Union, and

European national central banks that belong to the

Eurozone are obliged to adopt these Guidelines.

The ECB Guideline is generally consistent with IFRS and

contains detailed guidance where the ECB practices

diverge from IFRS.7 For example, the Bank of Spain has

adopted the accounting guidelines published by the

ECB in its internal rules and the annual accounts are

prepared in accordance with the accounting principles

established for the European national central banks of

the Eurozone.8 Consequently, the financial information

of central banks belonging to the Eurozone iscomparable.

Likewise, central banks in Latin America, through the

Center for Latin American Monetary Studies (CEMLA),

have made some progress towards the development of

a SORP. Established over 50 years ago, CEMLA conducts

research and disseminates knowledge on central banking

matters.9 The recommended practices are contained in

the Budgeting Committees Technical Notes Proposal to

the IAS10 and include recommendations such as the

accounting treatment by central banks for gold and

derivatives.

Guidelines such as SORP may help address the

challenge of comparability across central bank financial

statements and provide additional useful information

to management and key stakeholders. Again, a one

size fits all approach may not work, but harmonization

across central banks is likely to have a positive overall

impact.

6 Guideline of the ECB of

10 November 2006 on the

legal framework for

accounting and financial

reporting in the European

System of Central Banks

(ECB/2006/16), Official

Journal of the European

Union, European Central

Bank, 2006

7 Appendix V: Differences

between the accounting

and reporting principles in

the Eurosystem and the

International Financial

Reporting Standards

(IFRS), IMF Working

Paper WP/05/80

Transparency in Central

Bank Financial Statement

Disclosures, International

Monetary Fund, April 2005

8 Annual Accounts of the

Banco De Espaa,Annual

Report 2009, Banco de

Espaa, May 2010

9 About CEMLA

http://www.cemla.org/

about.htm, CEMLA, 2010

10 Technical Notes

Proposal to the IAS

(standards such as IAS 2,

7, 21, 37)

http://www.cemla.org/

Budgetary.htm, CEMLA

Related party transactions

Central banks may also face challenges regarding numerous related

parties and related party transactions. This can be a challenge where

there are transactions with other government entities, government

controlled entities, and central bank controlled entities or entities that

share common directors with the central bank. In addition, the amount of

lending to government entities may be defined or prohibited by the

Central Banking Act. The challenge is not only to ensure that appropriatedisclosures have been made in the financial statements, but also that the

central bank complies with the regulatory framework and that proper

controls are in place to safeguard against fraud.

Management should give appropriate consideration as to whether

transactions are on an arms-length basis and whether there are any

recognition, valuation or disclosure issues. The sufficiency of disclosures

in reporting related party transactions continues to be an important

debated subject.



Valuation challenges

Valuation became one of the most difficult issues for

financial institutions to deal with during and following

the financial crisis. Not only have the markets made it

very difficult to price transactions, but numerous

accounting and auditing guidance statements have also

been issued in an attempt to provide clarity. The reality is

that this has continued to be one of the most

challenging areas for central banks.

One key area of concern is that the initial

assumptions used to design financial models have

been based on a historical trend of economic growth

and stability. These may not be relevant in todays

world. Analysts could point out that the conclusions

drawn from these models may not be appropriate

given the increased interconnectedness, the increased

sensitivity to systemic failure, and the increased risk

of a recession that we face in todays globalized

economy. Model risk has become an issue in some

central banks where rescue packages launchedfollowing the recent financial crisis resulted in a

variety of atypical assets on the balance sheets of

central banks.

One example would be Maiden Lane LLC (ML LLC),

which was created as a financial vehicle by the Federal

Reserve Bank of New York in March 2008 to facilitate

JPMorgan Chase & Co.s (JPMC) merger with Bear

Stearns Companies Inc. (Bear Stearns), and to prevent

the likely severe impact of Bear Stearns collapse on

market functioning and the broader economy.

