Transparency of a modern central bank for democratic accountability

This article discusses some of the key issues related to audit committees in central banks. Among the issues to consider, when designing an appropriate governance structure, are the prevailing legal tradition and the type and complexity of the central bank’s financial operations. It examines the implications of these issues on central bank legislation and recommended more explicit references to an audit committee (whether in statutes or in by-laws) for countries that lack strong corporate law traditions. It also suggests supplementary disclosures beyond the areas prescribed by the accounting framework, when central banks are active in complex financial operations, highlighting the key role for audit committees in this area.

An audit committee is considered as a means through which central banks may address principal-agent issues and effectively discharge their fiduciary duties, primarily regarding financial reporting. To avoid a configuration where management would be overseeing itself, and thereby limit conflicts of interest, several options are indicated, depending on the prevailing legal tradition: (i) ensuring a majority of external members without conflicts of interest in a one-tier board structure; (ii) stipulating that the non-executive directors have special oversight responsibilities for the financial condition without establishing a separate audit committee; (iii) setting up a special sub-committee of the board, which may or may not include additional members with special expertise; or (iv) the establishment of a separate supervisory board.

As a result of the growing complexity of central bank operations and their accounting frameworks, central bank boards may increasingly require specialised financial expertise. To address the need for special financial literacy, there are several options: (i) regulating the complexity of permitted operations, specifying the policy on derivative transactions for instance; (ii) requiring that a minimum of board members have special expertise in interpreting financial statements; or (iii) establishing a special body performing the functions of an audit committee. The article recommends pragmatism in balancing the type and complexity of central bank operations with the preferred format for their oversight. The effectiveness of an audit committee’s oversight of internal controls and financial disclosure may provide a strong safeguard against the emergence of reputational risk. The potential for reputational risk partly stems from public uncertainty as to the true financial condition of the central bank and from the difficult interpretation of financial statements in the light of differences between central bank objectives of monetary or financial stability and the standard commercial objective of maximising shareholder wealth.

An audit committee, or a similar body, could assist in designing and executing the central bank’s financial disclosure strategy. Increasingly complex central bank operations and adherence to international financial reporting standards raise the stakes for the scope of central banks’ financial disclosure. In this context, an audit committee can help provide further assurances of financial integrity and demonstrate high standards of good governance in central banks.

AUDIT COMMITTEES IN CENTRAL BANKS:  Good governance principles are fairly well developed for commercial corporations, and public sector organisations, but less so for central banks. In 1999 and revised in 2004, the Organisation for Economic Co-operation and Development (OECD) issued the OECD’s Principles of Corporate Governance for commercial corporations. The Principles cover five main areas: protection of the rights of shareholders, equitable treatment of the latter, the role of stakeholders, transparency and timely disclosure, accountability of the board toward the company, its shareholders and its stakeholders. The recommendations included in these codes may not always be mandatory, but they tend to be implemented as a result of the requirement to either comply or explain. Complementing its Principles, the OECD also issued in 2004 the OECD Guidelines on Corporate Governance of State-owned Enterprises, which recommend inter alia a strict separation between the state’s role as owner and regulator. The term fiduciary is derived from Roman law, according to Black’s Law Dictionary (1990), and designates a person holding the character analogous to a trustee. A fiduciary duty entails that the highest standard of care is imposed at either equity or law, which suggests that there cannot be a conflict of interest. Fiduciary responsibilities of a board and an audit committee typically imply responsibilities to all stakeholders in addition to the immediate shareholders/owners, but the extent to which they are explicitly mentioned in corporate law varies across countries. Corporations to which accounting frameworks are typically designed.

The objective of a central bank is usually effective and efficient policy implementation of its designated objective(s), functions, and tasks rather than maximisation of shareholder wealth. The financial reporting framework for a central bank should thus, in principle, be more focused on stewardship of public funds, i.e., its efficient use of resources. However, applying internationally recognised accounting frameworks for central banks performing a broad range of commercial transactions is very useful from a transparency perspective.

This article thus starts by referring to corporate governance practices in the private sector before discussing efforts to enhance transparency and accountability in government organisations. Company law is increasingly converging on the recognition of good governance principles, generally interpreted as the organisational configuration and procedures that will most effectively and efficiently help achieve the objectives, tasks, and functions of an organisation. Weil, Gotshal and Manges (2002) survey how the term ‘corporate governance’ is defined in national corporate governance codes across European Union member-states, illustrating differences in details and breadth of the definition and distinctions in emphasis on control and supervision. For the purposes of this paper, the definition used by the OECD is retained (OECD, 2004, page 11): “Corporate governance involves a set of relationships between a company’s management, its board, its shareholders and other stakeholders. Corporate governance also provides the structure through which the objectives of the company are set, and the means of attaining those objectives and monitoring performance are determined.” The OECD adds that “good corporate governance should provide proper incentives for the board and management to pursue objectives that are in the interests of the company and its shareholders and should facilitate effective monitoring.

The presence of an effective corporate governance system, within an individual company and across an economy as a whole, helps provide a degree of confidence that is necessary for the proper functioning of a market economy. As a result, the cost of capital is lower and firms are encouraged to use resources more efficiently, thereby underpinning growth.”  Since this is still an evolving process, these principles are even less explicit for central banks. Only recently have studies (among others Frisell, Roszback and Spagnolo, Foster, Lybek and Morris, Schiffman and Mooij) been focusing more explicitly on the governance of central banks,.  The focus is on the substantive functions of an audit committee, audit board, supervisory board, or similar body, rather than its form.

