Mr. Padoa-Schioppa reviews his experience in central banking over the last
Text of the remarks by Dott. Tommaso Padoa-Schioppa, a Deputy Director General of
thirty years
the Bank of Italy, at the Governors' Dinner held in Basle on 7/4/97.
1. To have been invited to attend and address the Governor's dinner is a very
great honour for me as I step down from the chair of the Basle Committee and leave the community
of central bankers.
When Governor de Larosière proposed my name to succeed Gerry Corrigan, he
admitted, so I have been told, that my curriculum vitae was not that of a full-time bank supervisor.
Presenting this handicap as an advantage, he suggested that my previous involvement in a variety of
central banking activities could be useful because of the growing interaction between monetary
policy, payment systems and banking stability. You were generous enough to accept that view. That
was an act of confidence. As words like confidence, trust and credibility are the very essence of the
vocabulary of banking, I am deeply grateful for the confidence you granted me four years ago.
2. In view of my mixed background, I shall focus on central banking, rather than
just banking supervision, and try to sum up what I have learned and what I have witnessed over the
last thirty odd years: first about the tasks of central banking and then about the context in which such
tasks are performed.
3. A person of my generation is inevitably struck by the difference between
what he was taught at university in the sixties and the reality he faced in the two following decades.
In the lecture room central banking had just one pole, monetary policy. In the real world I found it
was triadic, as monetary policy was combined with involvement in the payment system and banking
supervision.
At the Bank of Italy, for instance, more than half the staff of just over 9,000 is
devoted to the operation of the payment system (the note issue, clearing systems, Treasury
inpayments and outpayments, interbank funds transfers, etc.); around 15 per cent is engaged in
banking supervision; less than 5 per cent is concerned with monetary policy. Although not all central
banks have primary responsibility for banking supervision, the three tasks are inextricably linked
because there is a close relationship between them and the three practically indivisible functions of
money as numeraire, means of payment and store of value.
Dealing with the complexities of triadic central banking has been for me both a
fascinating professional experience and an intellectual adventure bringing new insights nearly every
day.
4. Not only was monetary policy the sole task highlighted when I was a student,
but the word "monetary" was overshadowed by the word "policy". Monetary policy had always
existed, of course, but the rise of fiat money greatly increased the room for manoeuvre. The central
banker came to be seen in the fifties and sixties as a demiurg able to choose between inflation and
unemployment, and to do so almost on a quarter-by-quarter basis.
So delicate and powerful was the policy choice entrusted to the central banker that he
could not be left to make it alone. Few central banks were truly independent. The intellectual
paradigm that followed the demise of the Gold Standard, with its emphasis on discretionary goal
setting, implicitly suggested that elected politicians should have the last word. Future historians will
perhaps see this view of the role of central banks as having characterized only two or three of the
twenty or so decades of their modern history, which began when convertible paper superseded coins
as the main means of payment.
5. After a long period of neglect, payment systems have gradually returned to
the centre of the stage. When advances in data processing and telecommunications brought a new
revolution, we suddenly realized how much our monetary institutions, practices and even theory
owed to the previous revolution. Until the eighties the term "payment system" was almost completely
absent from central bank reports. Today, there are many who argue that monetary policy functions
would not have developed in the way they did without the first revolution in payment technology.
The raison d'être for central bank involvement in payment systems is to avoid, or at
any rate minimize, systemic risk, while fostering their efficiency through an appropriate blend of
cooperation and competition in the industry. Is there also a policy, or even a political, dimension?
Perhaps not. The issue of central bank independence would be a much less burning one if only
payment system tasks were considered. And systemic risk itself could become much less important in
the years to come with the shift from net to gross settlement that new technologies are making
possible. It is possible that payment system issues will move to the back of the stage again once
appropriate arrangements are in place to cope with the new technological environment.
6. Chronologically, if not logically, the task of supervising banks came after that
of running the payment system and before the advent of fiat money and discretionary monetary
policy. From a monetary angle, it was the consequence of the spread of deposit banking, which
ultimately resulted in bank money accounting for the bulk of the money stock. Runs on deposits can
be seen as collapses of confidence about the stability of the rate of exchange between a unit of central
bank money and a unit of commercial bank money. Commercial banks had to have sound
fundamentals if one-to-one convertibility was to be preserved hence, the need for bank supervision.
In the short run interventions, i.e. lending of last resort, could be - and was - used to support the rate.
But, as in the more familiar case of foreign exchange interventions, they were no substitute for sound
policies; credit provided too easily and too generously could even generate the risk it was meant to
avoid; today we call it moral hazard.
The ambivalent relationship between supervising banks and lending to them
(surveillance and conditional lending, in IMF language) explains why there is no clear-cut answer to
the question whether the central bank or a separate agency should be responsible for supervision.
Seven of the twelve Basle Committee countries have a separate agency, as against about 10 per cent
of countries in the world as a whole. More importantly, even where this solution has been adopted,
the centrality of the banking system, and of its money creation prerogatives, in the monetary policy
transmission mechanism means that no central bank disregards the "state of health" of its banks or
completely rules out lending of last resort in extreme circumstances.
