IDEAS AND TOOLS FOR CENTRAL BANKS

Why Change?

Central banks are often acutely aware of the specific political, economic and technological
challenges they face. What receives less attention is the underlying process of
organisation and management change. Is that risky?

(This text was published in 2005 by Central Banking Publications as Chapter 3 of Central
Bank Modernization. If you use or quote from this material please attribute it to the
author and publisher.)

Central banks are proud of their traditions and conscious of their pivotal roles in
economies and societies. From that platform of historic achievement and current
relevance, it is easy to conclude that central banks are an inherent and permanent
feature of the landscape. History teaches us otherwise.

This has been a central-banking century. The number of central banks has risen from
18 in 1900 to 172 in 1998. The world now has almost half a million central bankers. (The
Economist, 28 November 1998)

As that quotation demonstrates, the central banking industry has only recently
boomed, and from small beginnings. But surely central banks are strong and powerful
entities that are now here to stay? Not necessarily!

The first quarter of the 21st century saw central banking become a small, mature and
genuinely global industry. In developing economies, central banks either grew more
effective and efficient or disappeared. In more developed economies, central banks found
vigorous new roles or dwindled into historical curiosities. (Hypothetical economic history text, circa
2032)

This second quotation is not real. But it could be. How central bankers lead and manage
organisational change will be a key determinant in the futures they will create -- or fail to
create -- for their organisations.

So is the question even necessary?

Yes.

Change is not a natural process that automatically happens as and when it needs to. On
the contrary, people tend to build and operate routines in all aspects of their lives. The
usual response to any proposed change to those routines is resistance.

Organisations don't naturally change either. In fact an organisation can be defined as a

collective endeavour to standardise activity and thereby resist change. All too often the
reflex of resistance leads to denial of change needs, a lack of evolutionary change and a
mounting "change deficit". Ultimately the organisation bows to reality and changes, but
in a disruptive or even destructive way. It is no accident that despite all the best advice
on change planning and management, most organisations still undergo occasional rapid
change amid much longer periods of constancy.

Reshaping capability and performance to meet -- and ideally to anticipate -- external

pressures is a continuing challenge. The laws of evolution apply just as much to
economic and social organisms as they do to biological organisms. And in economics and
society, just as in biology:
It is not the strongest of the species that survives, nor the most intelligent that survives.
It is the one that is most adaptable to change. (Charles Darwin, the founder of the theory of evolution)

To convert that general statement about biology to a specific statement about central
banks, we might say that:

Those central banks that are prepared to actively take up the challenge of internal
change are the ones most likely to achieve continued relevance, independence and
influence in the 21st century. (Brian Lang, representing the Reserve Bank of New Zealand at the 2004
Currency Conference in Rome)

So the simple question Why change? has a simple answer -- change is essential to
survive and thrive. But we can be more specific than that. The direct benefits of
organisation and management change will vary, but they are likely to include:

Greater effectiveness -- better achievement of clearer objectives

greater efficiency -- achieving the same result with fewer resources
Lesser distraction -- stronger focus on core functions
Better decisions -- faster and more reliable choices between options
More time at the top -- improved delegation that creates more space for strategic
thinking and management
Stronger motivation -- staff who are more committed to more fulfilling roles
Increased innovation -- progressive organisations attract and keep creative people

Important indirect benefits can be attained too. Central banks often need to dispense
unpopular medicine. They frequently preach reforms of structural rigidity and vested
interests. The moral authority gained from "we practice what we preach" gives such
policy advice more weight.

The upside of organisation and management change sounds impressive. What about the
downside?

Change inevitably has costs as well as benefits, and the risks of change are far from
negligible. Organisation and management change can be a disruptive event that leads to
reputational damage, loss of institutional memory and reduced operational effectiveness.
So change needs thoughtful management to maximise net benefit.

That leads us to more specific questions.

