Activities of the BIS - The year 2002-03 in review

Speech delivered by Malcolm D Knight, General Manager of the BIS, on the occasion of the Bank's Annual General Meeting in Basel on 30 June 2003.

Since my appointment as General Manager of the BIS began with a new financial year three months ago, my report on the Bank's activities in 2002-03 will mainly describe accomplishments of my colleagues and of my predecessor, Andrew Crockett. The fact that the past year was one of significant activity and noteworthy successes makes me all the more proud to have been given the opportunity to address you today. In my remarks, I will first describe the salient features of the past year's activities. Then, I will report in some greater detail on the specific areas on which the work of the Bank and the Committees hosted by the Bank has focused.

1. Special features of the Bank's activities during the past financial year

Three special features of the Bank's activities over the past financial year deserve to be drawn to your attention. They are transparency, a focus on the needs of our clients - central banks and financial regulators, and further outreach to the central banking community throughout the world. Let me explain to you what we have accomplished in these three areas over the past year, before turning to a review of our other, ongoing activities.

Transparency

As the Bank's President noted in his address, dealing with uncertainty has been one of the great challenges facing all those charged with managing the world economy and the international financial system in recent months. Quite often, transparency is an effective tool for mitigating the negative impact of this uncertainty.

What is true at the macro level of the world economy equally applies, I believe, at the micro level of the individual institution. I am therefore pleased to note that the BIS has also taken - with the guidance and support of the Board of Directors - a number of significant steps over the course of the past year to ensure that its functions and performance are better understood, and that the Bank is governed in a sound and prudent way.

Perhaps the most important step has been the modernisation of the Bank's accounting policies. Starting in April, the Bank's traditional accruals accounting practices were replaced by new accounting practices that are now aligned with the International Financial Reporting Standards. This will ensure that a more comprehensive and accurate picture of the Bank's financial operations and performance is presented. As a complement to this, after 73 years, the BIS abandoned the Gold franc as the Bank's unit of account on 1 April 2003. It was replaced by the Special Drawing Right, a weighted basket of currencies, defined by the IMF, which is much more representative of the main currencies used in international trade and financial investment. The switch to the SDR as our unit of account will offer greater scope for managing the Bank's economic capital in an efficient way. In early April, the Bank undertook the necessary operations to align the currency composition of its own investments to the SDR basket, so as to eliminate foreign exchange risk on its own investments other than gold. However, given the Bank's own sizable holdings of gold (the price of which is not included in the SDR), exposure to price risk in this market will remain under the new accounting framework.

A further transparency initiative has been to disclose information which hitherto was considered for internal use only. In a few days, we will place on our website the code of conduct of the staff, while the Annual Report now releases details about the remuneration of senior Management and the Board of Directors. Special attention has also been given to how we can present a clearer and more comprehensive picture of what the BIS's role is, how it functions, and how it is managed. By making this information publicly available on our website, we hope to present a more accurate and accountable picture of how the BIS contributes to international cooperation.

Dedicated client service

As a service provider, the BIS needs to remain focused on the needs of the community of central banks and other financial authorities. In this context, I would like to single out three major projects that were undertaken over the past year: the Thiessen Report; the e-learning project of the Financial Stability Institute; and the enhancements to the reserve management instruments offered by the Banking Department.

At the end of the past year, the Bank asked Gordon Thiessen, former Governor of the Bank of Canada, to undertake a survey to identify and better understand the views of our central bank clients on how the BIS could help their cooperative efforts. A few months ago, Mr Thiessen presented to Management a most comprehensive and thoughtful document. And he summarised the report for the Governors on the occasion of the May bimonthly meetings. We were all pleased that its basic message was positive. The report nevertheless contains various suggestions and recommendations as to where we could fine tune our services. The proposals are being studied with care and an effective follow-up will be given to them to the fullest extent possible.

My second illustration of the Bank's attention to providing an adequate response to the needs of central banks and supervisory authorities is the Board's approval, in September 2002, of an e-learning programme for financial sector supervisors. The programme will be designed and implemented by the Bank's Financial Stability Institute and will use the internet to offer, on a truly global scale, courses covering a broad range of topics of supervisory interest that address the needs of all those closely involved in the supervision of banks and other financial institutions.

In our role as banker for central banks, we have always adhered to the guiding principle of focusing on the needs of our clients. We have met central banks' needs for marketable, competitively priced and secure instruments by significantly widening our range of BIS instruments for their foreign reserve management. Medium-Term Instruments (MTIs), introduced a little more than four years ago, have been particularly successful in this regard, with the stock of these instruments representing some 34% of total customer placements at the BIS at the end of the past financial year. Reserve managers at central banks have also sought to increase the duration of their portfolios in the light of the recent generalised decline in interest rates, in particular at the short end of the yield spectrum. To meet this desire for longer-duration portfolios, the Bank has responded by extending the maturity profile of MTIs to 10 years.