The Federal Reserve Bank of New York loaned

approximately US$28.8 billion to ML LLC in the form of

a senior loan, which, together with funding from JPMC

of approximately US$1.15 billion in the form of a

subordinate loan, was used to purchase a portfolio

from Bear Stearns of mortgage-related securities,

residential and commercial mortgage whole loans and

associated hedges (derivatives).11 At 31 December 2009,

ML LLC held approximately US$9 billion of assets for

which the determination of fair value was based on

proprietary valuation models because external price

information was not available. Key inputs to the models

considered factors such as market spread data for each

credit rating, collateral type, collateral value, and otherrelevant contractual features.12

11 Fed Says Bear Stearns

Portfolio Declines $2.7

Billion, Bloomberg,

23 October 2008

12 Maiden Lane LLC

Supplemental Report,

2009 Annual Report,Federal Reserve Bank of

New York

http://www.newyorkfed.

org/aboutthefed/annual/

annual09/MaidenLanefins

tmt2010.pdf, June 2010

A key risk area for many financial institutions is the

allowance for loan losses. Typically this has not been asignificant risk area for central banks given the low or

nonexistent loss history. However, during the financial

crisis, many central banks significantly expanded their

lending facilities to their member banks. For most

financial institutions, the allowance analysis involves

robust processes resulting in a comprehensive quarterly

allowance analysis. As a result of the financial crisis,

the increased lending volume, and the shifts in credit

profiles of member banks, there is an increasing need

for central banks to maintain a robust loan allowance

analysis. Central banks may not have the processes,

methodologies, or systems to prepare such loanallowances. A lender of last resort should also consider

the quality of collateral accepted in its lending activity

since its value may deteriorate during periods of

financial turmoil. Any potential loss or impairment

needs to be reflected in the allowance analysis.

Additionally, central banks may not have robust internal

controls, analytical tools, and data sources to value

illiquid/thinly traded collateral.

Other valuation issues may result from situations where

the central bank sets interest rates, and is, in substance,

behaving as the clearing house or the market for certain

asset classes. Arguably, the rates the central bank earns

on its own assets may be considered to be market rates

because the central bank is the market. This becomes

more of a risk for central banks operating in smaller

economies where there is weak-form market efficiency

and an illiquid market with a low volume of trades.

Under these circumstances, a potential for mis-pricing of

assets may exist. In developing economies, central banks

internal systems and processes may not be robust or

reliable enough to accurately price securities.

A key risk area for manyfinancial institutions is theallowance for loan losses.


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Another potential valuation challenge impacting centralbanks is where a central bank owns and conducts its

operations in a landmark building or building of

significant historical value. The potential risk is that the

central bank may have maintenance costs which are

significantly higher than is typical in a given market.

Management may find it challenging to justify the

recorded value based on market comparisons, and this

may lead to difficult valuation and/or impairment

discussions. For example, historical buildings such as the

Bank of England and the Bank of Latvia may present

valuation challenges. The historical building of the Bank

of Latvia is actually listed as a monument, showing the

historical significance of the building to Latvia.13 Valuation

experts would need to use skill and judgment to make

adjustments to reflect the landmark status of the

building, but also to reflect any costs of maintenance

that are higher than other buildings. Valuation practice

would be to adopt a more prudent figure when valuing

for financial statements of a central bank.

Valuation of collateral of a central bank plays a key role

in protecting a central bank against loss. The Bank of

England suggested in its Financial Stability Report

(December 2009) that significant improvements in

disclosure of valuation, such as explanation of fair-value

techniques, is desirable.14 For example, the Bank of

England assesses the validity of a model price by

comparing it to similarly traded securities and drawing

on relevant market intelligence from marketparticipants.15 Engaging valuation experts to assist in

testing the assumptions underlying the models,

reasonableness of the results produced, and a review of

the reasonableness of the input source data will provide

additional support for central bank valuation positions.