What special issues do central banks present to the change leader and manager?
How can central banks reduce disruption, and change through evolution? How can
they stay ahead of the change curve, not just react?
What will drive change?
What type of change leadership and management will maximise benefits while
minimising costs and risks?
What is needed to begin?

This chapter will consider each of those questions in turn.

What are the special issues?

The unique histories of individual central banks can divert attention away from inherent
features of central banking. As a context for leadership and management change in
central banks, consider the development of a hypothetical central bank through "three
ages". (This concept was first developed in two articles by the author for Central Banking Journal. The articles
include a comparison of leadership and management practices typical of each age and diagnostic questions. They are
available at www.mendhurst.co.nz)

The founding role of a central bank its first age emphasises operations. That role is
a practical one of providing operational support to a national government and to the
institutions and individuals of a national economy. Specific central bank functions are
likely to include:

Issuance of circulating currency and collection of seigniorage

Inter-bank settlement
Banking services for the government and perhaps others
Management of fiscal instruments
Other operational services specific to the time and place

In that "first age", the priority is to be effective. Customers and stakeholders seek
predictability, consistency and reliability. The central bank is expected, indeed
encouraged, to operate as a bureaucracy -- in the positive sense of that word.

Internally too, the bank's practices will tend to favour predictability, consistency and
reliability. Organisationally as well as operationally, the central bank is likely to become
bureaucratic. A civil service culture that emphasises tradition, precedent, technical
knowledge and job security will develop. Less desirable cultural traits such as hierarchy,
conformity, dogma and form over substance are likely to emerge too. But those negative
aspects of a bureaucracy do not matter greatly. Command and control can deliver
effectiveness. The "managers" of a first-age central bank need only to be capable
administrators.

In its second age, a central bank will have new roles that require broader knowledge
and more sophisticated judgment. The banks direct customers, and its wider
stakeholders, now also require policy functions such as:

Management of the nations foreign reserves and exchange rates

Development and implementation of monetary policy
Regulation and oversight of financial institutions
Expert advice perhaps even decisions -- on economic development

New specialisms favour youth and education over age and experience. Market operations
require fast, frontline responses that cannot wait for hierarchical decision-making
processes. Effective oversight of financial institutions requires business skills and a
willingness to look beyond prescriptive rules. Diversity of opinion and free expression
become essential.

Bureaucratic first-age characteristics that once were strengths now become weaknesses.
A few "war stories" demonstrate the conflict between second-age challenges and first-
age leadership and management practices:

At one eminent central bank I asked why so many people with high management
rank but little management responsibility -- and only those people -- formulated
policy. I was told that it was important to have a wide diversity of views at the
policy table, and also important that all those at the table had a long internal
career first so that they "understood what was required". From other
conversations it became clear that there was in fact little diversity in policy
discussions. Younger staff felt powerless and shut out of the policy process.
Management failed to see that people who climb a narrow and hierarchical career
ladder are unlikely to have diverse views by the time they reach its top...
 At another central bank I asked why banking supervisors rarely visited the banks
they were individually responsible for. My question puzzled management -- all the
data came here, so what would be gained by such visits? I suggested that
intuitive impressions gained from on-site visits and individual interviews would be
a valuable complement to "hard" data. Management then agreed in principle, but
said that the career central bank staff engaged in supervision lacked the people
skills and business nous to obtain those benefits from such visits. Yet the same
management then found many good reasons why recruitment or secondment
from the private sector was "impossible"....
A central bank in a developing economy diligently collected statistical information
from private industry for its policy formulation. Management pointed proudly to its
long data series. But a quick check showed that this data came from voluntary
surveys that had long ceased to be representative. In fact data for one important
industry was being collected only from a single small company in a remote
location! Procedures were being diligently followed, and no one had been willing to
challenge precedent....

