Creating a Leading Central Bank

Creating a leading central bank

Fifth edition

Central Bank network

November 2020

KPMG International

home.kpmg/banking Introduction

Periods of crisis such as that caused by the COVID-19 pandemic call for decisive action from financial authorities to provide economic support and maintain public confidence. Central banks need to act as the first line of defense — protecting economies, while also stimulating the recovery of trading, commercial and financing activities.

It has been welcome and impressive, The size of the aid is obviously a variable of therefore, to see the way in which central the capacity of the country budget, and in banks have stepped up: their actions have some economies where constraints are more been rapid and on an enormous scale. relevant, creative alliances with the private sector were also formed. This element was In China, the People’s Bank of China (PBC) essential in developing economies such as in gave a 3 trillion renminbi (RMB) injection Latin America, Africa and Asia. into the banking system in the first half of February, with a further RMB20 billion at While all efforts have been directed to deal the end of March, along with other financing with the crisis, central banks also have support measures. In the US, the Federal to maintain and in some cases enhance Reserve (Fed) slashed interest rates by their internal controls and risk governance. a full percentage point to effectively zero Supervising a banking system on the edge of and launched a US$700 billion package an accelerated era of transformation is a major of quantitative easing (QE). This was task. As a result, this year has been one of the accompanied by a huge fiscal intervention — busiest and most demanding for central banks the US$2.3 trillion Coronavirus Aid, Relief and in living memory. Economy Security Act (CARES). In Europe, the European Central Bank (ECB) extended Although some of the second quarter data its QE program by more than 750 billion indicates that global GDP and countries’ specific euros (EUR). The ECB Banking Supervisor outputs have not been as severely affected as has also allowed significant institutions initially projected, this crisis still seems likely to to operate temporarily below the Pillar 2 generate bigger impacts than even the global guidance, the capital conservation buffer, financial crisis (GFC) that began in 2008/09. and the liquidity coverage ratio. In the UK, The ramifications could last for many years and the Bank of England slashed interest rates by central banks will continue to have a pivotal role 65 basis points to 0.1 percent, expanded its to play in enabling the recovery. holding of government bonds by 200 billion In this updated publication of the KPMG pounds sterling (GBP), and made Central Bank network, we share some of GBP330 billion of loans and guarantees our experiences in engaging with central available to businesses.1 banks around the world during the crisis — to Richardo Anhesini Additionally, a deal was agreed between six support their responses and transformation Global Chair, major central banks including the Fed and the projects, and help them formulate strategies Central Bank network ECB to lower their rates on currency swaps that further bolster risk management and KPMG in Brazil to help financial markets function normally. performance in extraordinary times.

1 Central Banks respond to COVID-19, Frontiers in Finance, KPMG International, May 2020

2 Creating a leading central bank

Legacy data systems: Moving towards further central bank 1 digitization

2 Greening the financial system

3 Stepping up the three lines of defense

Stepping up governance, risk management and internal 4 controls

5 Central bank digital currencies: Which way forward?

6 Cyber security in a digital financial services landscape

7 Supervising stability and regulatory compliance

8 Transformation: Building a high performance organization

Implementing International Financial Reporting Standards 9 (IFRS)

Dynamic Risk Assessment (DRA): Is it possible to predict 10 the impact of a crisis like COVID-19?

Creating a leading central bank 3

© 2020 Copyright owned by one or more of the KPMG International entities. KPMG International entities provide no services to clients. All rights reserved. Legacy data systems: Moving towards further 1 central bank digitalization Is another patch really a solution? The late 90s and early 2000s ushered in what were the first real waves of “modern” information technology (IT) for central banks and the commercial banking community.

The new IT tools significantly reduced stakeholders. Central banks face three observed that cost considerations may reliance on mainframe IT infrastructure key objectives and challenges: keeping not appropriately account for existing and manual data manipulations, but it running, keeping it innovative and internal maintenance efforts and the they are in many cases still coupled keeping it economical. manual data manipulations that users with other inherent challenges. Such must perform to try accomplishing the challenges include: the ever-increasing A patchwork of fixes? processes’ objectives. Another related cost of maintaining and securing underlying factor is interaction between programs and systems; dependency on Over time, KPMG has seen central bank mission, IT strategy and a high degree of manual interfaces; and organizations manage these challenges budgetary planning. COVID-19 has legacy system limitations that make with varying degrees of success. There made it clear that essential and urgent it hard for central banks to add much are inherent trade-offs — sometimes crisis response efforts may shift needed functionality and optimize the investments in innovation are priorities and resources away from risk mitigation. While these systems curtailed to make critical security longer-term IT strategy initiatives. continue to serve central banks, they improvements (often patches are often operating beyond their themselves), and in other cases, In the face of these obstacles, central intended useful lives and purpose. perceived cost pressures prevent banks can and should broadly consider management from deploying optimal the benefits that result from a more The critical technology legacy solutions; instead they ‘buy time’ with digitized and adaptable IT framework. systems of central banks span virtually more short-term manual workarounds. the entirety of their operational While some customized fixes are Developing a world class IT mandates — from data systems necessary in discrete instances, operating model facilitating payments and supervision the trap is when such measures are and regulation tools, to economics pervasive and longer-term, as this likely A leading central bank IT operating research tools and databases; from adds costly complexity and instability model takes many years to fully enabling internal support functions to operations. The factors contributing develop. An initial step begins with a for human resources, to underpinning to the reliance on ‘patching’ are many thorough analysis of the stakeholders’ organizational enterprise management and typically include: a familiarity current and forecasted operational systems. Given the prominence and with the legacy systems; fear of and business needs as well as risk pervasiveness of the role of those the extent of change; and financial assessment and overall digitalization systems, their operational stability is considerations that are too narrowly objectives. This scoping requires cross- paramount to both internal and external defined. On this last point, we have functional input from the internal and

Throughout this document, “we”, “KPMG”, “us” and “our” refers to the global organization or to one or more of the member firms of KPMG International Limited (“KPMG International”), each of which is a separate legal entity.