A CORPORATE PERSPECTIVE: An audit committee may be envisaged as a mechanism to address principal-agent challenges and fulfill fiduciary duties. The challenge is how owners (the principal) can monitor and ensure that the employee (the agent or management) pursue the owner’s objective. The principal-agent theory and its implicit assumptions—that maximisation of simple material returns is pursued by rational individuals—have dominated the discussion on how to improve governance. The real-world complexity has often forced company legislators to instead consider ‘maximising stakeholder wealth’ by elaborating the fiduciary responsibilities of the various governing bodies and management. Smallman (2004) examines three theoretical paradigms in corporate governance: shareholder theory, stakeholder theory, and stewardship theory. He argues that stewardship provides the future direction for corporate governance practice ‘if organisations are to deliver benefits to both their owners and other beneficiaries whilst not significantly harming the interests of other groups.”

The audit committee may either perform its duties as principal whereby the legislation would hold it directly accountable, or it may be acting as the agent of the board, which would retain ultimate responsibility. It is, therefore, essential that the committee fully understands the capacity under which it operates. Fiduciary duties discharged by audit committees and, in some countries, the emergence of legal liability also stem from the separation of management and owners. They entail that the highest standards of care be taken by truly independent members and imply that the focus on maximising ‘shareholder wealth’ be broadened to encompass ‘stakeholder wealth.’

Underlying the interest in oversight effectiveness is the recognition that businesses may lose as much value from weak internal control and financial reporting as from poor strategic decisions. The oversight function may be strengthened by either attributing specific functions (e.g., oversight and strategic decisions) to different boards, depending on the prevailing legal framework, or by adjusting an existing unitary board structure, altering its composition to increase its independence (e.g., the number of external members and their qualification requirements), or resorting to subcommittees. These subcommittees may either have explicit legal authority to perform certain functions, or act in a purely advisory capacity. If they have formal legal authority, their mandate must be clearly stipulated to guard against the dilution of their responsibilities from a subsequent addition of other subcommittees. Regardless of the structure of oversight, it is important to state upfront that audit committees, like external auditors, are not a panacea to prevent instances of reporting malpractices or fraud.

The impetus for strengthening oversight through audit committees in the private sector is partly market-driven, and partly a response to regulatory developments. Tighter statutory disclosure requirements from regulators have led to  development of the audit committee function, even if the frameworks are not prescriptive as to the form of such an oversight body. In the financial sector, the Basel Committee on Banking Supervision issued Core Principles for Effective Banking Supervision. They require the internal audit function to report to an audit committee, or an equivalent structure, and request the audit committee to include experienced non-executive directors in organisations with a unicameral Board structure. Capital markets and the emergence of private pension funds may have contributed to de-linking management and the ultimate shareholder, thereby increasing the importance of high quality reliable financial disclosure for honoring a company’s fiduciary responsibilities. Additional controls may also have stemmed from the complexity of financial reporting standards, key accounting issues (e.g., the treatment of pension obligations and stock options and the application of fair-value accounting), and the increased use of earnings management, which require special financial expertise. For a discussion of these accounting issues, see OECD (2004)  Caruana et al. (2002), using Enron as a focal point to explore the challenges posed by failures of financial reporting also address some fundamental concerns about future accounting. Although fair-value accounting is a sound principle in a market economy, it may be manipulated, particularly in the way future-envisaged revenues are discounted. Accordingly, the stakeholders must hold boards responsible for developing better processes to ensure the existence and operation of appropriate control and reporting frameworks.

Notwithstanding diversity in corporate approaches across legal systems, the discharge of fiduciary duties by the body entrusted with audit committee functions is remarkably similar. By way of illustration, the main features of audit committees in three legal traditions. Within the single board configuration of Anglo Saxon countries, the emphasis has varied from initially strengthening either the external representation on the board (UK) or to establish an audit committee, which seems to have began earlier in the US. For guidance on strengthening audit committees without undermining the unitary board structure in the UK. In July 2003, “The Combined Code on Corporate Governance” in the UK superseded the recommendations on corporate governance from June 1998 by the Hampel Committee. The Combined Code covers both the recommendations of the Higgs group’s review of the role and effectiveness of non-executive directors and the Smith group’s review of audit committees. For a review of the literature on audit committees in the US, see for instance DeZoort (2002).

The German corporate structure is an example of a two-tier board structure. A similar approach is used in several other European countries. According to Ugeux (2004, page 345 and footnote 22), French law, for example, does not allow the board to delegate decision-making authority to a committee. A structure similar to that of the German corporate sector is adopted by some companies in France, which choose to establish a Directoire as the management board and a Conseil de Surveillance as the supervisory board. It is important to bear in mind that company laws in the European Union still differ significantly (See Weil, Gotshal and Manges, 2002 and, for a comparison of the UK and Germany, Davies, 2000). Companies registering under the new European company law (Societas Europaea) may elect a one- or a two-tier board system. See Title III Article 38 of the European Council Regulation (EC) No.2157/2001.  Although the oversight role may, in principle, be more clearly delineated, audit committees seem to begin to play a more explicit role. Also note the ‘comply or explain’ approach dominating in the European countries, including the UK and the more regulatory approach in the US with Sarbanes-Oxley.