The second-age central bank needs to replace many aspects of first-age bureaucracy
with a more modern approach. Change is likely to include a thorough rethink of the
banks functions and structures. Overall staff numbers will probably fall substantially to
recognise functional and technological change, with remuneration structures reflecting
economic value not length of service. The standard tools of 20 th-century business
measurable objectives, cost accounting, management reporting, stakeholder
accountability and systematic performance improvement -- have to be adapted to the
specific needs of the central bank. In the second age, senior staff need to be genuine
managers and not just administrators.

The shape of the third age of central banking is still emerging. But some outlines are
already apparent. The balance of economic activity is moving from production of tangible
needs to intangible wants. Information and communications technology is altering
economic structures, relationships and transactions to create a complex, technologically
advanced and global knowledge economy. Most fundamentally for central banks, the
"national economy" macroeconomic model that underlies the concept of a national
central bank will become steadily less relevant.

In the third age, operational functions that are not unique to central banks move
elsewhere, or become more "high-tech" with far fewer people involved. The flavour of
policy functions changes from prescription and intervention to influence and risk
management. Across all functions, attitudes and experience date more rapidly and
information technology plays a strategic role. These third-age functional changes
challenge even second-age organisation structures and management practices.

As national boundaries diminish and national currencies disappear, former roles

inevitably become less important. But to balance that inevitable risk to central banking
organisations, a new opportunity emerges. With its unique overview that combines
theory and practice, a central bank can study issues that business and government may
be neglecting. "Thought leadership" may even become the central bank's key function.

Central banks have always thought strategically, but they have mostly relied on
centralised management to achieve their strategic intent. And while central banks
recognise the need to build and maintain capacity, their traditional organisational
structures and management practices are not well matched to the type of learning that
needs to occur. The third age demands a new and more complex style of organisation
and management:
 Organisational boundaries need to blur as the central bank shares its tasks with
external organisations.
It will be vital to exchange people and ideas with other sources of expertise, in
highly flexible ways.
Staff will expect to work in a creative, team-based environment in which they
make a substantial and recognised personal contribution.
Internal boundaries need to be made permeable in ways that do not jeopardise
security and confidentiality requirements.
A businesslike emphasis on goals and performance will still be important, but a
more open-ended approach to knowledge management will be needed.
Project sponsorship and management become core skills, not just desirable ones.
The exclusive club of lifetime careers changes to a looser network of associates.
Individual "employment" arrangements need to creatively facilitate movements
within the central bank and to and from the outside world.
The ability to direct and coordinate activity increasingly depends on good
relationship management rather than statutory or hierarchical authority.
Training and development investments require careful thought and innovation.
"Career" progression becomes more of a joint responsibility, jointly funded.
Succession planning is replaced by capability planning.

Common shorthand for distinguishing between effectiveness and efficiency is that

effectiveness demands doing the right things, while efficiency demands doing things
right. To complement effectiveness and efficiency, the third-age central bank will need to
add a new dimension that we might call exploration -- influencing new things in new
ways. Through exploration, a central bank can do much to help its society make difficult
economic and social transitions.

The third age demands that central banks add to their traditional virtues of integrity,
professionalism and public service ethic... (the new qualities of)... "flair, openness,
innovation and the imaginative anticipation of future risks and opportunities. (Robert
Pringle, in the November 2002 issue of Central Banking) In the third age, senior staff must
predominantly become leaders and facilitators, not just managers.

Which age are most central banks in? All of them at once, to some extent. But two
general statements can be made.

Absence of the later dimensions inhibits achievement even across earlier ones. A central
bank that fails to pursue efficiency for example by remaining overstaffed and bogged
down in bureaucracy -- will resist changes in operational methods and erode its
effectiveness. A central bank that fails to pursue exploration for example by
emphasising authority over dialogue in staff relationships -- will lapse into stereotyped
policy responses.

Conversely, virtuous circles of achievement can operate. A central bank that becomes
more efficient will become more effective as a result. An "early adopter" of exploration
concepts can tap a wealth of internal and external creativity across all its functions.

How to stay ahead?

How any particular central bank should aim to blend the three dimensions of
effectiveness, efficiency and exploration will vary with circumstances.

