Activities of the BIS - The year 2003-04 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, 28 June 2004.

Ladies and Gentlemen

On behalf of the Management and staff of the Bank, I would like to welcome you to the 74th Annual General Meeting of the Bank for International Settlements.

In reviewing the activities of the BIS over the past year, I will cast my remarks in the context of the Bank’s basic mission. In a nutshell, what motivates all our activities is the desire to contribute to greater monetary and financial stability by promoting the cooperation of monetary and supervisory authorities and stimulating a constructive dialogue among them. In today’s world of globalising markets and the challenges this poses for international cooperation, I believe this mission is becoming even more important.

The desire to promote international cooperation has motivated the Board and Management of the BIS ever since its inception in 1930. But the way in which cooperation has taken place and the group of central banks involved in the dialogue have evolved significantly over the past 74 years. The past decade or so in particular has seen significant changes, and I would like today to highlight some of these recent changes.

The Bank’s Annual Reports provide a good illustration of the scope of central bank cooperation over the years. Take, for instance, an Annual Report of the late 1980s and you will notice that, apart from some discussion of trade and capital flows between mature and developing economies, key financial and monetary issues were analysed primarily from the point of view of the mature economies. Similarly, BIS meetings brought together mainly central bank representatives from the mature economies.

That other central banks were not closely involved in the analysis and discussions largely reflected the fact that the systemic importance of the developing economies for the world economy or for financial markets was still relatively small. However, beginning in the early 1990s, the transformation of the economic and financial landscape in central and eastern Europe and the rapid development of several Asian and Latin American economies called for an understanding of developments in mature and emerging economies alike, and the exploration of their implications for global financial stability and international cooperation.

In response, the Bank’s activities adopted the global perspective that central bank cooperation requires today. One element of this global commitment has been the growth in our membership. Over the past year, six new central banks, those of Algeria, Chile, Indonesia, Israel, New Zealand and the Philippines, accepted the Board’s invitation to become member central banks, joining the 12 other central banks from emerging market economies that have become shareholders of the BIS since 1996.

I recognise that our membership is not universal. Yet this does not imply that only those who have membership status can benefit from the cooperative framework that the Bank tries to build through its financial and analytical services. Indeed, I hope it will become clear from what I will say today that, in all the areas of cooperation in which we are engaged, our goal is to involve the central bank community as widely as possible and, increasingly, include the supervisory community as well.

Another aspect of central bank cooperation that is now promoted by the BIS is the fact that virtually all the meetings we organise or for which we provide support include representatives from a significant number of systemically important emerging market economies.

A good example of this development is the Working Party on Monetary Policy organised by the Bank’s Monetary and Economic Department. Where this used to be a single meeting exclusively devoted to monetary policy issues in mature economies, several such working parties now take place, each with a specific focus on the respective challenges faced by central banks in Asia, central and eastern Europe and Latin America. And, we have also endeavoured to offer such a discussion forum to policymakers from Africa although it has been on a modest scale and on an irregular basis to date.

Similarly, our research activities now encompass a very broad spectrum of questions covering, from a global perspective, issues of monetary and financial stability, the complex interaction between micro- and macroprudential approaches to stability, and the functioning of markets.

What is true of our economic and financial research and our analytical support to meetings applies equally to the many other areas of central bank cooperation under the aegis of the BIS. To take just one example from the statistical area, in the latest survey of foreign exchange and derivatives markets a record 52 central banks undertook to collect data on turnover and amounts outstanding in these markets. This represents a major effort, not only on the part of the BIS, but also by the participating central banks. Yet, if we want to produce a comprehensive picture of these key financial markets in today’s globalised world, such an effort is essential. Another very successful line of investigation and data collection is the compilation, through a network of more than 40 central banks, of information on a variety of governance issues that are of specific and great relevance to central banks.

Outside these more familiar areas, we also made a special effort last year to involve a larger number of central banks in discussions on topics such as reserve management, internal audit practices, legal issues, and the use of information technology.

Another important illustration of how the Basel community is trying to reach out as globally as possible can be seen in the area of banking supervision. Many authorities are facing big challenges in strengthening the oversight over their banking institutions. The BIS, of course, stands ready to assist these authorities in their efforts. But in practice the scale of the challenge can easily dwarf the resources available to meet it. During a recent visit to China, for instance, I was told that the authorities urgently need to train some 25,000 bank supervisors to manage the task of overseeing the domestic banking system.

A survey that the Bank’s Financial Stability Institute conducted last year on the specific issue of Basel II implementation indicated a similar challenging message: in the 107 jurisdictions the FSI surveyed around the world, some 9,000 supervisors will require assistance in mastering Basel II topics.

Given such orders of magnitude, the normal technique of organising seminars and workshops for senior supervisors, which the Basel Committee on Banking Supervision and the Financial Stability Institute have relied on so far, is simply unequal to the task. Just to put into perspective the numbers I quoted a moment ago, last year’s intensive schedule of more than 50 FSI seminars and workshops served 1,700 participants. As positive as that may sound, it is far less than what may be needed in the years to come.

So, to respond to this challenge, the FSI has been working hard at designing, and developing content for, an internet-based interactive tool called FSI Connect. This is an online information and learning resource aimed specifically at banking supervisors. FSI Connect is being launched at this very moment and will offer tutorials on important risk management topics, such as the management of credit risk, market risk and operational risk, and of course capital adequacy (including Basel II). Courses on a full range of other banking supervisory topics will be added on a continuous basis over the next two years. FSI Connect is designed for supervisors at all levels of experience and expertise and can be accessed 24 hours a day, 365 days a year. It will be a strong complement to the FSI’s existing activities and will enable the FSI to reach out to a much wider audience globally. I believe this project demonstrates the BIS’s ongoing commitment to supporting financial stability in individual jurisdictions and worldwide.