In the original Japanese corporate model, a statutory board of auditors is hierarchically equivalent to the board of directors, reporting directly to the shareholders, although it manages the external audit process and reviews audit findings in much the same way as in the two other models. Japanese law is more prescriptive, and requires the board of auditors to attach their audit opinion to the financial statements. Accordingly, the Financial Service Agency of Japan persuaded the US SEC to exempt Japanese issuers listed in the US from the Sarbanes-Oxley Act.

A CROSS-COUNTRY PERSPECTIVE:

 THE UK AND THE US: The In 1992, the Cadbury Committee issued the Code of Best Practice that recommended that boards of U.K. companies include at least three external directors and that the position as chief executive officer (CEO) and chairperson of the board be held by different individuals. The U.S. Securities and Exchange Commission (SEC) and the New York Stock Exchange (NYSE) have recommended the establishment of corporate audit committee with a view to reinforce oversight. During the last two decades, the requirements for audit committees have become more detailed. In both countries oversight is expected to be strengthened by including more external directors, but analysts in the U.S. (where the CEO typically remains the chairman of the board) question the effectiveness of the latter if they are involved in too many boards. The Sarbanes-Oxley Act of 2002 contains mandatory measures for audit committees covering the following areas: (i) management notification of significant internal control deficiencies and any instance of fraud involving management; (ii) the receipt of reports from auditors on critical accounting policies and practices; (iii) direct responsibility for the appointment, compensation, and oversight of external auditors; (iv) the establishment of procedures for receiving and dealing with complaints regarding the company’s accounting and internal controls for auditing matters; (v) the setting up of procedures for handling employee concerns—whistle blowing—on accounting issues; and (vi) the inclusion of members that are financially literate. Regarding the latter, the SEC requires that at least one member observe the financial expert definition, while both NYSE and NASDAQ require all members to be financially literate. In the U.K., the Smith group published “Audit Committees Combined Code” in January 2003, where listed companies not following these guidelines must explain why, while noting that (1.5): “All directors remain equally responsible for the company’s affairs as a matter of law.”

Germany

The German corporate structure is an example of a two-tier board structure, which is used in several other European countries. A supervisory board (Aufsichtsrat) comprising mainly external members, and sometimes employees has the highest authority and oversees the management board (Vorstand). The supervisory board is also involved in making strategic decisions, but the degree to which it should be involved in these decisions, as they become more tactical, is often debated. One of the challenges is the interaction between the two boards. Since management (and the CEO) plays a role in nominating members of the supervisory board, there is a need to ensure that the supervisory board has full access to all relevant information from management. To address this, the German corporate governance code (the Cromme Code) prescribes that a supervisory board shall set up an audit committee (5.3.2), that the chairman of the supervisory board must not be the chairman of the audit committee (5.2), and that the latter must not be a former member of the management board (5.3.2).

 JAPAN: In Japan, both types of corporate governance models (single and two-tier board structures) now exist for listed companies. Historically, Japanese corporate law has used a two-tier board structure, consisting of a board of directors and a board of corporate auditors (kansayaku). The distinguishing feature of the Japanese approach is that the two boards are of equal hierarchy vis-à-vis the shareholders, to whom they report directly, though in parallel. Although the statutory board of auditors comprises non-executive directors, in practice, the relationship between management and board members remains fairly close. Amendments to the Japanese company law are thus directed toward strengthening the definition of a non-executive director, effective 2005. Other reforms give Japanese companies the option, as of 2003, to adopt a unitary board configuration, provided they establish committees for nomination, audit, and remuneration, each comprising three or more members, half of which must be outside directors. The Japanese law is fairly prescriptive about the role of the board of auditors and the scope of their oversight. It stipulates their fiduciary duty to the shareholders is to audit the activities of the business through a business audit and a financial audit. The business audit is similar to a compliance audit and does not cover the integrity of decisions made by the board of directors, unless they believe that there has been a breach of their ‘duty of care’ to the shareholders. The financial audit is an audit of the financial statements and is performed by a specialist company elected at the shareholders meeting.  The recommendations of the Treadway Commission in 1987 were followed by those of the Blue Ribbon Committee in 1999 (most recently updated in 2004) and the Sarbanes-Oxley Act of 2002.  For an elaboration and interpretation, see, for instance, Emmerich, Racz, and Unger (2005) or Chapter 3 OECD (2004).

GOOD GOVERNANCE IN PUBLIC SECTOR: With a widespread trend toward decentralisation, outsourcing and private-public partnerships, governments are devoting greater attention to public sector accountability. By public sector accountability, the OECD means ‘the obligation of those entrusted with particular responsibilities to present an account of, and answer for, their execution’ while control is defined as ‘a process designed to provide reasonable assurance regarding the effectiveness and efficiency of operations, reliability of reporting and compliance with applicable laws and regulations’, OECD (2005). Issues of corporate governance thus extend beyond commercial corporations. Since government entities are accountable to citizens for the proper management of their taxes, they may be expected to be governed by equivalent or even higher standards than their private counterparts. Recent public sector reforms in industrialized countries were directed toward the internal control function, holding decision makers accountable on how public funds are managed and reflecting a shift from ex ante control of funds (i.e. before spending is authorized) to ex post assessments of the efficiency with which resources were allocated. In fact, performance indicators are increasingly adopted in budget and management systems in OECD member countries, some of which are also implementing risk management approaches in internal control. This approach, pioneered by Australia and the U.K., also stimulated interest in Ireland and Japan. For more details, see OECD (2005). Enterprise risk management is defined by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) as “a process, effected by an entity’s board of directors, management and other personnel, applied in strategy setting and across the enterprise, designed to identify potential events that may affect the entity, and manage risk to be within its risk appetite, to provide reasonable assurance regarding the achievement of entity objectives.” (See p.2 of the COSO integrated framework on risk management).