The recent announcement of the launch of the Asian Bond Fund (ABF) deserves special mention. At the request of the central banks belonging to EMEAP, the Executives' Meeting of East Asia-Pacific Central Banks and Monetary Authorities, the BIS will manage for them an open-ended fund consisting of sovereign and quasi-sovereign Asian bonds denominated in US dollars. Given the large holdings of official foreign exchange reserves in Asia and the comparatively small size of the Fund, the Asian Bond Fund is not meant to become a major instrument of reserve management at least in the short term. Rather, its main immediate objective is to give further impetus to the development of domestic capital markets in Asia which we all agree would help reduce a major source of financial vulnerability, revealed so painfully during the region's crisis of 1997-98.

There is, however, one particular service that - after careful consideration - we decided we are not able to provide. Several central banks had indicated that they would like the BIS to become a settlement member of the Continuously Linked Settlements (CLS) Bank - a private sector initiative aimed at eliminating settlement risk incurred in foreign exchange transactions. The idea was that the BIS would provide a third party service to central banks on a cost-sharing basis. After a thorough investigation by an advisory group, it was concluded that such a BIS-based solution would be uneconomic, primarily because low volumes of central bank foreign exchange transactions would keep unit costs at unacceptably high levels.

Global outreach

A global focus has been a key element of the BIS strategy for a number of years now and is visible in most activities of the Bank. The majority of meetings organised by the Bank now benefit from active participation by senior officials of both mature and emerging market economies. An increasing number of meetings, such as the Working Parties on Regional Monetary Policy, deal with specific issues preoccupying central banks in the various regions of the world. Information on BIS activities and supervisory matters is disseminated to a global range of central banks and supervisory agencies. In addition, all committees hosted by the BIS have developed channels for engaging those not directly participating in the committee activities.

A key role in this global outreach is played by the Bank's two representative offices. The office in Hong Kong SAR has now gained four years of experience and is well positioned to contribute to cooperation among the Asian central banks. The office has benefited greatly from the guidance of the Asian Consultative Council. Last November, we celebrated the inauguration of the Representative Office for the Americas in Mexico City. In the Western Hemisphere, we thus hope to strengthen, through our office and in collaboration with regional organisations, the relations and cooperative arrangements among the regional monetary authorities. This also includes serving these institutions' financial needs better.

Finally, I am pleased to announce that the Board of Directors of the BIS decided yesterday to invite six central banks - those of Algeria, Chile, Indonesia, Israel, New Zealand and the Philippines - to become members of the BIS.

2. Review of main developments

Let me now turn to a quick review of the other, ongoing aspects of the Bank's activities in 2002-03. I would like to do this under three distinct headings: banking services, BIS contributions to international cooperation; and the work of the committees and groupings hosted by the Bank. The further progress in the formulation of a New Capital Accord for the banking industry was one of the main highlights of the committee activities.

Banking operations

At the end of the past financial year, the balance sheet reached a third successive end-of-year record, expanding by almost 6% to a total of just over USD 180 billion. Unlike in previous years, the rise resulted almost entirely from exchange-rate induced valuation changes, in particular the impact of the depreciation of the USD on the value of the portion of the Bank's balance sheet denominated in other currencies.

The Bank aims at building a deposit base that is as global as possible. Some 130 central banks manage part of their reserves using the BIS as an intermediary. In particular, banking operations for Asian customers have grown significantly.

The low-yield and low-spread environment over the reporting period encouraged the Bank to sharpen further its focus on remaining competitive. Notwithstanding the difficult market conditions, the Bank was successful in sustaining growth in the underlying profitability of its deposit taking activity. This reflected a modest increase in intermediation activity, as our customers adjusted their positions in BIS instruments with great frequency. A second factor was the greater diversification in the investments of the funds entrusted to the Bank.

The challenge of maintaining superior risk management and sound profitability will stay with us for a long time. Meeting this challenge may require, on the liability side, new product development and pricing adjustments. On the asset side, what is needed is a policy of investment diversification that preserves the Bank's status as a prime credit intermediator, but allows stronger revenue growth. At the same time, efforts to foster the Bank's asset management capability will also be sustained.

Such a policy programme will require a strong internal system of risk control and risk management. In accordance with best practice, a separate risk control unit, reporting directly to the Deputy General Manager, and through him to me, is charged with the close monitoring of credit exposures, liquidity, market and operational risks.

Direct contributions of the Bank to international cooperation

One of the key ways in which the Bank seeks to promote cooperation among central banks is the organisation of meetings on topics of current interest or concern. In the past financial year, the senior central bank officials participating in these meetings often sought to assess the strength of the world economy and the resilience of financial markets in the context of a particularly uncertain environment. On many occasions, central bank concern also focused on recent revelations of corporate reporting irregularities. This triggered in-depth discussions of the potential weaknesses in the current infrastructure of financial markets, and of the reforms that could help restore confidence in this infrastructure. Of course, exchanges of views took place on many other themes of both a financial stability and a monetary policy nature. How to deal with deflation was arguably the most intense and lively of those exchanges.

As I mentioned before, in a number of these meetings the BIS has been making a conscious effort to highlight the emerging market perspective. In this regard, I would like to make a special mention of the organisation of a meeting for African central bank Governors in December of last year.

