of this century there were only 18 central banks. the usa managed without a central bank until 1913. private banks issued their own currency notes and coins and banking crises were fairly frequent. the federal reserve bank of usa was established mainly to supervise banks and act as lender of last resort. today, only a few central banks, including fed reserve is still responsible for bank supervision. others have handed this job to a separate agency. in the 1960 ’ s the conventional economic wisdom was that monetary policy could reduce unemployment and directly promote economic growth. the theoretical basis for this was provided by the famous phillips curve, which depicted an inverse relationship between inflation and unemployment in britain ; when unemployment was high inflation was low and vice versa. this appeared to have suggested that central banks could permanently reduce unemployment by tolerating a bit more inflation. in fact, many countries attempted to do so. we all have our experience in attempting to directly promote economic activities by releasing high powered money through various credit schemes and direct involvement in development activities. however, at the end we had more inflation, either visible or hidden, without an appreciable reduction in unemployment or improvement in growth. in fact, the rate of inflation associated with a given level of unemployment had risen through the 1970 ’ s and policy makers had to abandon the philip curve. this in fact was predicted by milton friedman and edmund phelps who challenged the phillip curve. as they pointed out, the trade off between inflation and unemployment was only short term. as soon as people come to expect higher inflation they would demand higher wages, and unemployment would rise again. there is no trade off between inflation and unemployment. in the long run, monetary policy could influence only inflation. today most central banks are concentrating their monetary policies on maintaining price stability ; and maintaining inflation at lower stable levels. john exter, founder governor of the central bank of sri lanka emphasized on the very first day of the establishment of the central bank, “ there is no financial wizardry by which the bank can suddenly pull out of a hat a higher standard of living for everybody. the bank ’ s contribution must necessarily be a long - run contribution. the bank does not itself produce goods and services, but it should, by creating the right monetary conditions enable the country …. to do so ”. central bankers would like very much to have the ability of a captain or a pilot who knows exactly where he is heading, how his craft ( i. e. economy ) works and how his actions affect it course

and the emerging global best practices of central banking. hence, it is a continuing learning and knowledge enhancement process for auditors of a central bank. by any measure, this is not a simple challenge. it is only with this superior knowledge base that auditors acquire the capability of making a proper risk assessment of a central bank and play their new role as a “ risk - alerter ” to the management and legislators. this requirement equally applies to both internal and external auditors of a central bank. the major risks faced by a central bank the policy failure risk, ( that is, the inability to maintain the stability of the value of the currency on a continuous basis ) and the associated reputation risk ( that is, the public no longer trusts the central bank and its action ) of a central bank are well known. but, a lesser known risk of a central bank is the “ insolvency risk ” which could loom over a central bank with or without the presence of the policy failure risk. in other words, a central bank can run the risk of being insolvent, even when it has been successful in maintaining the stability in the value of its currency. the insolvency risk of a central bank is less obvious, because of the very nature of a central bank. a central bank, even if its capital is negative and its currency liability is not matched by an equivalent value of foreign assets or valuable domestic assets, could still continue to be in business unlike a private organisation. in the case of a private organisation, if the net - worth is negative, it has to be re - capitalised as an urgent need. if it does not happen, it cannot operate as a going concern and has to be liquidated on the ground of insolvency. however, a central bank can still operate with a negative net - worth, by continuing to issue currency as long as the members of the public are willing to accept such currency in exchange for the assets held by them. it could, in these circumstances, defer and hide the need for recapitalising itself and continue to be in operation. the fact that the insolvency of a central bank is not known to the outside world does not mean that a central bank is without problems. a central bank ’ s operations are smooth and faultless, if its expenses are funded out of net interest income it earns on its foreign reserves or its domestic asset portfolio. but, if it has to meet its day to