13 About the Bank of

Latvia Buildings

http://www.bank.lv/en/

about-the-bank-of-

latvia/bank-of-latvia-s-

building, Bank of Latvia,

2010

14 Section 3 Safeguarding

stability, Financial

Stability Report, Issue

No. 26, Bank of England,December 2009

15 Fisher, P. Central bank

policy on collateral,

Bank of England,

14 April 2011



Managing currency in circulation

One of the most significant balance sheet liabilities for

many central banks is the nations money supply in

circulation. The liability is an accumulation of currencies

issued into circulation less those withdrawn from

circulation. Due to the rapidly moving and changing

nature of this balance, it is not feasible to count directly.

It is often challenging to design control procedures that

can provide reasonable assurances to central bankmanagement, governing committees, stakeholders,

and external auditors to the completeness of this

liability as no third-party assurance is possible.

In order to reflect currency in circulation accurately,

central banks will, or should, implement controls similar

to inventory controls in a manufacturing environment.

For example, this would include controls around the

receiving and shipping of the currency inventory, and

appropriate controls for the systems tracking the

movement and cutoff at financial year end. This may

also include controls over the review of invoices fromcurrency printers, ensuring that stock movements are

tracked accurately. Having independent, robust and

reliable currency tracking systems in place is key for

management to ensure that currency in circulation is

accurately reported.

However, many central banks may not have internal

controls that are robust enough for their stakeholders

to deem reliable. This poses a challenge for management

teams and auditors to be comfortable with such a

significant liability balance that is so crucial to a central

banks core functions.

This situation warrants, and typically results in, an

ongoing dialogue between the management team,

the governing committee, and auditors to determine

how best to evaluate the accuracy of the currency in

circulation. For external auditors, it requires designing

procedures specific to the circumstances, often

involving very detailed and extensive testing.

One of the key challenges for a central bank withcurrency in circulation is controls over currency

inventory marked as destroyed or earmarked for

destruction. For example, how does a central bank

ensure that the currency is in fact destroyed? Currency

on hand and destruction of currency are areas with

significant potential fraud liability, and accordingly, need

to be an area of focus with robust control measures.

For example, the Central Bank of Perus currency control

department periodically identifies currency that does

not meet quality standards either through automated or

manual methods. The Committee of Destruction,composed of specialists that manage the currency and

concurrent controls, sample the currency to be

destroyed, validate the quantity, authenticate the state

of deterioration, and verify the destruction. If the

Committee of Destruction identifies any currency not

meeting the destruction criteria, the destruction process

is suspended. Notes for destruction are destroyed inside

the Bank in presence of the Committee of Destruction.

Coins are destroyed outside the Bank and similar

controls are applied.

One of the most significant balance sheet liabilities for manycentral banks is the nations money supply in circulation.


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Central banks could manage currency costs more

efficiently by creating an annual production/destruction

plan that is aligned to real demand by forecasting

future requirements of a specific currency and tracking

system performance. In addition, cost accounting

systems could be implemented as an effective tool to

control related expenses and support audit trails.

The design and implementation of key controls

surrounding a central banks currency inventory need to

be well understood and documented. A central bank

should be in a position to provide support for its control

processes and be open to discuss potential issues where

the control environment may need improvement.

16 Central Office for

combating counterfeiting

of currency, Banco

Central de Reserva del

Per (BCRP)

In recent years the destruction process has become

more demanding as the need to destroy notes no

longer deemed suitable for circulation increases.

The Committee of Destruction is managing this growing

need by prioritizing the lowest denominated notes for

destruction, and by also enhancing the dissemination

of best practices on the use of coins and notes in order

to reduce their deterioration. There is also a focus to

ensure committee members with the proper skills are

appointed to define the standards for destruction and

oversee the process.

The controls to combat counterfeiting are key to

managing currency. Five years ago, Peru passed a

regulation that facilitated the creation and function of a

Central Office to combat counterfeiting of currency,

called OCN. The OCN comprises professionals assigned

by the Bank that include members of the police and

prosecutors. The OCN combats counterfeiting throughcooperation agreements with international agencies

and rewards for information about counterfeit crime.