Needless to say, broader central bank participation also marks the activities of the various committees hosted by the Bank that focus on the promotion of financial stability. With the active collaboration of various non-Committee members, the Committee on Payment and Settlement Systems is undertaking a project to formulate guidance on the design and development of a sound and effective payments infrastructure. Recently, too, a working group of the Committee on the Global Financial System completed a study on foreign direct investment in the financial sector of emerging market economies. Such investment was an important driver of the transformation of the global financial system in the 1990s. Given the importance of communicating the results of this study more widely, and of receiving feedback from those not directly involved in its execution, the Committee has scheduled a series of meetings with a large number of central banks in various regions.

Furthermore, the Basel Committee on Banking Supervision has consulted in a notably extensive way with all those who have a stake in the development of the new capital adequacy framework. I will return to this in a few minutes.

The broadening of central bank cooperation would not have been as effective had the Bank not been able to rely on the two representative offices that it has established in recent years in the Hong Kong Special Administrative Region of China and in Mexico City. The primary objective of these offices is to promote close relationships and foster cooperation between the BIS and the central banks and supervisory authorities in their respective regions: Asia and the Pacific, and the Americas.

I hope that those of you who come from these regions will regard the BIS representative offices as your primary channel for bringing your wishes for cooperation to our attention, in the same way as we make use of them to involve you in our activities. In the case of Asia, the Bank has benefited greatly from the advice and direction given to the activities of its Hong Kong office by the Asian Consultative Council, which held its seventh meeting here in Basel two days ago.

The Bank’s global perspective on central bank cooperation is probably most firmly established in its provision of financial services. As you all know, the BIS offers a diversified range of financial products and services to the central bank community and other international financial institutions. Needless to say, we are proud that some 140 central banks and international financial institutions invest part of their financial assets with us. We would like to feel that it is through our dedicated service and the security of your investments at the BIS that we earn and maintain your trust in our banking operations.

In an environment characterised by uncertainty and extensive foreign exchange intervention, the Bank’s balance sheet grew strongly over the past financial year, reaching 167.9 billion SDRs, or nearly 249 billion US dollars, at 31 March 2004. The growth in currency deposits from Asia has been particularly marked, with nearly half of total deposits now coming from this region.

The significant growth of currency deposits has to be seen in the context of the Bank’s prudent investment strategy, which rests on maintaining the highest possible credit standing and developing products or services that offer an attractive mix of risk and return on the investments of its central bank customers. In August last year, for example, we introduced a medium-term investment instrument with an embedded call option. Depending on the expected interest rate environment, this callable medium-term instrument has the potential to significantly enhance the yield to its holder. Moreover, in order to maintain the competitiveness of shorter-term instruments, their pricing in both US dollars and pounds sterling was improved appreciably in early 2004.

In order for us to continue to offer both an adequate return and a secure investment in a rapidly changing global environment, the financial risk management practices of the Bank are being continuously enhanced. Credit, market and liquidity risks are managed day-to-day through an independent and specialised Risk Control unit, reporting directly to the Deputy General Manager, and through him to me. Risk positions are reported regularly and comprehensively to appropriate management committees. And operational risk is addressed by business unit managers across the Bank.

As a final important element in the management of the Bank’s financial operations, I should mention the change in the reporting framework for the Bank’s financial statements that was introduced at the start of the past financial year. This has allowed us to present a still more accurate picture of the Bank’s financial performance in an environment where the Bank’s financial operations are increasingly being managed on a mark to market basis.

As the theme of my remarks is the global nature of the Bank’s activities, it seems appropriate to conclude with a few words about a major initiative that is likely to exert a global impact on financial markets and institutions in the years to come. Only two days ago, on Saturday afternoon, the Governors and Heads of Supervision of the G10 countries gave their support to the proposal of the Basel Committee on Banking Supervision for a new international capital standard – better known as Basel II. The development of this new capital adequacy framework owes much to the hard work of the members of the Basel Committee and its secretariat. Special recognition should go to the Committee’s current and previous Chairmen, Jaime Caruana and Bill McDonough, who with great commitment and energy have guided the effort over the past six years.

By aligning the capital measurement framework with contemporary risk management practices in banking, Basel II represents a major – and indeed necessary – revision of the international standard on bank capital adequacy that was first introduced in 1988. But the efforts to develop this framework have not been solely those of the experts of the Basel Committee. In accomplishing this important piece of work, the Committee has been able to rely on significant contributions by other supervisors, as well as the global banking industry. The fact that the third consultative paper, released in April 2003, attracted responses and comments from over 200 organisations is just one illustration of the unprecedented degree of consultation with which the Basel II project was undertaken.

The implementation of Basel II will start in the member countries of the Basel Committee as from the end of 2006, with the most advanced measurement approaches being subject to one further year of impact analysis and parallel running. Just as the first Basel capital standard was adopted in over 100 jurisdictions, I am convinced that supervisory authorities worldwide will want to upgrade their regulatory regimes in line with Basel II once they have adequately prepared themselves to do so.

The Basel Committee – in particular the Accord Implementation Group and the Core Principles Liaison Group – as well as the Financial Stability Institute, stand ready to assist you as comprehensively and effectively as their and our resources permit.

I hope that my remarks today have convinced you of the global commitment with which we approach our objective of helping you establish monetary and financial stability in a cooperative fashion. My final word is thus one of thanks to you, for all the support that you have given us again over the past year in pursuing this important mission, and to the staff of the BIS, who have worked so diligently at realising the Bank’s goals.