Central banks in developed economies currently present a mixed picture. In some, the
third age a growing reality. Others are still struggling with second age transitions or even
clinging on to first age structures and practices. The relevance, reputation and influence
of individual central banks will increasingly reflect the success or failure of their change
leadership and management, not just their technical capability.

In less developed economies, the balance of risks is likely to demand closer attention to
traditional functions. For central banks struggling with essential operations and skill
shortages, the main priority may be building a critical mass of basic capacity. "First age"
management systems are necessary and appropriate.

But in many developing economies central bank achievement is being constrained by

outdated leadership and management practices. Symptoms include:

Organisational structures that do not support current functions well

Overload at the top through insufficient delegation or outdated business processes
Too few good middle managers, making effective delegation hard to achieve
Difficulty in attracting and retaining talented people
A struggle to get creative outputs from policy functions
Proliferating "internal support" units that consume disproportionate resources
Above-market remuneration paid to long-serving staff of limited future value
Weak cost information and difficulties in controlling costs

A transition to the second age needs committed and strong internal leadership. Key risks
to manage may include political interference and a shallow pool (internal and external) of
management skills. But the potential returns are huge. An effective and efficient central
bank can play a leadership role not only for the government sector but for business too.

Paradoxically, the "thought leadership" of the third age may be even more important in
developing economies. Often the central bank will be the only institution that can capably
apply resources to issues that are important though perhaps not urgent. And because
globalisation compresses timeframes for economic and organisational change, central
banks in less developed economies should make an early start on planning for the third
age. A pragmatic approach may be to deliberately tune management practices around
different operational and policy functions, accepting the consequent lack of uniformity
across the organisation.

What will drive change?

Central banks are not usually subject to the disciplines of competition. And unlike most
public entities, they are naturally self-funding and usually free from direct budgetary
control by governments. The external drivers of organisation and management change
are inherently weak.

An optimist might conclude that central banks are uniquely able to plan and implement
systematic, long-term internal change. A pessimist might say that autonomy makes
central banks uniquely susceptible to inertia and staff capture. Both are right.

Autonomy makes it easier to avoid change, in the short term at least. But there are
compelling reasons for central banks to follow the optimist's line.

Deferring or minimising change is counter-productive. Inadequate or belated internal

responses cumulatively undermine organisational capability. As capability deteriorates,
external credibility and esteem will erode. Change will then be demanded and imposed,
not just desired and requested.

In the past, doing nothing often seemed less risky. Today, the balance of risk is shifting.
Institutions that are seen to put their own interests ahead of stakeholders and customers
face increasing criticism. As an organisation reliant on market reputation and public
confidence, a central bank would be unwise to let inertia dominate.

The positive reasons to change are even more compelling. Just as weak internal
responses will progressively undermine organisational capability, strong internal
responses will enhance capability. The freedom of action that central banks enjoy in
relation to their internal organisation and management should be used not to defer
change, but to optimise the benefits, costs and risks of change.

But precisely because speedy and drastic change is not driven from outside, more
attention needs to be paid to defining change directions and creating change momentum.
Intrinsic motivation, driven from a future-oriented vision, needs persistent sponsorship.
Management mechanisms such as strategic planning and budget review are important,
but without leadership support from the top they will ultimately achieve little. Central
bank leaders and managers need to diligently commit to sponsor and drive internal
change over a sustained period.

How to lead and manage change?

Each change program will be different, but a few common features can be identified.

Change is painful. Organisations facing little competition inevitably develop low-value

structures and processes. And as Parkinsons Law explains, bureaucracy fuels its own
growth. No change management program can improve effectiveness and efficiency
painlessly. Not everyone will welcome change, or gain from it. Strong leadership --
particularly leadership by example -- is an essential ingredient of successful organisation
and management change.