To combat counterfeit currency more effectively, central

banks should be aligned with the judicial system,

interact frequently with international agencies, and

strengthen the security features of currency.16



Confidentiality versus transparency

Transparency, as it relates to central banks and financial

agencies, refers to an environment in which the

objectives of policy, its legal, institutional, and economic

framework, policy decisions and their rationale, data

and information related to monetary and financial

policies, and the terms of agencies accountability, are

provided to the public on an understandable, accessible

and timely basis.17

In summary, transparency enables the public and

investors to make judgments about the integrity and

stability of a nations financial system. Furthermore, the

need for transparency is even greater during times of

economic crisis, as a lack of information from central

banks may exacerbate doubts about the health of an

economy and jeopardize an economys recovery cycle.

Conversely, central banks may need not to disclose

certain information that may be viewed as sensitive,

such as the creditworthiness of borrowers. It is thisbalance between weighing the publics need for

transparency and the desire for confidentiality that

presents a significant challenge in determining

appropriate disclosure by a central bank.

It should also be noted that not all central banks are

keen to publish a full set of audited financial statements.

Although it is understandable that there may be

confidentiality concerns, this lack of transparency may

raise many more concerns. Publishing audited financial

statements is a best practice and it is also commonly a

requirement of a nations Central Banking Act.

An example of transparency and public availability of

information can be seen with the Bank of Spain.

The annual accounts of the Bank are available on their

website, together with information regarding the

structure of the Bank, the members of the Governing

Body, as well as a detailed report of approximately

300 pages with an analysis of the economic situation

of Spain. In addition, on a monthly basis, a statistical

report is issued including an abridged balance sheet for

the month of the study and several breakdowns about

the assets in the balance sheet classified under different

criteria: residence, type of financial instrument, currency,and so on.18

Central banks may want to add a Management

Discussion and Analysis section to the financial

statements to better explain what financial and

monetary stability actions they have taken or may be

contemplating. Increased frequency and timing of

financial reporting could also benefit financial statement

users. Such additional disclosure can help to address the

unique challenges in applying an accounting framework

and producing transparent financial statements.

17 Code of Good Practices

on Transparency in

Monetary and Financial

Policies: Declaration of

Principles, International

Monetary Fund,September 1999

18 Publications

http://www.bde.es/webb

de/en/secciones/informes/,

Banco de Espaa, 2010


12/2010

Governance, risk management and compliance

functions

Top-down, sound business risk approaches require

significant attention to an organizations governance

structures, risk management practices, and internal

controls. Proper governance typically includes the

existence and effectiveness of a governing committee

(usually in the form of an audit committee), an appropriate

internal audit function, and overall risk managementfunctions.

The roles of a central bank are to control inflation,

stabilize the financial system and promote macroeconomic

development according to its nations specific needs.

The financial crisis required central banks in many

countries to be more visibly involved in stabilizing the

overall financial system in cooperation with other

regulatory agencies. This may be the natural outcome as

central banks in many countries are the only

organizations that have access to solvency and liquidity

information for individual financial institutions, whileregularly monitoring the macroeconomic situation and

overall financial market. However, this new objective

provides central banks with enormous challenges to

governance as it could cause a conflict with their most

important mission price stability. Furthermore, this shift

may facilitate the intervention by politicians into central

banks activities, thus jeopardizing their political

independency, a long assumed component of

governance of central banks.

For example, the massive liquidity injection in order to

dispel the concerns of market liquidity evaporation from

several major central banks during 2008 and 2009 could

have threatened the price stability of some countries.

At the same time, the quantitative easing policies to prop

up the macro economy required central banks to

purchase risky assets or make investments in companies

deemed too big to fail. Central banks have historically

been expected to be the lender of last resort when large

market players face critical liquidity problems, which

could lead to systemic risk. After the Japanese banking

crisis in the 1990s, the Bank of Japan introduced the

four principles to its lender of last resort function

indicating the systemic risk exception, meaning that the

Bank of Japan would act as lender of last resort onlywhen there is a possibility of systemic risk. 19

This lender of last resort function, however, may come to

end if the era where too big to fail is gone forever. Thus,

a central bank could face extreme pressure when faced

with a decision to bail out a large market player facing

collapse.