KPMG International Limited is a private English company limited by guarantee and does not provide services to clients. No member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm.

4 Creating a leading central bank

© 2020 Copyright owned by one or more of the KPMG International entities. KPMG International entities provide no services to clients. All rights reserved. external facing units of central banks. Executive management To make well informed decisions, leading the strategy management should also prepare a To make the best-informed comprehensive baseline of the “all-in” Executive management together with costs of IT legacy systems themselves. central bank functional heads and decisions, management As noted above, there are less obvious, CIOs should provide lead oversight should also prepare a yet often significant, operating efforts, in determining the digital strategy. which create costs that are frequently Taking the foundational information comprehensive baseline of borne by frontline system users. gathered about scoping and solutions, These usually manifest themselves in they should be able to make critical the “all-in” costs of IT legacy the form of manual parallel tasks and decisions about the modernization systems themselves. data handling. Operational matters actions. These decisions should include are best considered in tandem with prioritizing IT project and existing IT architecture and central banks mission imperatives; proposing capital should consider these holistically and operating budget envelopes; when evaluating alternatives. validating the selected implementation Next, management should seek to partners and IT products and solutions; understand the suite of benefits, and balancing the degrees of functionality enhancements and related centralization versus decentralization cost offsets that modern cloud-based (i.e. the operational and IT hierarchy in or hosted solutions and services can executing the strategy). This last point deliver. Most of the newer generation is important as there are numerous of solutions can provide: an ease of tactical decisions in projects of this integration and internal connectivity; scale. Leaders should develop and expanded and flexible reporting set clear delineations of authority and functionality; and a higher degree responsibility across the central bank to of user satisfaction. These cost/ enable the strategy to be deployed at benefit and case analyses are most an appropriate pace. effective when organizations leverage their own internal operational and IT Central banks can achieve the resources with objective professionals institutional resilience and flexibility that who can contribute their external optimized digitization provides. Legacy perspective and experience from other systems will continue to age and strain to transformation IT projects. These fulfil their purposes, but with thoughtful facilitated analyses go step-by-step and governance and deliberate action, deeply assess institutional processes management can balance the immediate and supporting technology tools and mission and make progress towards a design the ideal replacements. Thus, world class IT operational model. management can see the benefits of leading-edge technology contrasted against a more complete picture of the true costs (IT and personnel) of its legacy operations.

How the KPMG Central Bank network can help The KPMG network of central banks professionals and partners understand the unique nature of central bank operations and possess the multi-disciplinary skills to assist a central bank in its progress towards a future state, digitalized IT operating model.

Some of the ways KPMG firms clients balance IT performance, cost and risk:

— evaluate optimal IT governance, reduce risk, and increase people and organizational effectiveness

— define the IT vision and principles, target operating model and change management

— assess cloud suitability and define the target architecture that defends against the latest threat vectors

— design and implementation of improved processes and tools for IT service management, IT asset management, data and system security safeguards, project and portfolio management, and technology business management.

Creating a leading central bank 5

© 2020 Copyright owned by one or more of the KPMG International entities. KPMG International entities provide no services to clients. All rights reserved. Greening the financial 2 system Central banks can have an important role in the greening of the financial system, delivering sustainable finance and taking account of ESG risks.

The financial system is undergoing consequences of biodiversity loss and a transformation in which ESG redistributed water resources are only (environment, social and governance starting to build up. Central banks must aspects) is integrated into financial understand and assess strategies, processes, products All these challenges present financial and practices. Sustainable finance risks that impact upon a central bank’s the scope and size of addresses the whole value chain in mission and core objectives, including the risks that arise to the finance sector and central banks financial stability, resilience and are taking an increasingly active role in longer-term prosperity of countries. financial stability from the development by e.g. issuing green Like other organizations, central bonds in countries such as France, societal challenges and the banks are adapting to this changing Germany and Sweden. The process is risk landscape. Central banks must financial institutions that backed up by regulation in many parts understand and assess the scope and of the world, not least in the EU. they supervise. size of the risks that arise to financial Financial stability is one key driver. stability from societal challenges IMF notes in its Global Financial and the financial institutions that Stability Report of April 2020 that they supervise. More longer-term, disasters as a result of climate change forward-looking and judgment-based are projected to be more frequent and supervision is needed to examine more severe, which could threaten these financial risks. In addition, they financial stability. The report argues need to be able to determine effective that better disclosures and stress strategies to make the financial testing for financial firms can help system more resilient to any of these preserve financial stability and should societal transitions and help the complement policy measures to system to adjust itself efficiently, for mitigate and adapt to climate change. example, by implementing policies to scale up sustainable finance. In addition to climate change and the COVID-19 pandemic, there is a range An increasing number of central banks of other environmental and social are taking action to adapt their scope challenges impacting financial systems of responsibilities, strategies, policies and institutions, such as aging and organizational processes to the populations, large-scale involuntary new risk landscape, including climate migration, the demand for diversity change as a systemic risk. and resource scarcity. Insights into the