The greater desire for accountability toward stakeholders has led to the establishment of public sector oversight bodies in a number of countries. More than half the countries participating in the World Bank/OECD 2003 Survey on Budget Practices and Procedures stated that they established a centralized body for internal audit oversight, a third of which are located in an independent government organization.24 Underlying this governance structure is the desire to reinforce the impartiality of internal control, separate it from day-today management, and address duplication between internal and external control.

Some governments have developed specific guidelines for audit committees in ministries, agencies, or departments. The handbook developed by the U.K. Treasury, for instance, is designed to help the audit committee elaborate a strategy for briefing the accounting officer or the board prior to their reporting to the parliamentary Public Accounts Committee (PAC). Accounting officers and boards cannot be expected to know all the operational details of the organization but will still need to have the assurance that governance mechanisms are in place, since they will be held to public account. Responsible for the availability and accuracy of information, the audit committee is an integral part of the formal accountability procedure and provides the required assurance of efficient, effective, and economic control systems. The good practice guidelines clearly state that the PAC will not accept any lack of knowledge of internal control vulnerabilities as a justification for poorly managed or realized risk.

The greater desire for accountability toward stakeholders has led to the establishment of public sector oversight bodies in a number of countries. More than half the countries participating in the World Bank/OECD 2003 Survey on Budget Practices and Procedures stated that they established a centralized body for internal audit oversight, a third of which are located in an independent government organization.24 Underlying this governance structure is the desire to reinforce the impartiality of internal control, separate it from day-today management, and address duplication between internal and external control.

Some governments have developed specific guidelines for audit committees in ministries, agencies, or departments. The handbook developed by the U.K. Treasury, for instance, is designed to help the audit committee elaborate a strategy for briefing the accounting officer or the board prior to their reporting to the parliamentary Public Accounts Committee (PAC). Accounting officers and boards cannot be expected to know all the operational details of the organization but will still need to have the assurance that governance mechanisms are in place, since they will be held to public account. Responsible for the availability and accuracy of information, the audit committee is an integral part of the formal accountability procedure and provides the required assurance of efficient, effective, and economic control systems. The good practice guidelines clearly state that the PAC will not accept any lack of knowledge of internal control vulnerabilities as a justification for poorly managed or realised risk.

 

The greater desire for accountability toward stakeholders has led to the establishment of public sector oversight bodies in a number of countries. More than half the countries participating in the World Bank/OECD 2003 Survey on Budget Practices and Procedures stated that they established centralised bodies for internal audit oversight, a third of which are located in  independent government organisations.  Underlying this governance structure is the desire to reinforce impartiality of internal control, separate it from day-to-day management, and address duplication between internal and external control.

Some governments have developed specific guidelines for audit committees in ministries, agencies, or departments. The handbook developed by the UK Treasury, for instance, is designed to help the audit committee elaborate a strategy for briefing the accounting officer or the board prior to reporting to the parliamentary Public Accounts Committee (PAC). Accounting officers and boards cannot be expected to know all the operational details of the organisation but will still need to have the assurance that governance mechanisms are in place since they will be held to public account. Responsible for  availability and accuracy of information, the audit committee is an integral part of the formal accountability procedure and provides the required assurance of efficient, effective, and economic control systems.

The public audit committee’s lines of accountability and members’ personal incentives differentiate it from that of a commercial corporation. The difference in government departments is being held accountable by ministers, and/or parliament rather than an annual meeting of shareholders, and unlike boards in commercial corporations, policy responsibility is split between decisions taken at ministerial level and the provision of agency or departmental advice. Moreover, the non-executive members of the audit committee act as advisers or consultants and do not have the same incentives as their private sector counterparts. In representing the government rather than the shareholders, they do not share the liability of a corporate board member and may be dismissed with a change in the administration at the end of an electoral cycle. To ensure that independent external membership does not unduly represent third-party interests or expose privileged information, governments typically issue guidelines on public appointments to maximise the benefits of external expertise and independent judgment.

Public service objectives further distinguish the role of audit committees in government entities placing a greater emphasis on members’ personal qualities. The Australian government guide offers a discussion of process issues in the establishment and operation of audit committees designed to help public entities apply principles of better practice. The Better Practice Guide Public Sector Audit Committees also includes alternative audit committee charters which may be tailored to an entity’s particular circumstances. The Australian public sector entities are statutorily required to establish an audit committee, and the guide applies to all entities governed by the Financial Management and Accountability Act 1997 and the Commonwealth Authorities and Companies Act 1997. The guide states explicitly that audit committee members, over and above the functions specified in the charter, have a responsibility to exercise due diligence and act in good faith in the best interest of the entity. One of the recommended personal qualities is the ability to appreciate an entity’s culture and values in considering ethical issues that might arise. This usefully extends staff and officials’ responsibilities (normally established in internal codes of conduct or ethics) to the external members of the audit committee. The guide calls upon the committee members to adopt a culture of ‘continuous improvement’ rather than a punitive approach, arguing that it is a more constructive way of interacting with management.