7. The other, perhaps more important, change concerns the context of central
banking. This can be seen in terms of both time and space. I began my career in a world of annual
accounts and quarterly or monthly statistics, in which paper was the medium and mail the carrier. For
the bulk of financial transactions the two parties, the intermediary, the currency of denomination, the
relevant laws and courts, and the central bank all belonged to the same jurisdiction. And that
jurisdiction was not only economic, as it included the political jurisdiction from which public
institutions derive their legitimacy through the democratic process. This simple description never
fully coincided with the state of the world, of course, but twenty-five years ago it was still a workable
approximation. Today, that is no longer true. The advance of data processing and telecommunications
technology has been the most powerful single driving force of this change. But the low cost of
transportation, the evolution of economic ideas, the desire for closer and more peaceful relationships
among nations have also been crucial.
8. The time dimension of our world has shifted from the long and medium
waves of the year and the quarter to the short and micro waves of the day and the intra-day. The
direct credit controls many of our countries still used ten or fifteen years ago called for compliance at
the end of the month, as did most other prudential requirements. Payment finality at the close of the
day, achieved through clearing and settlement in central bank money rather than correspondent
banking, was considered sufficient. Monthly figures (not monthly averages of daily data) were
judged adequate for the purpose of computing compulsory reserves. The exchange rate and other
prices were "fixed" once a day.
The reality of the monetary and financial world is becoming that of the intra-day, the
micro wave; we are moving towards a continuous-time economy. We do not yet have markets for
"one-hour money", real-time accounting and reporting, and other similar devilries. But they will
come. The Basle Committee has stated that "although regular reporting will in principle take place
only at intervals (in most countries quarterly), banks are expected to manage the market risk in their
trading book in such a way that the capital requirements are being met on a continuous basis. i.e., at
the close of each business day". Naturally, cost considerations will set a limit to the process, but the
effects will be - and to some extent already are - sufficient to upset many of the operational and
regulatory instruments on which central bankers rely. Indeed, market players have so far been much
more at their ease in the new microcosm than public authorities.
9. As regards the space dimension, markets have grown bigger than
jurisdictions. A single transaction is now likely to involve a multiplicity of "nationalities" in terms of
currencies, players, authorities and legal systems. We used to regard the "State" as the universal
container providing the grounds and the rules for the game played by profit-driven players. Today,
we sometimes have the impression that no one is responsible for maintaining the grounds or making
the rules and even that central banks are the balls some round, some oval - being hit or kicked around
in a free-for-all of baseball, golf, cricket, soccer, rugby and American football.
10. Even the most independent, best equipped and highly reputed national central
banks are hard put to perform their triadic task effectively in the new conditions of time and space.
The new context has been created by the market, evolves in response to market forces and basically
meets the needs of private interests. It is a creature of the market much more than of public
authorities.
Partly because of this evolution central banks and governments have become much
more respectful of market forces, even humble. They are much more conscious that wealth and
welfare are created primarily in and by the market. They know that this is a much more powerful
beast than its would-be tamer. The effectiveness of both the instruments on which central bankers
rely - banking operations and regulatory provisions - have been eroded by the innovation in market
practices and the blurring of national frontiers.
To some extent this is healthy. Market players are not there to serve us, we are here to
serve the economy. Yet, this downsizing of our role should not be carried too far. There is still a
public interest to be promoted that private actions cannot be counted upon to serve. There are still
grounds for being proud to serve the public interest and for claiming that central banks should have
the means to achieve their ends. The fact that markets are powerful, global and fast-moving, while
central bank operations and regulations are national, intrusive and burdensome, does not mean the
monetary system can do without a central bank or a bank regulator.
11. Basle, the BIS, the meetings of the community of central bankers, from the
Governors down to junior officials, are where our profession has strived, largely successfully, to
maintain the upper hand over the reality that calls for its public function. The task is being performed
notwithstanding the wide diversity of national laws, traditions, operational practices and institutional
constraints.
I am a convinced institutionalist, because I believe that without a "Rule of Law"
liberty and peace - the key prerequisites for economic activity - cannot survive for long. And my
basic training, as well as much of my professional experience, have been in the European arena,
which is a highly institutionalized cooperative system.
In international monetary cooperation Basle stands at the "soft" end of the spectrum
no legal basis, no written terms of reference, no extensive minutes. Mostly personal contacts and
work based on the key words of banking and central banking: confidence, trust, credibility,
confidentiality.
12. Although I started to attend BIS meetings well before this tower was
constructed (in the old hotel building of the Centralbahnstrasse), it was only when you called me to
the Basle Committee that I fully realized how strong this soft approach could be. Lawyers say that the
Basle Committee "does not legally exist". When I was appointed to its chair, my secretary had to take
my word for it because she could not find any written evidence of the decision. Yet the Committee
rules, once endorsed by you, are adopted by the markets, followed by national legislators and spread
to all countries worldwide.
When considering the working methods of the Basle Committee, I have often thought that
international cooperation among central banks can be compared to Italo Calvino's "Nonexistent
Knight". When Charlemagne, reviewing his paladins before the battle against the Infidels, reached
the last knight, Agilulf, clad entirely in white armour, the cavalier refused to show his face to the
emperor. The explanation he gave was simple: "Sire, because I do not exist". Charlemagne insisted
and when the knight finally raised his visor, the helmet was empty. "Well, well! Who'd have thought
it!" exclaimed Charlemagne. "And how do you do your job, then, if you don't exist?". "By will
power and faith in our holy cause!" said Agilulf. He fought with valour and bravery. His special
status assisted him in the accomplishment of his duty and indeed he proved to be one of the best
paladins.