In addition to the increasing pressures to demonstrate

good governance, the expansion of the scope and scale

of central bank operations has increased their exposuresto risk. The most significant risk facing a central bank is

possibly reputational risk, however, other risks include

market and credit risk such as:1) counterparty risk

associated with money market transactions; 2) market

and credit risks associated with collateral accepted by

central banks against funds provision; and 3) foreign

exchange risks associated with the foreign exchange

reserves.

Traditionally, central banks risk management has been

dominated by the idea of zero-tolerance of risk.

However, the environment surrounding risk managementof central banks has been changing rapidly. First, central

banks have purchased a variety of risky assets to increase

their fund provision under the (quasi-) zero interest rate

condition. For example, central banks such as those of

Sweden, Switzerland, the United Kingdom and the

United States have seen their risks increase due to a

significant change in the composition of the asset side

of their balance sheets.20 Second, the implementation

of Basel II, which includes operational risk management,

left no room for central banks to keep their distance from

the risk management that they advocate for commercial

banks. It may be possible to marginalize market and

credit risks taken by central banks but next to impossible

to do the same for operational risk, in particular, in

countries where central banks experienced scandals.

Third, due to their own post-crisis reform agenda, central

banks could become less dependent on credit rating

agencies.19 On-Site Examination and

Off-Site Monitoring, and

Credit Extension as the

Lender of Last Resort,

Functions and Operations

of the Bank of Japan,

December 2000

20 Pikkarainen, P. Central

bank liquidity operations

during the financialmarket and economic

crisis: observations,

thoughts and questions,

Bank of Finland

Discussion Papers

20/2010, December 2010



In the new environment, the transparency of central

bank risk management systems could be challenged.

The limitation of holding government bonds as a certain

proportion of cash issued by central banks is one

example of traditional protection against the deterioration

of asset quality. However, there are no externally

transparent limits on other much riskier assets such as

securitization products or REITs. What is defined is that

each central bank is expected to have its own riskassessment system and to assess its adequacy of capital.

For example, the European Central Bank decided to

increase its capital by 5 billion Euros to 10.76 billion

Euros in December 2010 against the increasing risk of

quality deterioration due to the purchase of

governmental bonds of crisis-ridden member countries.21

It was also reported that the Bank of Japan considered

increasing its capital as a provision against the increase

in risk of its newly purchased assets including exchange

traded funds.22 Still, there are no disclosures as to how

central banks assess risks of holding assets and the

related adequacy of capital.

Consequently, in the area of risk management, central

banks may be required to:

1) Enhance risk management to properly assess potential

assets to be purchased without depending on credit

rating agencies, and assess operational risks in

accordance with the same methodologies that central

banks advocate for private banks;

2) Enhance accountability of risk management and of

the process of assessing their own capital adequacy,

through disclosure of the framework, process, and

analysis of their risk management; and

3) Enhance disclosure of policy board minutes that

discuss the issues of prudential policies.

These enhancements in risk management and

governance will increase confidence in central banks

ability to manage the financial sector, set an example

for financial institutions to follow, improve the general

quality of the financial system, and possibly lessen the

severity of future banking crises.

In the new environment, thetransparency of central bankrisk management systemscould be challenged.

21 ECB to nearly double

capital with 5 billion

euro hike, Reuters,16 December 2010

22 BOJ plans capital boost

to provision against

losses, Reuters,

8 May 2011


14/2012

Attracting and retaining people

In most industries, businesses are able to benefit by

applying best practices observed in the marketplace and

knowledge from trusted advisors. However, in the case

of central banks, there is a limited pool of benchmark

organizations to draw best practices given that there

is typically only one central bank in each country.

Central banks may find it difficult to develop, nurture,

and institutionalize a depth of specialization in theparticular issues that central banks typically face.