Reflecting developments in the corporate sector, the extent of legal liability is emerging as a source of concern, although this varies from one country to another. Although the Australian guide is pragmatic rather than prescriptive, it goes further than the UK Treasury.  The good practice guidelines clearly state that the PAC will not accept any lack of knowledge of internal control vulnerabilities as a justification for poorly managed or realised risk. The Better Practice Guide Public Sector Audit Committees also include alternative audit committee charters which may be tailored to an entity’s particular circumstances. The Australian public sector entities are statutorily required to establish an audit committee, and the guide applies to all entities governed by the Financial Management and Accountability Act 1997 and the Commonwealth Authorities and Companies Act 1997. The handbook recommends that audit committee members arrange for appropriate indemnity insurance. Their liability is limited in that it will not be greater than that of an executive of (or a service provider to) the entity.

 

HOLDING AUTONOMOUS CENTRAL BANKS ACCOUNTABLE:  Effective disclosure and integrity help central banks strike a balance between autonomy and accountability. The earlier central banks, established as commercial enterprises with special note issuance privileges, were fairly easy to monitor (often by private shareholders) since they were guided by a simple monetary rule. Widespread nationalisation in the 1930s and 1940s increased the government’s involvement in central banks, and to the extent that private shareholders remained. Their oversight role was limited. The advent of deregulation and the reliance on discretion and indirect monetary instruments were accompanied by greater autonomy to alleviate the so-called time inconsistency problem. Attention then shifted towards transparency, holding autonomous central banks accountable for achieving clearly defined and prioritised objectives. A particular focus on efficiency emerged since lower yields on international reserves, revaluation losses, and sterilisation costs have undermined the financial position of several central banks.

An effective system of central bank reporting, backed up by demonstrably good governance, is instrumental in proper functioning of an autonomous central bank. The challenge is how to hold central bankers accountable since they are unelected public officials, managing public resources and implementing policies that affect society at large. The demonstration of appropriate oversight of internal control and financial reporting provides central banks with strong grounds to defend themselves against unwarranted external influence. Examples of waste, corruption, or extravagance may lead to a situation where statutory amendments, ostensibly designed to address operational deficiencies, could effectively curtail independence, recreating the so-called inflation bias to the detriment of sustainable economic growth.

 The focus on governance and accountability provides strong incentives for a central bank to adopt an audit committee, drawing on the experience of other sectors. For a central bank entrusted with banking supervision, establishing an audit committee would apply a ‘practice-what-you-preach’ approach since corporate governance principles are also developed for commercial banks. Essentially, as revealed in the survey of selected central banks, the core function of an audit committee in a central bank remains similar to that of other sectors to oversee the integrity of internal control and the transparency of financial reporting. Depending on the governance structure specified in the law, the audit committee functions may be discharged by a body acting as a sub-committee of the governing board or as the body with direct responsibility for discharge of the functions. The audit committee is not involved in management or operational duties; its focus remains on the board’s discharge of fiduciary obligations.

Several challenges arise in central banks’ application of accounting standards which could distinguish their audit committees from those in other sectors. The trend towards harmonisation of central bank accounting under International Financial Reporting Standards (IFRS) facilitates comparability, transparency, and helps avoid that central banks ‘cherrypick’ their accounting treatment. It also increases the responsibilities of boards and audit committees in reviewing accounting policy and disclosures. Difficulties may arise from the central banks’ not-for-profit focus, a move to an expanded use of fair-value accounting, and the best practice of only including realised gains in central bank transfers of profits to governments. While striving towards compliance with prevailing accounting standards, a central bank must ensure that financial reporting neither conflicts with its objectives and law, nor exposes its capital base. Disclosure requirements, in the area of liquidity support for commercial banks or the composition of foreign reserves portfolios for instance, may conflict with the bank’s policy functions. IFRS requirements to report foreign currency revaluation gains and losses through the profit and loss account can generate significant volatility in the central bank’s profit due to the specific structure of its balance sheet. These issues require care when preparing financial statements to ensure that the statements reflect reality, do not generate perverse incentives and still comply with the IFRS requirements. This may necessitate some education of stakeholders.

EMERGING CHALLENGES FOR CENTRAL BANKS: Supplementary disclosures beyond areas prescribed by the accounting framework may help boards better fulfill their fiduciary responsibilities. Both public-and private sector entities have found that the growing complexity of financial statements makes it difficult for readers with limited financial literacy to understand them. Central banks may draw on the experience of codes in the US, Canada, and the UK for such supplemental disclosures elaborated. For central banks to maximise the benefits of communicating with financial markets, better, rather than more, transparency is required. In financial reporting, this may entail providing further explanations to help interpret the central bank’s balance sheet, since the absence of a profit maximization objective makes it more difficult to assess a central bank’s performance. An independent audit committee may facilitate this process for central banks.
 

 Supplementary disclosure affects the qualitative aspect of a communication strategy giving readers of financial statements a better ability to assess an entity’s financial position and performance. The expectation is that these disclosures will be written in plain language and provide a transparent assessment of the company’s financial position and prospects. Together with the financial statements, they form part of the annual report and provide the opportunity for a company to demonstrate to its stakeholders how well it is managing its resources, meeting stated strategic objectives, and planning to address future issues. Although these disclosures are mandatory for listed companies and are written primarily for current and prospective investors, they are applicable to a wider range of users.