6 Creating a leading central bank

© 2020 Copyright owned by one or more of the KPMG International entities. KPMG International entities provide no services to clients. All rights reserved. In addition to these, central banks How the KPMG Central Bank need to analyse what climate network can help risks actually mean for them. are An increasing number of Assessment of the impact of KPMG firms’ network of Central Bank adverse climate scenarios and other professionals work with central banks central banks are taking environmental factors on bank capital of varying size and sophistication to action to adapt their adequacy is also on the to-do list. advance the integration of ESG factors in the core duties and organizational scope of responsibilities, In December 2019, the Bank of England processes of the bank, including: set out the narratives, specification and strategies, policies and modelling approaches to three climate- — quantifying and assessing the organizational processes risk scenarios — “orderly”, “disorderly” financial risks that can arise from and “hot-house world” — intended climate change and other ESG to the new risk landscape, to be the focus of the 2021 Biennial factors Exploratory Scenario. It also provided including climate change five alternative scenarios to help users — benchmarking of sustainability as a systemic risk. assess the effects of different key performance against comparable assumptions. The BES is on hold due to institutions COVID-19, but is expected to go ahead in due course. Similar exercises also — supporting with determining effective take place elsewhere, for example in strategies and policy measures to France with the bank supervisor ACPR. mitigate financial risks from climate The central bank will provide scenarios change and other ESG factors for this. — integration of ESG factors in core In May 2020, the central banks and duties, organizational processes and Supervisors Network for Greening the systems and governance structures financial System (NGFS) published a — support with entering and guide for supervisors on integrating operating on the market for green climate change into prudential and social bonds supervision. It sets out five non- — providing up-to-date knowledge and binding recommendations for understanding of regulatory changes supervisors intended to co-ordinate around the world in the field of a common regulatory response to sustainable finance climate-related and environmental risks. — supporting with improving the central bank’s sustainability The ECB is preparing a guide on how performance of it’s own organization, it expects banks to manage climate- such as sustainable procurement related and environmental risks safely and prudently and to disclose these and carbon footprint risks transparently under the current — improving disclosure effectiveness prudential framework. The guide of ESG performance of the bank includes supervisory expectations towards society and other key on governance and risk management stakeholders. frameworks, the formulation and implementation of business strategies, and enhanced disclosures. ECB encourages banks to develop stress- testing scenarios that incorporate climate-related and environmental risks. The 2019 EBA workplan on sustainable finance committed it to developing dedicated climate-related stress tests.

Creating a leading central bank 7

© 2020 Copyright owned by one or more of the KPMG International entities. KPMG International entities provide no services to clients. All rights reserved. Stepping up the three 3 lines of defense Central banks are no strangers to managing risk, but the bar for best practice on internal risk management and control is being raised. Central banks should be holding their own practices to account.

In the shadow of the 2007-2009 crisis, and transparency and, when lending Not all central banks are yet equipped to risk management, governance and public funds is at stake, expectations meet such demands, while others are internal control have been hot topics around risk management, good control maturing and undergoing fundamental on board agendas across the entire and overall operational resilience are high. changes, such as introducing new financial sector. Central banks have organizational structures and processes. helped to drive this focus — and it goes Clarity of management This may call for redesigned policies without saying that, as the standard responsibility and controls, as well as training and bearers of quality and risk management, recruitment to bring in new skills. central banks need to hold themselves As well as helping ensure the risks faced to the same high standards. What’s by the central bank are well-understood more, central banks tend not to have and within risk tolerance levels (linked to the same loss absorbing capital buffers the capital agreements with the central as their commercial bank counterparts. bank’s government/national treasury Without rigorous risk management department), management should have How the KPMG frameworks, this can mean that a clear delineation on who takes risk and Central Bank network central bank governor risks picking up who manages it. Having this structure can the phone to the national treasury and bring sizeable benefits to the central bank can help requesting further capital to absorb as well as its commercial counterparts. KPMG firms’ network of Central unforeseen losses. With central bank As one example, involvement of all Bank professionals work with lending rapidly escalating in the global three lines of defense in setting up central banks of varying degrees of response to the COVID-19 pandemic, new monetary policy schemes leads size and sophistication to advance it’s a risk that is only increasing. to dynamic and agile decision making, governance, risk management meaning internal controls and processes and overall operating standards, The three lines of defense are thought through up-front rather than including: retrospectively. So where should central banks focus — rethinking the organizational in order to address this? Looking at Heads of Risk commercial institutions, over the last structure, including core processes and systems for decade many of them have brought Another interesting trend that we banking activities and reserves about a rebalancing of the ‘three lines of have observed within the Central management defense’ within their organizations. The Bank network recently is the growing overall balance of employees in different number of central banks recruiting for a — refining the operation of the areas of organizations has shifted from Head of Risk. This individual is typically audit committee, executive front line profit driven activities, into responsible for establishing risk tolerance management or risk Compliance, second line risk and third frameworks linked to capital agreements management roles line internal audit. Central banks have with local government and has the benefit typically come later to this party, with the — assessing the quality of internal of being an independent voice focused on justification that they do not “take risk” audit to create profits and are not answerable risk management within the second and to shareholders in the traditional sense. third lines at the governor’s table, much — enhancing financial reporting Nevertheless, the public and other like a commercial institution. processes and associated stakeholders expect full accountability internal controls.

8 Creating a leading central bank

© 2020 Copyright owned by one or more of the KPMG International entities. KPMG International entities provide no services to clients. All rights reserved. Stepping up governance, risk management and 4 internal controls Good governance is not just a box-ticking exercise for central banks; it underpins the integrity and stability of a country’s financial system. Enhanced governance principles have budgets, use resources efficiently How the KPMG Central Bank emerged to respond to the current global and build strong teams with the right network can help financial and corporate crisis resulting capabilities. They need clear reporting from COVID-19. This has highlighted frameworks and benchmarking of KPMG firms’ network of Central the importance central banks play in performance against comparable Bank professionals work with central a countries security and protection of institutions. banks of varying degrees of size and society. As the standard bearers of sophistication to advance governance, The public and other stakeholders expect quality, central banks need to visibly risk management and overall operating full accountability and transparency raise the bar in terms of independence, standards, including: to uphold political independence and expertise and professionalism, not just demonstrate that central bank policies are — rethinking the organizational structure, as an example to other institutions, but contributing to lasting economic growth. including core processes and systems to help ensure the smooth running of for banking activities and reserves the wider economy. In addition to robust Not all central banks are yet equipped management policies and systems, the governor and to meet such demands, while others the executive and non-executive board are undergoing fundamental changes, — refining the operation of the audit members should possess exceptional such as increasing/decreasing their committee, executive management or skills and independence in order to scope of responsibilities and introducing risk management roles manage and oversee the bank’s activities. new organizational processes. This — assessing the quality of internal audit may call for new organizational design Like any organization, central banks — enhancing financial reporting processes and policies, as well as training and and associated internal controls. have to manage performance, approve recruitment to bring in new skills. Case studies

Rehabilitating the national banking system In a substantial exercise to value assets and liabilities, a KPMG Central Bank network team assisted the central bank and two commercial banks in the country to recapitalize. The KPMG Central Bank network mobilized a cross-border team of specialists in valuations, real estate, insurance and accounting, whose work has underpinned discussions between international creditors, the Ministry of Finance and the central bank. The subsequent full recapitalization (via the conversion of uninsured deposits into shares in the commercial banks) has formed a vital part of the restructuring and rehabilitation of the national banking system. Enhancing the risk management system The risks faced by central banks can be significantly different to those faced by commercial banks. Several years ago, one of the world’s major central banks decided to apply certain risk management requirements, which are obligatory for commercial banks in its jurisdiction, to its own internal processes. The KPMG Central Bank network team analyzed the application and implementation of those requirements. This resulted in recommendations to the board on updating and enhancing the internal requirements and on making the internal processes more effective in practice.