Central banks face diverging issues when it comes to

talent. In some countries staff turnover tends to be

extremely low at central banks, and this drives the

question of how central banks can develop a culture of

change that is needed in todays fast-changing

environment. In many countries the recent passage of

regulatory reform introduces a premium on people with

regulatory experience with a central bank or other

supervisory entity. This demand in the market will make it

even more difficult to attract and retain talented people.

This is the challenge that is currently being faced by the

Central Bank of Ireland (CBI). The CBI has undergone

significant change in organizational and governance

structure since the start of the economic crisis. The Bank

has taken renewed ownership of responsibilities for

financial regulation in Ireland due to perceived past

weaknesses in supervision, particularly in banking.

Additional resources were granted to the Bank to

implement improvement. The recruitment drive is proving

successful in that a number of people have been

attracted to the CBI from professional services and from

industry. The current challenge for the CBI is in

successfully integrating a large number of new hires into

the organization. In the near to medium term the

challenge for the CBI will be to retain this expertise in

face of the likely demand from industry for regulatory

knowledge.

The need for the CBI to focus on continual training and

development of their employees and actively managing

the talent they have attracted and recruited is highlighted

in the CBIs Strategic Plan 2010-2012.23 The plan states

that CBIs objective of implementing a human resources

strategy aligned with their responsibilities will be

addressed by carrying out the following:

Undertake a program of recruitment to substantiallyincrease our manpower and supplement our skills.

Implement a program of training and development for

all staff, focusing on developing core competencies.

Enhance the performance management system to

align personal work plans with business objectives.

Improve internal communication to aid achievement

of strategic priorities.

Monitor and review our policies to retain staff.24

In addition, systems and technologies may help with

improving operational efficiency and developing people.

Banks can use technology to enhance performance

management systems to align employee work plans with

business objectives, to deliver training programs, and to

develop knowledge management systems. For example,

the Reserve Bank of New Zealand has a knowledge

management group that implements tools, such as its

intranet, to allow sharing of information and to provide a

forum for employees to engage in open communication.25

Central banks that have both an effective knowledge

management system and a formal training program are

better placed to manage the limited resource pool.

With this organizational capability in hand, central banks

are able to widen their ability in which to draw

prospective recruits and new employees. Furthermore,

when this infrastructure is in place, central banks not only

improve their ability to draw in new talent, but can also

improve their ability to incorporate best practices from

outside sources.

23 Central Bank Of Ireland

Strategic Plan 2010-

2012, Central Bank of

Ireland

24 Ibid.

25 Knowledge services,Reserve Bank of New

Zealand Annual Report

2010, Reserve Bank of

New Zealand, October

2010



This report highlights several challenges faced by central

banks. Central banks, as lenders of last resort, have

indeed been called upon many times during the

financial crisis to stabilize markets and prevent contagion

by injecting liquidity to capital markets and purchasing

preferred stock of newly nationalized banking groups.

As the global financial services industry evolves and

adapts to the general publics demand for safer markets

and new regulations to ensure market stability, centralbanks should not only be prepared to support the new

changing financial landscape but should also lead by

example.

Ben Bernanke, Chairman of the United States Federal

Reserve, commented in late 2009, Our supervisory

approach should better reflect our mission, as a central

bank, to promote financial stability. The extraordinary

pressure on financial firms last fall [2008] underscored

how profoundly interconnected firms and markets are in

our complex, global financial system. Thus, any effort to

address systemic risks will require a more system wide, ormacroprudential, approach to the supervision of

systemically critical firms. More generally, supervisors must

go beyond their traditional focus on individual firms and

markets to try to identify possible channels of financial

contagion and other risks to the system as a whole. 26

Global and local jurisdictional regulatory reforms are

moving forward. How these regulations will affect the

global financial services industry and the role of central

banks is yet to be seen. One thing is certain the

previously well-understood nature of central banks will

need to change, and central banks will need to adapt

to a new era. Central banks around the world will not

only need to expand their toolkits of monetary policy

in order to deal with financial contagion at themacroprudential level, but will also need operational

effectiveness and expertise to deal with financial

uncertainty.