The diversity of stakeholders with an interest in central bank disclosures underscores the need for carefully crafting their communication strategy. Politicians, financial institutions, economists, and the public at large all form part of the central bank’s audience, with varying interests in operational details and levels of financial literacy. Yet, the technical nature of modern financial statements requires their readers to be financially literate. Central banks may, therefore, base their disclosures on a non-technical summary of the balance sheet and profit and loss statements, written in a form that all readers can understand. Part of the role of an audit committee, judging from the experience of the private sector, may be to assess the substantive transparency of these disclosures, and the extent to which they are accurate, complete and consistent with the financial statements. Bromilow and Berlin (2006) include, in  list of transparency and disclosure considerations, the recommendation that audit committees assess whether the disclosures are clear, candid and understandable, that they ensure prominence is given to the most important information and that they do not simply repeat the information contained in the financial statements. If these disclosures are mandatory and have to be audited by the external auditor, the audit committee would either oversee these additional disclosures as part of its oversight of the external audit function, or include the preparation of disclosures within its own responsibilities.

 Applying the corporate sector’s experience with audit committees to central banks is a challenge, as institutional objective and governing incentives differ. Reliable and transparent financial statements are crucial for central bank credibility and effectiveness, but the overriding objectives—typically price stability and financial sector stability—differ from those of shareholder wealth maximisation. A Governor’s incentives are also fundamentally different to those of a commercial corporation’s CEO and performance is measured against a range of indicators other than the ‘bottom line’. Some executives may, for various reasons, assign higher utility to achieving the interests of the collective organisation for which they work than serve their narrow personal material interests—the stewardship paradigm referred to earlier, as discussed by Smallman (2004). Their objective function is broader than salaries and pensions, as it also includes such incentives as reputation and stature and may explain why well-qualified individuals opt for public sector or central bank employment in spite of lower pay. The focus of central bank financial disclosure and the functions of its audit committee will, therefore, tend to differ from that of a private sector entity. Consideration could thus be given to interpret financial results with specific reference to central bank objectives and to determine a methodology to better assess the efficiency of the services provided.

HOW AUDIT COMMITTEE FITS IN A CENTRAL BANK: Notwithstanding functional demarcations within a central bank, it is the complementarities between them that support the thrust toward good governance. The audit committee is a subset of the governance function, neither replacing internal or external audit functions, nor interfering in management’s operational responsibilities. Rather, its role is to ensure the existence of effective systems of internal controls, risk management, and financial reporting. To do so, it relies on the management, internal audit, accounting and risk management and external audit functions.

Only through a process of iterative interaction with key governance functions of the central bank will an audit committee be able to fulfill its duties. Cooperation and open lines of communication should be established across the organisation for the audit committee to effectively discharge its functions. It is important to view the audit committee within the broader governance framework. For instance, with the financial controller, the committee will be called upon to discuss accounting principles, required disclosures and significant operational or reporting issues affecting the financial statements. With the compliance unit (or the legal department), the committee should help assess the entity’s compliance with its external regulatory requirements and internal regulations, especially those of particular sensitivity to financial reporting. With the internal audit, it will review the work programme, the results of the audits, and resolution and follow-up of findings and recommendations.

The key to oversight effectiveness is a carefully designed organisational structure which removes the possibility for any gaps or overlaps in responsibilities. This entails a clear understanding of what each of the central bank’s functional areas is required to oversee, and the manner in which it should report back to the board and interact with its counterparts. Regardless of the way the central bank is configured, it is important that its audit committee function integrates seamlessly into the overall governance framework. There should not be any scope for duplication of efforts, or for any breach of coverage; otherwise the board’s execution of fiduciary duties would be severely jeopardised.  In the interest of ensuring that nothing ‘falls through the cracks’ it is probably better to err on the side of duplicating efforts rather than avoiding overlaps in oversight. See Bromilow and Berlin (2006 p.19) for a discussion of the way in which three of the surveyed companies tried to address the potential overlap between the risk management and audit committees. In one of these, the chairperson of the risk management committee acts as the deputy chairperson of the audit committee and vice versa.  A related issue is the potential for competing oversight frameworks to emerge if oversight responsibilities are not clearly allocated.

The form and extent of delegation should balance the advantages of supporting the board’s execution of fiduciary duties against the danger of diluting its responsibilities. The ultimate responsibility for financial integrity remains vested in the board of directors, even though the authority to discharge this responsibility may be delegated to the audit committee. The scope of this delegated authority depends to a large extent on the complexity of the central bank’s financial operations and its application of the accounting framework. The board is obligated to find the time and have the expertise to fully interpret and explain its financial statements, which can be facilitated by the audit committee. Yet, a potential for reputational risk may emerge if the public fails to understand the true financial condition of the central bank. This provides a key role for an audit committee (or a similar body) to carefully design and execute the central bank’s financial disclosure strategy.

 

DIGNING EFFECTIVE AUDIT COMMITTEE FOR CENTRAL BANKS: Central banks may learn from the experience of private and public sectors when considering the establishment of an audit committee. This section suggests that designing an effective oversight structure entails three main factors: its appropriateness in terms of country-specific factors, its independence as guaranteed by appointment, composition, and skills mix and its interaction with the board from which it derives its authority.

Board(s) mark distinction between different types of functions performed by one or more boards. The policy board determines or prioritises policy objectives from the broad responsibilities (monetary, exchange rate, financial stability) assigned to the central bank by the government, and sets targets to reach the objective(s) stipulated in the central bank law. Such boards will often be chaired by the Governor. A policy board will usually include external members.