Creating a leading central bank 9

© 2020 Copyright owned by one or more of the KPMG International entities. KPMG International entities provide no services to clients. All rights reserved. Central bank digital currencies: 5 Which way forward? Bitcoin and other altcoins have been around for more than a decade now, yet they haven’t replaced traditional currencies, money systems and banks. Nor could they have done, given their inherent nature. They remain a minority affair, an avant-garde phenomenon.

We no longer even regard Bitcoin and alternative to cash, CBDC would Squaring the circle? altcoins as cryptocurrencies, because maintain the direct link between the for the most part they don’t meet the end users of money (households Trying to create an electronic alternative definition, or any of the traditional and firms) and their central bank. to cash can seem like squaring the features, of money. Instead, we treat Normal bank deposits do not perform circle. Cash is materialized and totally them as a special category — crypto- this role, despite also being digital anonymous, whereas digital money is assets.2 Their biggest benefit for the records consisting of zeros and dematerialized and extremely difficult mainstream system has been that ones. There is always a third person or even impossible to circulate entirely of intellectual stimulation, spurring between the depositor and the central anonymously — which has kicked off us to think of money in a new and bank — a commercial bank, often a a large debate about the technological different way. private one. The differences between infrastructure on which to base CBDC. cryptocurrencies/crypto-assets, bank Inspired again by crypto-assets, some One of the key consequences of this deposits and CBDC were neatly central banks are considering using stimulation is the concept of Central illustrated by Morten Bech and Rodney distributed ledger technology (DLT), a Bank Digital Currencies (CBDC), Garratt in their influential and still much more general version of blockchain, but which has been under development cited article.3 one that has little in common with the for years. Intended as an electronic original blockchain created for bitcoin

t te Central bank liabilit anne ied

Commodity money Cash Reserves Crt aet CC itcin etc Bank Cash deposits nierall Bank acceible account lectrnic eerteer lectrnic money

Source: Bech, Garratt

2 This definition has been established by key international authorities like the Bank for International Settlements (https://www.bis.org/bcbs/publ/d490.pdf), or the Financial Stability Board (https://www.fsb.org/wp-content/uploads/P160718-1.pdf). 3 Bech, M., Garratt, R.: Central bank cryptocurrencies, BIS Quarterly Review, September 2017, based also on Bjerg, O.: Designing New Money — the policy trilemma of central bank digital currency, Copenhagen Business School Working Paper, June 2017; and Committee on Payments and Market Infrastructures: Digital Currencies, November 2015. 10 Creating a leading central bank

© 2020 Copyright owned by one or more of the KPMG International entities. KPMG International entities provide no services to clients. All rights reserved. by the mythical Satoshi Nakamoto. The forms of payment are booming. A notary node which, as an authority, original blockchain was designed as a representative of the first category is assists in verifying token transactions. completely public and open network Sweden, where the share of cash in It’s a two-tier system in which e-krona where transactions are verified through the stock of money has fallen below are issued to commercial banks in the a complex, slow and energy-intensive 2 percent. The Swedish central bank, first tier and distributed to end users in process of decentralized approval based the Riksbank, was one of the first to the second. The pilot is to test whether on economic incentives for ecosystem start experimenting with CBDC. This this non-anonymous mechanism can participants (known as “miners”). February, just before the outbreak of work as a cash substitute. Central banks are not planning to use the COVID-19 pandemic, it initiated a an open, public and fully decentralized pilot for its own CBDC, the “e-krona”. 4 The Chinese approach network, and it seems that DLT is This token system — based on the being employed rather to enhance company R3’s Corda DLT platform — A representative of the second the technological attractiveness and offers a parallel infrastructure to the category is China, where the number innovative image of CBDC. No wonder, existing payment system. It’s a very of mobile payments increased 36-fold then, that no fully functional CBDC has long way from the original blockchain, between 2013 and 2018 (from 1.7 5 been rolled out to date, even after years as it is a closed system fully controlled billion to 61 billion) and platforms of intensive work. by the central bank. The central bank such as Alipay and WeChat Pay have alone decides who gets to participate become technological leaders in the The Swedish model in the system. Payments are made field. The Chinese central bank is through a digital wallet installed as an therefore developing and — this year — Not surprisingly, the CBDC front- app on a mobile phone or PC. As the piloting its “digital currency electronic 6 runners are either countries where following figure shows, the Riksbank payment” project, known as E-CNY. traditional cash is rapidly disappearing runs the network, but transactions This, too, is a two-tier system, one in from circulation and central banks are are made between the participants which new renminbi — forming a cash therefore losing seigniorage income, themselves, each of which has their complement not a cash replacement — or countries where new electronic own node. The system also has a are distributed through banks. It again

nd er $ $ $ $ $ $ igital allet

Merchant

Withdrawal/ Deposit/Payment Issue/Redeem Participant Participant Participant Transfers Node Node Node e-krona network connections

ikbank de Notary Node e-krona network

Source: Riksbank ikbanken

4 The Riksbank’s e-krona pilot, Sveriges Riksbank, February 2020. 5 Rtail CBDCS — The next payments frontier, OMFIF, London, 2019. 6 Wilson, K.-A.: China’s next world-first, OMFIF Daily Commentary, London, 7 July 2020.