Change is about gain, not just pain. In developing and transition economies with growing
central banks, many opportunities exist to introduce modern management approaches
that build capability and redirect existing resources as new roles evolve. Even mature
central banks that need to downsize can do that in ways that reward good service and
help staff create new roles for themselves elsewhere.

Change is about people. Often impacts on people make organisations hesitate to make
necessary changes. But a central bank exists to serve its economy and society, not staff
interests. And in a changing world, only an organisation that remains relevant, effective
and efficient can offer staff a secure and motivating future. Hesitation is ultimately
counter-productive -- large-scale redundancy programs usually result from hesitation to
change at an earlier stage.

Beginnings are vital. The key initial challenge is create a mandate for change and
generate a critical mass of support. The visioning process outlined later will help.
However the leadership task of creating and sustaining a clear vision should not be
underestimated. The underlying benefits must be simple, undeniable and clearly
communicated to everyone.

Intangibles matter most. It is relatively easy to change job definitions and formal
management systems. But unless organisational values and culture shift, progress is
likely to stall. Values and culture do not change overnight -- sustained change
commitment is vital. Most crucially, leaders and managers must personally "walk the
talk".

Change programs encounter obstacles. Management is a craft: a creative combination of

science and art, rational planning and emotional commitment. Transitional issues should
be quarantined and managed in ways that do not compromise longer-term objectives.
Pragmatism and practicality, without compromising core objectives, will be essential.
Strong project sponsorship and project management skills will be needed.

Think from the outside in, not just from the inside out. Central bankers inevitably lack
comparative advantage in managing organisation and management change. Change
programs need fresh perspectives and independent quality assurance.

Change should not be off the peg". The unique features of central banking often defy
generic solutions. However while central banks have unique features, no organisation is
entirely unique. Central banking knowledge should be blended with a broader perspective
to plan customised change.

How to begin?

Internal leadership and management have often had a low priority for central banks. As
Governors rather than Chief Executives, central bank heads tend to concern
themselves mainly with external relationships and activities. Internal leadership and
management have usually been delegated to career central bankers with strong
technical interests. As a consequence, central banks can lag well behind best practice in
organisation and management, often without knowing that.

If you dont know where youre going, any route will get you there

Catching up to today's practices is not the right target. The one thing we know for certain
about the future is that it will be different from the present. Shaping the organisation and
management change around the demands of today may reduce immediate pressures, but
a change deficit will soon re-emerge.

Better to get ahead of the game. Picture the future by asking and answering a series of
questions. What are the outputs of our central bank likely to be at some future target
date? What would we like them to be? What organisation structure, resource base and
management systems are likely to best deliver our future outputs?

Then plan backwards from that future state. How does it differ from today? What
structures, resources and systems should we start to wind down? What new capabilities,
practices and processes should we aim to build? Which external and internal expectations
should be encouraged, and which ones discouraged?

This is harder than it sounds. Thinking "outside the box" of traditional organisation
structures and management practices is especially difficult in a technically oriented
organisation. Even those who accept the need for change may have low motivation or
vested interests. The banks leaders will need to sponsor the visioning process and "sell"
the resulting vision to others.

Developing a practical vision that inspires belief and change motivation is however highly
feasible. As other chapters in this book demonstrate, there is an evolving body of case
studies within central banking. Furthermore benchmarking -- the process of identifying,
understanding, and adapting outstanding practices from within the same organisation or
from other businesses to help improve performance (From Practical Benchmarking - A Managers
Guide to Creating Competitive Advantage" by Sarah Cook) -- should not be restricted to central banks.
The operational, policy and regulatory services that central banks deliver can be usefully
compared to similar business processes elsewhere.

A visioning process builds a picture of the future. But even a compelling vision can
flounder at the next step -- building specific action plans.
If you dont know where you are now, it will be hard to confidently move
forward.

A central banks policy and operational effectiveness relies heavily on information. Good
decisions come from good information, and central banks put enormous effort into
collecting, checking and analysing actual and forecasted information.