Central banks will continue to be the lenders of last

resort in times of economic crisis to the nations they

serve and to the greater good of global markets.

The evolving landscape, especially through a heightened

scrutiny and transparency, will place pressure on central

banks to ensure that they are perceived to be prepared

and equipped when called to execute extraordinary

measures for the stability of local and global financialsystems.

Central banks face many challenges, which rank high

on the agendas of central banks governing

committees. However, not all central banks face the

same challenges. In order to serve their nations

effectively, central banks must overcome the challenges

that may weaken their ability to fulfill their role within

the financial markets both on the individual financial

institution level and on a systemic level.

Conclusion

26 Financial Regulation

and Supervision after

the Crisis: The Role of

he Federal Reserve,

speech by ChairmanBen S. Bernanke at the

Federal Reserve Bank of

Boston 54th Economic

Conference, Chatham,

Massachusetts,

23 October 2009

One thing is certain thepreviously well-understood

nature of central banks willneed to change, and centralbanks will need to adapt to anew era.


16/2014

Deloitte Central Banking Network

In response to the demand for specialized services for

central banks, Deloitte member firms have mobilized a

global network of over 700 professionals in more than

80 countries who have relationships with some of the

worlds largest central banks. The experience we have

gained in serving these central banks for many years is

complemented by our skills and knowledge in the global

financial services industry (GFSI), where Deloitte memberfirms serve many of the sectors leading financial

institutions. Our GFSI network provides global resources

and global capabilities, yet our presence is local with a

clear understanding of a clients market and way of

doing business in each particular country. This experience

has given us an intimate understanding of the

environment in which central banks operate and the

unique challenges and opportunities they encounter.

Deloitte member firms currently audit over 25 central

banks, spanning four continents, from the largest

economy in the world to one of the smallest.

Leveraging our global network and multi-disciplinary

service capabilities, Deloitte member firms also provide

a market leading breadth and depth of advisory services

to central banks.

Deloitte member firms address the unique challenges ofcentral banks by sharing experience, leading practices,

methodologies, and resources through the Deloitte

Central Banking Network. Our network is key to sharing

information and knowledge amongst member firm

audit and advisory professionals.

Deloitte member firms currentlyaudit over 25 central banks,spanning four continents, fromthe largest economy in the worldto one of the smallest.



Authors

Karen Bowman

Hong Kong

+852 2852 6786

[email protected]

Karen Grieve

Tokyo+81 90 6560 5580

[email protected]

David Pulido

New York

+1 212 436 2420

[email protected]

Key contributors

Pengiran Izam Ryan Bahrin

Singapore+65 6538 6166

[email protected]

Miguel Angel Bailon

Madrid

+34 9 1514 5000 x1734

[email protected]

Frank Dubas

New York

+1 212 436 4219

[email protected]

Mary Fulton

Dublin

+353 1 4172379

[email protected]

Roger Furholm

Oslo

+47 23 27 93 27

[email protected]

Ana Maria Grande

Madrid

+ 34 915 145 000 x1927

[email protected]

Norela Jimnez Mendez

Cali

+57 2 524 7027 x3001

[email protected]

Martin KopatschekFrankfurt

+49 69 75695 6105

[email protected]

Michael Lait

Moscow

+7 495 787 0600 x2303

[email protected]

Carol Larson

Pittsburgh

+1 412 338 7210

[email protected]

Aase-Aamdal Lundgaard

Oslo

+47 23 27 92 82

[email protected]

Tara Matthews

Richmond

+1 804 697 1828

[email protected]

Alastair Morley

London

+44 20 7303 4785

[email protected]

Tsuyoshi Oyama

Tokyo

+81 90 9834 4302

[email protected]

Andre SalzNew York

+1 212 436 4545

[email protected]

Clifford Smout

London

+44 20 7303 6390

[email protected]

Henrik Woxholt

Oslo

+47 23 27 93 42

[email protected]

Editors

A special thanks to many others in the Deloitte Central Banking Network who also contributed to this report.


18/2016

Notes


19/20


20/20

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