Creating a leading central bank 11

© 2020 Copyright owned by one or more of the KPMG International entities. KPMG International entities provide no services to clients. All rights reserved. takes the form of an e-wallet app, A key area of innovation — designing CBDC infrastructure although in this case the e-renminbi based on state-of-the-art principles, visually resembles the existing Despite this progress, CBDC may respecting the requirement for banknotes as faithfully as possible. The seem to be jinxed by the problems transparency, operational resilience system contains a range of regulatory mentioned at the start. Driven by the and tokenisation on one side and vogue for DLT, to sceptics it sometimes elements whereby the central bank scalability plus interoperability on the might appear to be a solution seeking a limits transaction numbers and other volumes and there will be mechanisms problem. to limit the amount or to slow down the — defining necessary and desirable speed of E-CNY withdrawal to avoid Nonetheless, it’s a key area of regulatory and supervisory CBDC innovation in central banking, and the risk of a sudden outflow of funds. infrastructure elements Like cash, E-CNY will be non-interest KPMG firms are prepared to provide bearing. According to the central bank, consultancy in the following areas: — performing the data analytics the system will be in “controllable necessary for the correct calibration anonymity” mode. E-CNY will be rolled — advising on the current state of of CBDC pilots. out more widely after it has been the conceptual, technological and piloted under limited conditions. technical debate on CBDC in key countries Case study

Helping to investigate alternatives KPMG’s Central Bank network professionals supported a European central bank in its effort to examine the pros and cons of the current monetary system of elastic money, and the ways that central bank and commercial banks interact in the existing monetary framework against the backdrop of the last financial crisis. Moreover, KPMG experts helped to analyze some alternative systems, their features and also practical challenges that would need to be addressed should the core of the banking system be remodeled along an entirely new set of principles of money creation.

12 Creating a leading central bank

© 2020 Copyright owned by one or more of the KPMG International entities. KPMG International entities provide no services to clients. All rights reserved. Cyber security in a digital 6 financial services landscape How central banks are transforming their posture to deal with cyber risks in the financial services system.

Like all organizations, central banks expectations of counter-parties, the can better identify, investigate and are heavily reliant upon technology general public, management and data respond to incidents in order to limit and for operational continuity. A reliable, protection requirements. reduce the impact of undesired events. uninterrupted process gives the Central banks work closely with central bank, the government, financial How the KPMG Central Bank commercial banks and other financial market counter-parties and the wider network can help institutions and engage outsourced population confidence that transactions commercial service providers to KPMG firms’ network of Central Bank (increasingly in real time) will proceed enhance operational efficiency and professionals can assist by developing smoothly. Those central banks that effectiveness. These relationships a clear digital strategy that fully oversee commercial banks’ payment often require the exchange of sensitive supports central banks’ objectives systems need to have the necessary information and connection to external and which places a greater focus on skills and IT and reporting structures in systems that introduce an assortment the economic and business impact place to identify systemic risks. of risks. An external party’s failure to of technology. With organizational The risks are increasing, with new restrict access to its IT environment continuity as a key objective, the threats and attacks targeting several could render connected central bank main risks facing organizations are banks worldwide in recent times. The systems vulnerable to intruders. addressed. As trusted advisors to current COVID-19 crises has exacerbated governments and industry around Several initiatives have started to this risk. Customers who were originally the world, the KPMG Central Bank demonstrate commitment to cyber- reluctant to adopt online banking found network helps to find creative and security risk management and to provide themselves with few alternative during forward-thinking ways to address cyber ways to reduce central banks exposures. lock-downs. security and enhance internal controls For example, The Bank for International during the digital transformation. This Banks have transformed their businesses Settlements (BIS) has carried out includes: models. Not only by enhancing important initial work in this area over the services such as cashless payments past 2 years. The European Central Bank — establishing digital and technology and transactions, but also through the has recently started to collect information strategies adoption of technology like APIs and from 18 of the Eurozone’s biggest banks, artificial intelligence to interact with which will be obliged to inform regulators — project management, vendor customers and provide new offerings. of ‘significant’ cyber attacks, the main selection and system testing Central banks face the challenge to objective being to identify trends and — carrying out business process establish additional methods to identify to inform banks of possible impending reengineering and recommending and protect the banking system against events. new IT infrastructure and cyber threats and to detect, respond to Given the highly sensitive nature of applications for existing and new and recover operations during or after central banks, any kind of negative payment systems cyber security incidents. incident could attract unwelcome Organizations can no longer rely publicity and undermine trust and — assessing and developing strategies on traditional techniques to protect confidence. Therefore, management to mitigate external party risk themselves adequately against new will be keen to develop strong — carrying out digital risk threats because the attackers know defenses against external threats. assessments, including full cyber what works. There are state and non- The KPMG Central Bank network has security transformation assistance state actors present who possess assisted central banks in developing a significant resources to create complex preventative approach to protect the — evaluating and improving controls attacks, which are neither easy to digital environment. With improved threat over insider trading, money detect nor contain. The sophistication detection, security analytics and response laundering and procurement. of attacks is increasing, along with the capabilities in all digital initiatives, banks Creating a leading central bank 13

Transforming core banking services Over 3 years, a team of professionals from the KPMG Central Bank network worked closely with the central bank in one of the largest developing economies to produce a step change in efficiency, improving transaction processing, introducing real-time reporting, internet banking for customers and automated settlements and enhancing liquidity management processes. The team led the business process reengineering, helped with tenders and subsequent vendor evaluation, contracts and service level agreements and project managed the transition. The client now provides a far more effective core banking service to its stakeholders, with better funds flow.

A step change in IT performance Through an understanding of the unique challenges of IT in central banking, along with the KPMG Central Bank network’s commercial banking experience, the KPMG Central Bank network team was able to help a major European central bank with a wide range of important programs. The KPMG Central Bank network team worked on IT strategy (including infrastructure architecture), IT management (such as process optimization and IT compliance) and systems design. The central bank now has a far more comprehensive reporting and analysis capability and greater confidence in managing the monetary infrastructure, with higher levels of resilience, continuity and security.