The implementation board determines central bank operations to reach policy targets and objectives, for instance, when to increase or decrease interest rates to achieve a specified target. These decisions may be taken by the policy board, a monetary policy committee, a management board, or be the sole responsibility of the Governor, typically depending on the type of autonomy and monetary regime. If done by a board or committee, it is usually chaired by the Governor and comprises heads of relevant operational departments, and even outside members with special technical expertise.

 

 

A supervisory board oversees the central bank’s both policies, including the process and outcome of decisions by the policy board, implementation board, and management for achievement of objectives, tasks and functions effectively and efficiently, as well as financial performance, including reporting, internal controls and efficient use of resources. Purely oversight boards would typically include a majority of non-executive members and should not be chaired by the Governor while an oversight board performing policy and particularly implementation decisions should be chaired by the Governor unless the formal authority is delegated to a committee chaired by the Governor.

Special expertise and insights to ensure a balanced and informed view can be introduced via external board members (representing economic sectors or regions, for instance), an advisory board (or committee, depending on the degree of organisational formality and delegation) without formal decision-making authority, or delegating to a committee. Various central bank functions may be delegated by the board to specific committees, but it is important to distinguish between committees assisting the board in performing its tasks and assisting the management with, for instance, open market operations, international reserve management etc. assisting the management. An audit committee may assist the board or may even solely have some formal oversight responsibilities, particularly in case of the absence of a pure supervisory board.

The management is responsible for implementing the decisions of the governing bodies in an effective and efficient way, i.e. responsible for the central bank’s day-to-day operations. A wide variety of management structures exist within central banks. Often the formal management authority rests with the Governor, who oversees a structure of deputy governors, general manager, and/or management committee, or there may be a special board of governors. Management is responsible for designing appropriate internal controls, while the board must ensure that management is actually doing so.

Internal auditor is responsible for an ongoing review of the operation of internal controls, reporting to management and the board on the effectiveness and efficiency of the system, including financial reporting procedures. He is charged with evaluating compliance with legal and regulatory requirements (in coordination with the legal department), including on code of conduct, ethical standards, and organisational objectives and procedures and reports to management and the board (and perhaps the audit committee).

    External auditor is responsible for examining financial statements and accounting system, issuing an independent opinion on the extent to which they are true and fair, in accordance with accounting standards and financial reporting framework. He is increasingly asked to attest to the integrity of internal controls.

 

ISSUES TO CONSIDER WHEN DESIGNING AN AUDIT COMMITTEE:

Objectives: Fiduciary governance duties require quality and transparency of the financial reporting process and adequacy of internal control environment. Authority refers to delegated authority from the board, but ultimate responsibilities remain with the board. An Audit Committee reports to the board, but must keep in mind its fiduciary responsibilities. Minutes of meetings should be also circulated to the board. There must be special statement in annual financial statements or in the annual report. The committee must be independent to remain credible. It has difficult issues to handle: prior employment at the bank, receipt of compensation, close familiar ties with the management team, representation of a major shareholder, a significant customer or supplier. It is ideally composed of non-executive directors or at minimum the majority. One or more of these may be a board member. The committee should be able to co-opt independent technical experts. Other participants can be invited to meetings, including the CEO, chief financial officer (CFO), internal auditor, external auditor, and, when necessary, the legal counsel. The size of an Audit Committee depends on extent of responsibilities, not less than 3, typically 3–6 members. The committee is generally aligned with board membership with typically 2–3 years with the possibility for reappointment with a view to balancing continuity. Continuity can also be ensured with staggered terms, in which case a larger committee can alleviate shorter terms. Shorter terms, however, may also contribute with freshness (new members bring in a different perspective). At least one member of the Audit Committee should have accounting or related financial management expertise. S/he should be a senior financial officer with oversight responsibilities, and should have experience in risk management and must be able to commit sufficient time and resources to the assignment. Depending on the composition, a non-executive board member may function as chairman, hence acting as a focal point for reporting to the board. The Audit Committee should have regular meetings with adequate time to review various reports and financial statements. Meetings should correspond with major phases of financial reporting and audit cycles. Agenda and supporting material should be distributed early enough before the meetings to allow proper consideration. Four to six meetings a year are common. An Audit Committee should have resources—administrative and secretarial support— necessary to fulfill its functions. New members should be provided with adequate background information and training [Sources: Apostolou and Jeffords (1990), PriceWaterhouseCoopers (1999, updated in 2003), Turner (2001), National Association of Corporate Directors (2004), Box 3.9 in OECD (2004),Bromilow and Berlin (2006), and The Institute of Internal Auditors (2006). These sources also offer a list of questions that audit committees should try to address.

Although establishing an oversight body such as an Audit Committee is increasingly accepted as a means of strengthening governance, it is important to maintain realistic expectations. An Audit Committee adds value by contributing to enhanced objectivity of financial reporting and internal controls, thus providing further assurances of integrity in the conduct of business. The advantage of a set-up based on delegated authority is that there is an independent check on internal audit, and through its role as focal point for the organization’s relations with external auditors, it facilitates the external audit process. The strength of an audit committee is its ability to seek out information until completely satisfied with the explanation provided. However, the expectations of an audit committee’s impact must be realistic. It effectively operates on a part-time basis, although the precise number of meetings per year will vary, and, more importantly, it has to rely on reports compiled by management, internal audit or the external auditor. The results of the latest survey of audit committee chairs in Bromilow and Berlin (2006) denote (on page 89) an increase in the frequency of meetings since the previous survey, from an average of 3.3 times a year in 1999 to at least 4 times a year in person (for 92 per cent of the respondents) and 4 or more additional meetings via telephone or videoconferencing (for 76 per cent of respondents).