Promoting cooperation has not been limited to issues of monetary policy or financial stability. The effectiveness and accountability of increasingly independent monetary authorities depends importantly on having put in place sound governance and organisational structures. Against this background, central bank governance has become an area in which central bank cooperation and interaction has proven particularly fertile.

In addition, cooperation on statistical matters has deepened significantly in recent years, with a rising number of central banks reporting key statistical information. Moreover the topical coverage of the BIS data bank has broadened significantly to include series of specific relevance to analysis in the area of financial stability.

Finally, less visible aspects of central banking, such as information security concerns, business continuity planning and internal audit practices, have also proven in recent years to be domains in which central bank cooperation can add significant value.

Not all central banks can be involved in each cooperative initiative. Accordingly, the Bank has remained committed to disseminating the outcome of its cooperative efforts and research to the wide community of central banks and other financial authorities. Initiatives in this area often take the form of close cooperation with regional central bank organisations and other financial groupings. In this regard, the cooperation with EMEAP, the study centre of the South East Asian Central Banks, the Joint Vienna Institute and the Centro de Estudios Monetarios Latinoamericanos deserves special mention. In the area of banking and insurance supervision, dissemination is undertaken by the Bank's Financial Stability Institute, mainly through seminars and workshops, in which over 1,600 representatives from all regions of the world participated in the past year.

Activities of the Committees and groupings hosted by the BIS

As you know, the Bank hosts the secretariats of a number of permanent committees. These committees trace their origin back to requests made by the Governors of the G10 central banks over the course of the past 30 years for the study of key aspects of the functioning of international financial markets and financial institutions. The main committees are the Basel Committee on Banking Supervision, the Committee on Payment and Settlement Systems and the Committee on the Global Financial System. The committees are chaired by senior officials of member central banks and are composed of central bank experts and, in the case of the Basel Committee on Banking Supervision, members from non-central bank supervisory authorities. In recent years, special initiatives have been undertaken to share experiences with, and invite the views of, those not directly involved in the work of the committees.

After more than four years of intensive work, the Basel Committee on Banking Supervision is on the verge of finalising the New Basel Capital Accord. Basel 2, as the New Accord is commonly known, is remarkable not only in terms of the energy and analysis that has gone into its drafting, but also in a number of other respects.

First and foremost, it seeks to align the quantitative measures of capital adequacy with the true underlying risk exposures of banks. In other words, the Accord is meant to induce firms to hold and allocate capital for regulatory purposes in a way that mirrors closely the internal capital allocation they would apply using modern risk management practices. In this context, the Accord also explicitly recognises the need to hold capital to cover operational risks.

Second, the quantitative capital requirements are supported by additional standards designed to strengthen the supervisory review process and to allow the market to exert its disciplinary power based on more relevant, accurate and timely disclosure.

Last but not least, I think it is no exaggeration to say that, never before in the history of standard setting, has there been such a wide ranging process of consultation. On no less than three occasions, the banking industry, as well as the global supervisory community, were formally asked to comment on the Committee's proposals. In addition, less formal but equally intensive discussions took place with a wide range of official and private representatives throughout the industry and across all borders. Against this background, there seem to be few grounds for claiming that insufficient scope for comment was offered in the construction of this new and needed Capital Accord.

Implementation will be the next big challenge on the agenda of the Basel Committee and its new Chairman, Jaime Caruana, Governor of the Bank of Spain. The Accord Implementation Group, in cooperation with the Core Principles Liaison Group, will have a key role to play in meeting this new challenge.

Time and again, revealed weaknesses in the functioning of financial markets demonstrate the need for a strengthening of the infrastructure of financial markets and a clear analysis of the underlying market processes. Against this background, the continuing work of the Committee on Payment and Settlement Systems chaired by Tommaso Padoa-Schioppa, member of the Executive Council of the ECB, on settlement systems for security transactions is to be welcomed. The assessment methodology, developed in collaboration with the Technical Committee of the International Organization of Securities Commissions, will provide a great deal of help to the IMF and the World Bank when undertaking their reviews of financial systems in their member countries. Having well-articulated standards will also allow private participants to make a clearer judgment of the soundness and efficiency of their securities settlement systems. Similarly, the Committee on the Global Financial System, now chaired by Roger Ferguson, Vice Chairman of the Board of Governors of the Federal Reserve System, is continuing its efforts to improve the understanding of the functioning of financial markets. The complex market for credit risk transfer instruments and its potential impact on financial stability were particular areas of focus on the committee's agenda last year.

In closing, allow me to make a final remark with regard to the independent organisations which have located their secretariats here at the BIS. These groupings are the Financial Stability Forum, the International Association of Insurance Supervisors and, since May of last year, the International Association of Deposit Insurers. It is not for me to report in detail on the activities of these various groupings. However, I would like to note that it is the view of the Bank's Management that the central banking community has benefited significantly from its interaction with these groupings and from involvement in a direct or indirect way in their activities. Physical proximity of these groupings, the central bank committees and the central banking community at large here at the BIS can create synergies that ultimately serve our common goal of promoting greater monetary and financial stability. Last but by no means least, I would like to thank the Board and the Bank's shareholders for their continued support of the Bank's efforts to reach out and cooperate with all those having a stake in a sound and efficient financial system.