Providing cyber security assessments KPMG in Qatar was selected by the central bank of Qatar to conduct a cyber security maturity assessment (CMA) across the banking sector. Working with the support of KPMG in India, the KPMG Central Bank network team worked closely with the Qatar Central Bank to design a framework for the assessment that comprised leading cyber security standards. All banks were individually assessed across various parameters and each bank was then provided with a view on their CMA, and a holistic view across the banking sector was provided to the central bank with recommendations and a roadmap.

Providing cyber security transformation KPMG in Brazil has been working together with complex clearing organizations, helping clients transition from a reactive to the proactive operating mode required for transformative change. The KPMG Central Bank network team assists clients to manage technological and system vulnerabilities and to address the core people processes, culture and behaviors related to the cyber security posture needed to properly manage cyber threats and risks. By bringing together specialists in information protection and business continuity, risk management, organizational design and digital, KPMG’s Central Bank network team tailors strategies relevant to our clients. Using their extensive experience, they were able to design, structure and implement programs that deliver sustainable benefits.

Benchmarking the central bank’s cyber security Cyber risks are a top priority for many central banks, not only due to the criticality of central bank systems and the high confidentiality of their information, but also due to the rapid rate of evolution of new cyber weapons. One of the world’s major central banks engaged a team from the KPMG Central Bank network to review and benchmark its processes and controls to manage cyber risks. The results showed the board that the bank was indeed up to the extremely high standard expected of a central bank, but also provided some recommendations to further optimize the internal controls and processes.

14 Creating a leading central bank

© 2020 Copyright owned by one or more of the KPMG International entities. KPMG International entities provide no services to clients. All rights reserved. Supervising stability and 7 regulatory compliance Central banks have been at the heart of discussions and new rules on regulating and supervising commercial banks.

Commercial banks face a huge increase of other countries when managing How the KPMG Central Bank in regulatory demands for liquidity, capital international financial crises and network can help requirements, recovery and resolution overseeing multinational groups. planning and customer-centric operations. Operating in firms throughout the world, Regulatory oversight has taken on Not surprisingly, many struggle to cope KPMG Regulatory Centers of Excellence new urgency in the wake of the global with the organizational and cultural offer telling insights into the implications financial downturn and central banks change and the associated reporting and of regulatory change and the direction want to be confident that they can data aggregation requirements. of developments around the world, perform this task competently, spot including Basel III, Solvency II, EU Central banks often have regulatory systemic or institutional weaknesses initiatives and the Dodd-Frank Act. This and supervisory authority over financial and reassure financial markets. expertise is invaluable in: institutions to ensure they are safe The recent crisis demonstrated starkly and operating in a stable financial — improving regulatory supervision, environment, to retain the trust of the need for stability in the economy, the currency, the financial sector and within to ensure that commercial banks customers and the wider financial adapt their structure, conduct and markets. individual financial institutions. Through monetary policy and macro- and micro- culture, data and reporting and risk Central banks may assess which banks supervision, central banks can steady governance (if any) pose a risk to financial stability the economic conditions. To achieve — providing up-to-date knowledge and and work more closely with these this, they may also have to redesign their understanding of regulatory changes institutions. They also coordinate with internal processes and systems. around the world. central banks and financial supervisors Case study

Getting up to speed with Basel Basel compliance is a critical objective for all commercial banks and an emerging markets central bank asked the KPMG Central Bank network team to carry out a comprehensive training program for all the country’s banks. KPMG’s Central Bank network professionals prepared and delivered country-specific training, covering necessary reforms, risk management and regulatory reports. Through a mix of classroom and breakaway sessions, the participants helped to provide far greater confidence in the banks’ ability to meet the new standards.

Creating a leading central bank 15

© 2020 Copyright owned by one or more of the KPMG International entities. KPMG International entities provide no services to clients. All rights reserved. Transformation: Building a high- 8 performance organization Increasing quality and efficiency with a view to becoming a high-performance and innovative central bank.

Central banks need to stay ahead long-established work culture (some over To help clients predict and avoid these of the financial ecosystems in their many decades) impacting its employees. pitfalls, the KPMG Central Bank network countries by embracing the dynamics Any transformation and change requires has a core set of project managers and of new technologies and current tailored change management initiatives. directors who work with all of KPMG’s working trends. To achieve its strategic service networks to assemble the objective, a central bank needs to How the KPMG Central Bank right team, the right approach and the ensure it is fit for purpose and has the network can help right delivery capability for any given higher motivation to move forward. transformational project or program. KPMG firms’ network of Central Bank In order to achieve its higher purpose professionals provide the understanding — Conduct macro and micro of a motivated organization, the central and insight to help central banks organization design. bank needs to place the transition of effectively navigate the transformation — Develop job grading and the institution as a priority program. journey and help avoid the major causes remuneration framework. A key objective is to build a human of failure. resource framework that has the — Prepare job description, and leadership skills to follow through the Most transformations are relentlessly workforce analysis. strategic values of the bank. complex whether they involve rolling out an incubated business, undertaking — Prepare change strategy and plan. Transforming a central bank is always a major operating model upgrade, or a challenge, as it traditionally has a implementing major organizational reform. Case study

An organization fit for purpose A central bank in a high-growth market embarked on a transformation program to increase its quality and efficiency and to be the most innovative central bank in the region. A team of professionals from the KPMG Central Bank network assisted the bank to validate its strategy and translated that into an organization design blueprint, which includes the enhancement of their operating model and recommendations for job profile, job level and FTE analysis to ensure the right people are at the right place in the right number. The team also helped the bank to review the existing job grading and remuneration system and enhance it to ensure the criteria and weightings match the needs of the bank and that it is fit for purpose to support the execution of the bank’s strategy of transition to a high-performing culture. The central bank’s governance framework was also enhanced by the KPMG Central Bank network team. The work included decision-making authority and reporting lines to ensure the governance framework facilitates the implementation of a robust review mechanism and promotes transparency in decision-making.

16 Creating a leading central bank

© 2020 Copyright owned by one or more of the KPMG International entities. KPMG International entities provide no services to clients. All rights reserved. Implementing International Financial Reporting 9 Standards (IFRS) The harmonization of financial reporting across the globe is already a reality for most countries — following or converging to International Financial Reporting Standards (IFRS).

