Banking in 21st century - role of a central bank: promoting financial stability

In one of the Sibos 2021 sessions, a panel discussion took place on the role of central banks in the rapidly changing financial landscape. In this session, called 'Central Banks: What should a 21st century central bank look like?', several panellists expressed their views on this topic from different perspectives. Given the important role of central banks in the financial sector, in this blog we share the key insights that were discussed during this session.

Central banks evolved with a clear mission in response to an easily identifiable need. As OMFIF US President Patricia Haas Cleveland put it: “Central banks around the world have similar responsibilities to ensure economic and financial stability, both of which are crucial for economic growth, stable money and financial infrastructure.” The people who developed the role of central banks, however, could never have imagined the current landscape.

Modernisation of the infrastructure requires new roles

Central banks have collaborated well together during the successive shocks of crashes and a global pandemic. However, they are now being challenged to play a much larger role, one that may push them into mission creep or even inhibit their ability to fulfil their primary function. Economies are dealing with sweeping tests like the pandemic and climate change, threats like income inequality, and an international drive towards sustainable finance and financial inclusiveness. At the same time, digital finance and fintech are forcing a rapid modernisation of infrastructure. So, what is the key role of the central bank in national and international economies?

European Central Bank (ECB) Director General Ulrich Bindseil believes that there is some flexibility enshrined in the ECB’s foundational documents. He explained that not only is there a mandate to support general economic policy in the communities but one of its assigned tasks is also to facilitate the smooth operation of payments within the zone and to act as a catalyst. That’s incredibly important during a time that cross-border payments are receiving more and more scrutiny.

Bindseil pointed out that where an outrageously expensive phone call, say between Germany and Pakistan, has now been replaced by a free video call, the price of cross-border payments has barely moved over the past two decades. This comes in part from banks’ aversion to risk and from the regulatory challenges to newcomers. It calls for a collaboration between the private and public sectors to speed up change in this crucial area.

The ever-increasing demand for faster payments

There is some risk, however, in this continuously increasing demand for faster payments, both on the domestic and international levels. Howard Lee, Deputy Chief Executive of the Hong Kong Monetary Authority (HKMA), warned that processing in real time presents different challenges than processing in batch. How do you ensure that safety protocols, such as Anti-Money Laundering, are enforced? How do you claw back payments if you see a financial crime?

The digital infrastructure to help answer these questions concerns not only payments but data. One role of the central bank might be to provide an infrastructure that protects individual privacy but provides the kind of digital identity management and identity verification that could be prohibitively costly for individual financial institutions. It could also offer individuals and corporations the ability to reclaim a data footprint that’s currently scattered across multiple platforms and opt into a single system to protect their data from third-party monetisation.

Of course, even this support can be the cause of some concern. There are some who worry that too much innovation from central banks will crowd out the public sector. HSBC Co-CEO Georges Elhedery disagreed. “Banks and central banks have shared interests and common targets of financial stability and price stability for clients and the community at large.” He went on to point out that commercial banks play the important role of buffering shocks, one that can be abridged if banks are heavily regulated whilst decentralised finance is ignored. He argues that central banks need to regulate cryptocurrencies commensurate to the risks they pose, in terms of consumer protection, crime and financial stability.

Investigation of the digital euro

One other way that central banks are looking at digital currency is to develop one themselves. The EBC is launching a two-year investigation of the digital euro. Bindseil noted that many solutions are projected onto central bank digital currency. This study will show what it can do in practice. The HKMA has been exploring CBDC as well. “All central banks would need to future-proof themselves for a wider adoption of CBDC in the future”, Lee noted. 

He also emphasised that central banks need to take a holistic look at digitalisation. New technologies are developing previously unheard-of risks that need to be considered for the sector as a whole. Imagine the seemingly innocuous choice of a bank moving its data from an internal centre to a secure cloud provider. If enough institutions move to the same cloud server, it could present a significant risk to the whole sector. “This is why we want to have a more comprehensive blueprint for the development of tech and fintech as a whole. We look at funding support, policy support and financial infrastructure and data infrastructure to help banks digitalise.”

The raison d’être of a central bank is to maintain stability. It makes sense that in a rapidly changing landscape, they would find their role evolving quickly. Central banks may find themselves performing different functions, from issuing a digital currency to maintaining an identity database. At the root, however, their role will continue to be to provide stability in a financial world that finds itself beset by both challenges and innovations.