But organisation and management information rarely receives the same attention.
Traditional financial accounting and reporting may classify income and expenditure by
type and calculate a financial result for the whole organisation. Organisation charts may
look tidy. But traditional management information often fails to meet the change
leadership requirement to "... address an entirely different set of questions:

What activities are being performed by the organisational resources?

How much does it cost to perform organisational activities and business
processes?
Why does the organisation need to perform (those) activities and business
processes?
How much of each activity is required for the organisation's products, services,
and customers?" (From "Cost & Effect -- Using Integrated Cost Systems to Drive
Profitability and Performance" by Robert S. Kaplan and Robin Cooper )

The truism that good decisions require good information applies internally as well as
externally. Unless the information to answer these questions is readily available, change
planning will be seriously hampered.

External accountability expectations are rising too. The call to action is clear. Central
banks that do not take the initiative to develop and disclose answers to those questions
will have accountability imposed on them.

Fortunately it is not that difficult to meet internal and external requirements. A single
good practice system for central bank reporting can readily achieve:

Commercial accountability -- report on overall results and commercial operations

in ways that meet international standards and apply best professional practice
Government sector accountability -- identify functions, set objectives, and
measure performance in ways that are meaningful and useful to others
management reporting -- monitor and create accountability for financial
management and for the effectiveness and efficiency of services delivered

(The author explains technical features and management requirements for that good
practice system in a text available from www.mendhurst.co.nz)

A visioning process can set future objectives. Information and reporting improvements
can be used to analyse the present. These two processes can be combined to start a
program to plan, manage and optimise the benefits of change.

In conclusion

The power of central banks has steadily increased over the past couple of decades. ....
Never before in history have central banks wielded so much power. (The Economist, 25
September 1999)

But as many other industries and institutions have discovered, no position of power and
supremacy lasts. Central banks face a rapidly changing environment. The direct power
central banks exercise today will give way to less direct forms of influence, more rapidly
than many expect.

Organisation and management change will be needed at most central banks, more
substantially and more urgently than in the past. To respond successfully, central banks
need to give internal leadership and management a high priority. Those that vigorously
take up this change challenge are the ones most likely to achieve continued relevance,
independence and success.

The evidence demonstrates that early adopters have much to gain. At New Zealand's
central bank, a remarkable program of organisation and management change not only
achieved large efficiency gains but also substantially improved effectiveness. The
establishment of internal practices very different from the central banking norms of the
time had many direct benefits. Indirectly, it gave the newly independent Reserve Bank of
New Zealand the moral authority to lead urgent economic reform. And as explained in
another chapter, that change orientation continues to generate new thinking and
beneficial evolution. (That programs methods and results are outlined in the authors IMF Working Paper
WP/94/37 -- "Improving the Management of a Central Bank -- A Case Study", available at www.mendhurst.co.nz)

Other chapters in this book outline change initiatives by other central banks. Many of
those examples come from developed economies. But central bank leadership and
management may be even more important in less developed economies. Successful
economic development demands not just the right policies but also the institutional
capability to implement those policies. Today, successful economic development is likely
to require the simultaneous application of effectiveness, efficiency and exploration. A
central bank can powerfully exemplify change leadership and management to directly
and indirectly support that process.

Why should a central bank change? This chapter has tried to answer that question in
detail. But all of that discussion can be summed up into just two good reasons:

For its own good. Central banks have enjoyed unique freedom to plan and
manage organisation and management change, away from the limelight. But that
situation is unlikely to persist. Waiting too long or doing too little will in the end be
counter-productive. The alternative -- approaching change with enthusiasm and
welcoming scrutiny -- is likely to pay high dividends in future independence,
relevance and credibility.
For the good of others. Central banking professionals rightly perceive their
organisations as uniquely placed to benefit the societies they serve. Maximisation
of those benefits demands not just technical excellence, but effective leadership
and management of organisational change.

So whatever the particular situation of your central bank, the question "Why change?"
should not be hard to answer!