The convergence of central banks How the KPMG Central Bank — benchmark with peers on accounting has been much slower, as illustrated network can help practices, reporting models and in the accompanying diagrams. The finance function primary reason is that IFRS have been KPMG firms’ network of Central Bank — development of accounting manuals developed with the main objective of specialists have extensive experience responding to the necessities of capital in assisting central banks worldwide in and procedures related to the markets and investors. This does not transitioning to IFRS. KPMG’s Central preparation of financial statements perfectly match the requirements of Bank network professionals have a and disclosures central banks, due to some specific unique blend of skills and long-standing — transforming and optimizing the reporting challenges of IFRS such as: experience in IFRS, the Eurosystem finance function Accounting Guidelines and other — Technical accounting issues: recognized standards. Our experience — adjustment to accounting systems — foreign exchange revaluation enables us to recommend approaches in order to bring them to compliance for virtually any challenges that an with IFRS — unrealized gains/losses and fair IFRS conversion project may bring value measurement to a central bank. — extensive training programs delivered to the finance department — gold accounting and reporting An IFRS conversion project encompasses of central banks. — cost of production of banknotes several components and perspectives: and issue of banknotes — diagnostic and assessment of KPMG Central Bank — special economic/financial IFRS transition impacts and network professionals assistance programs recommendations on potential have collaborated with measures to mitigate significant and — provisions and pension liabilities. central banks across the unwanted effects — Disclosures requirements, namely: world in IFRS matters: — solving specific technical hallengesc — IFRS 7 and cash flow statements related to complex transactions and — Bank of Portugal specific issues that affect central — significant management — Central Bank of Kosovo banks estimates and uncertainties — Nacional Bank of Angola — potential impact on the financial — related party disclosures. positions and statements of — Central Bank of Nigeria — Consistency with the central bank performance of central banks — the — Bank of Mozambique law and distribution of realized/ adoption of IFRS 9 requires detailed unrealized gains. assessment of financial, operational — Central Bank of Banco Cape and market impacts. Verde — Independence of the central bank. — recommendations to help ensure — Central Bank of São Tomé e compliance with central bank laws Príncipe and regulations as well as with — Nepal Rastra Bank reporting requirements to other organizations (such as the IMF)

Creating a leading central bank 17

© 2020 Copyright owned by one or more of the KPMG International entities. KPMG International entities provide no services to clients. All rights reserved. Dynamic Risk Assessment (DRA): Is it possible to predict the 10 impact of a crisis like COVID-19? The recent incorporation of increasingly rigorous mathematics into the science of economics has turned financial mathematics into a separate branch of learning, and has enhanced the quantification and measurement of risk.

Our existing human-economic network Staying connected require human ingenuity and financial is being challenged by a viral pandemic resources. And that, in turn, requires network. Indeed, COVID-19 is One answer lies in virtualization. institutions and business to keep essentially a network distributed threat Fortunately, recent years have seen functioning – responsibly – and in that has piggy-backed on our human a plethora of virtual tools emerge keeping with local health and safety and economic networks to wreak into the enterprise environment. requirements. havoc on global trade and capital. They include mobile hardware such as smartphones and laptops; digital Understanding the risks Until a medical breakthrough is tools like virtual meeting and sharing achieved, it seems the only way to forums; new communications models As the pandemic evolves, stakeholders break the viral network is by breaking that combine web conferences, are starting to ask tough questions the favorable, human-economic facetime and conference calls; and about the organization’s governance networks that it thrives on. We deny new workplace models that include and risk management. Having now the virus the ability to spread by long distance learning programs and suffered a ‘black swan’ event, reducing our ability to interact – we established work from home policies stakeholders will want to ensure the restrict freedom of movement, curtail and supports.While the virtualization organization will be better equipped the personal and physical interactions and of human interactions and networks next time. reduce shared human experiences – has served many businesses well essentially removing the human touch during the initial phases of the Boards will be asking management points. pandemic, few business leaders feel for clarity on their supply chains’ this is the optimal approach for the interlinkages and for assurance on The problem is that these human and long-term. Productivity losses have their resulting networking resilience. economic network activities are the been experienced along the way. The Finance Function will be seeking very core of what underpins modern And many are noting the unravelling to understand the weaknesses in (and day businesses’ supply chains and of some of the network effects and dependencies on) counterparties, workforces – indeed, the very essence productivity gains they had enjoyed credit and cash flows, as well as of how they operate.The big challenge through the centralization of business contemplating a revised approach facing businesses today, therefore, activities in major city centers. to investment and capital allocation. is how to preserve these beneficial The Chief Risk Officer (and the human-economic networks when Of course, given the alternative – Board Committee to whom they we need to destroy them in order to allowing the business to grind to a halt report) will question whether the prevent COVID-19 from spreading. and relying on government assistance risk methodologies and Business Simply put, how do we stay connected or insurance pay-outs that may or Resumption Plans are best-of-breed when we have to isolate? may not carry the business through and fit-for-purpose, and whether they the crisis – virtualization is preferable. make allowance for the networked Indeed, overcoming COVID-19 will dimension of risks.

18 Creating a leading central bank

© 2020 Copyright owned by one or more of the KPMG International entities. KPMG International entities provide no services to clients. All rights reserved. In essence, the inter-relationships and COVID-19 is a network distributed aggregate outcomes, and those co-dependencies between all factors threat. And its current mitigation individually benign risks that are Dynamic Risk Assessment (DRA): of production – including the impact of requires the fragmentation of our unlikely to trigger severe aggregate the socio-economic environment – will beneficial networks. DRA provides combinations of risks. need to be identified, understood and businesses with a unique, expeditious Is it possible to predict the managed as a networked, complex and network-illuminating and informing These insights are helpful in assessing adaptive system. process to help them act quickly and a bank’s resilience: cost-optimally in the face of today’s See the linkages network based-challenges. — the most likely future combinations impact of a crisis like COVID-19? of risks present the combinations KPMG Dynamic Risk Assessment How the KPMG Central Bank of risks to be tested in scenario (DRA) helps businesses quickly network can help analyses identify the relationships and inter- dependencies that need to be — potential future tail events inform KPMG firms have spent over 15 years capital adequacy and liquidity addressed; be it in their supply-chains, developing and enhancing Dynamic management assessments business environments (ecosystems) Risk Assessment (DRA). or chosen strategies. — the combination of future risks that The methodology identifies future DRA leads to a deeper understanding present the greatest systemic risk to risks, including unprecedented risks, organizations inform the individual of how a business operates within which result from combinations risk combinations to be tested and an ecosystem. It highlights the of individual risks (i.e. recognizing assessed for disaster recovery and critical flows that require major focus their interconnectedness and causal business interruption(s) and uncovers the opportunities relationships to other risks), future and vulnerabilities hidden in its potential tail events, the opportunities — and the opportunities to be found in idiosyncratic configurations. In the to be found in systemic risk networks systemic risk networks are helpful current environment, these ‘wins’ can and the combination of discrete risks in obtaining an understanding of the help organizations off-set some of that present the greatest systemic optimum order in which individual the efficiency losses that came from threat to organizations. It also reducing and virtualizing human touch risks are to be mitigated (i.e. distinguishes between individually optimizing the mitigation spend/risk points. benign risks that can trigger severe reduction outcome). Case studies

KPMG’s Central Bank network assisted a reserve bank in identifying and quantifying the consequences of expected future combinations of unprecedented risks, the identification of future tail events, combinations of individual risks that can undermine the credibility and reputation of the central bank and the individually benign risks that are scientifically likely to combine with other risks to produce severe aggregate outcomes.

The central bank used these insights to identify potential root causes to discrete but interconnected risks, identify the controls for the prevention, detection and remediation of these controls and to assign first, second and third lines of defense responsibilities to each of these.

Periodic reporting to the board was refined by decreasing the cadence of reporting on unconnected and individually benign risks, and increasing the frequency of reporting on individually significant and/or highly connected and/or high- velocity risks.

KPMG assisted a national securities regulator in identifying its strategic priorities and the future areas where it can make the biggest difference/contribution to society and the economy. DRA also identified the scenarios potentially most detrimental to the future economy, allowing realistic and practical scenarios and stress testing to be formulated, and response plans to be developed in advance. Future risks were stratified into contagious and more isolated risks, to be regulated accordingly.

Creating a leading central bank 19

The KPMG Central Bank network brings major financial market players, regulators KPMG’s Regulatory Centers of together knowledge and experience and leading industry bodies. Excellence help drive and shape from its specialists around the world the latest regulatory developments to help central banks deal with their KPMG Central Bank network and provide cutting-edge advice and unique challenges. specialists engage closely with central support in supervising compliance. banks around the world, advising them For central banks in fast growing The KPMG Central Bank network has and providing input on key strategic economies, our Financial Services a wealth of industry experience and challenges. In addition, the practice’s Growth Markets Network champions specialist knowledge, tapping into a steering group regularly considers new innovations and coaches and global network of audit, tax and advisory emerging issues and studies central challenges financial institutions and services. KPMG’s Central Bank network bank accounting practices through their regulators on strategies and has worked with central banks in mature benchmarking studies and other operations. and emerging economies and has thought leadership publications. close relationships with many of the Additional KPMG publications

Creating a world-class central bank Creating a world class central bank September 2018 December 2016 Creating a Creating world-class a world central bank class Fourth edition central Central Bank network September 2018 bank

Central banking erice Financial Services

For internal use only eceber

KPMG International KPMG International

kpmg.com/centralbank kpmg.com

Governance of central banks Peer analysis: Predicting supervisory Governance of August 2018 challenges Peer Analysis: May 2016 central banks Predicting Taking financial oversight to the next level Supervisory Challenges

aking te rigt deciin KPMG International

May 2016 August 2018

kpmg.com kpmg.com/ifrs

Creating a world-class central bank Evolving banking regulation part five February 2016 Creating a August 2017 world-class central bank

Third edition

Central Bank network

August 2017

KPMG International

kpmg.com/centralbank

20 Creating a world-class central bank

Global Chairman Financial Services Head of Global Banking & Capital Markets Jim Liddy KPMG International Judd Caplain T: +1 212 909 5583 KPMG International E: [email protected] T: +1 212 872 6802 E: [email protected] KPMG’s Central Bank network Chair Ricardo Anhesini Kim Lawry Venkataramanan Vishwanath KPMG in Brazil KPMG Australia KPMG in India T: +55 11 2183 3141 T: +61 2 9455 9541 T: +912239896000 E: [email protected] E: [email protected] E: [email protected]

Mark McFaddin Pascal Brouard Yael Selfin KPMG in the US KPMG in France KPMG in the UK T: +1 703 286 8725 T: +33155686996 T: +44 207 3112074 E: [email protected] E: [email protected] E: [email protected]

Mojmir Hampl Anthony Withers Network Coordinator KPMG in CEE Region KPMG in the UK Gayatri Devi T: +420222123376 T: +44 207 3115250 KPMG Global Financial Services E: [email protected] E: [email protected] T: +44 207 3115365 E: [email protected] Omar Mahmood Vanessa Yuill KPMG in Middle East Region KPMG in South Africa T: +974 44576513 T: +27 11 647 8339 E: [email protected] E: [email protected]

Sheldon Gunn Carla Scoca KPMG in Canada KPMG in Switzerland T: +1 613 212 2893 T: +41 58 249 30 19 E: [email protected] E: [email protected]

Creating a leading central bank 21

The information contained herein is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavor to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act on such information without appropriate professional advice after a thorough examination of the particular situation. ©2020 Copyright owned by one or more of the KPMG International entities. KPMG International entities provide no services to clients. All rights reserved. The KPMG name and logo are registered trademarks or trademarks of KPMG International. Designed by Evalueserve. Publication name: Creating a leading central bank Publication number: 137135-G Publication date: November 2020