The board of directors should ensure that the members of its audit committee have sufficient time to devote to their allocated task, and are not overburdened by other responsibilities. Petra (2005) or Hermalin and Weisbach (2001) offers a review of the literature on independent directors in US corporate boards. While serving on several boards may provide valuable experience and reputational benefits, external directors may also have other obligations that impede their effective oversight. Hence, the empirical evidence is mixed. Fich and Shivdasani (2006), however, find that using number of directorships as an indicator for a busy director in companies listed in 1992 in Forbes 500 during the period 1989–95, is significantly associated with weaker corporate governance, using market-to-book ratio as a measure of corporate performance.

The literature on audit committees in the private sector is increasingly considering the impact of incentives and organisational dynamics on effectiveness. See Olsen (1999) p.1102 for instance. The ten rules for committee effectiveness are also taken up in KPMG (2004) p.2. Dahya, McConnel and Travlos (2002) found, based on a randomly selection of 650 out of 1828 industrial firms on the Official List of the London Stock Exchange during the period December 1988 to December 1996, that the turnover of CEOs increased and that the negative relationship between CEO turnover and performance became stronger after the issuance of the Code. Song and Windram (2004) compared companies (identified by the UK Financial Reporting Review Panel) that published defective financial statements during 1991–2000 with their peers and found that: (i) strong representation of independent outside directors positively correlated more effective financial reporting (fewer defective financial statements); (ii) a more active audit committee (more frequent meetings) was positively correlated—although not statistically significant—with fewer defective financial statements and (iii) there was weak support that lack of financial literacy may undermine the effectiveness of an audit committee. Klein (2002), using a sample of 692 publicly traded firms listed on the S&P 500 as of March 31 1992 and 1993, found that abnormal accruals, used as a proxy for earnings management, was more pronounced for firms with less independent boards and audit committees.

 In designing oversight mechanisms, central banks may wish to consider the dangers of overloading audit committee members with too many responsibilities and ignoring the ‘expectation gap’ (Koh and Woo, 1998) that may emerge from placing undue emphasis on audit committees to uphold accountability and integrity. Another important factor to keep in mind is that the emphasis on audit committee expertise and authority may have an unintended consequence of creating confusion over liability, unless it is made very clear that the board of directors is ultimately responsible. See, for instance, Sulkowicz (2003) and the SEC Commissioner’s fears on Sarbanes-Oxley dissuade qualified and competent individuals from participating in boards. Three quarters of Audit Committee chairs surveyed in the preparation of the IIA booklet on audit committee effectiveness (Bromilow and Berlin (2006) p.22) are reported to have expressed concern that their responsibilities had increased beyond what could be considered reasonable.  Given the protection that many central bank laws afford to their staff in the conduct of their official duties, it may be helpful to delineate the extent to which non-executive members of their audit committees may be held liable for breach of duty or lack of due diligence.

For an Audit Committee to be effective, its precise configuration within the governance structure of the central bank should be in line with the country’s legal tradition. The audit committee as a non-executive subcommittee of a unitary governing board is a reflection of the Anglo Saxon model, while in the continental European dual board structure (distinguishing management from supervision), the supervisory board would usually be responsible for the functions of an audit committee. Audit Committee members will need to have a good understanding of their position in the central bank’s governance structure and the broader legal framework within which the central bank operates. Regardless of the precise configuration, management structures always include a separate internal audit department. So it is important that the modalities for delegating oversight duties are unambiguous to avoid any duplication of efforts.

Since the scope of financial disclosure also depends on the complexity of financial operations, some central banks may opt for more limited audit committee functions. Indeed, it is simpler to draft a non-technical summary of the balance sheet and profit and loss statements if the central bank does not engage in complex financial transactions. In such cases, the oversight function may not require additional resources or special expertise, and may be effectively discharged through an advisory committee to the board, rather than a more formal supervisory body which is established separate to the latter. A pragmatic approach that balances the type of central bank activities with the preferred format for their oversight is therefore recommended.

Some organisations may be too small for the practicable establishment of a separate Audit Committee with non-executive members. This is acknowledged in the UK Treasury guidelines on Audit Committees, and may apply to some of the smaller central bank boards, or less developed countries where the pool of qualified and truly independent individuals is quite limited. In such cases, the suggestion is for the board—or a subgroup of the board comprising external members—to act as the audit committee, although this would be at a different sitting from its regular meetings. However, the guidelines are very emphatic in stating that ‘this [configuration] should not be the ‘default’ option for smaller organisations; before deciding to take this course of action careful consideration should be given to other options.’ The board (in lieu of an Audit Committee) could develop a different mindset from that of its role is day-to-day operations but it would need to demonstrate that it safeguards objectivity by other means, such as chairmanship by a non-executive member. This is discussed in the Australian better practice guide; it offers a pragmatic approach to strengthening independence in the absence of a majority of non-executive members, suggesting that Audit Committees recognise potential conflicts of interest upfront. Their charter, for instance, could ensure that external members have as open an access to the organisation as their executive counterparts and that their presence be explicitly required for a meeting to form a quorum.

INDEPENDENCE OF COMMITTEE MEMBERS: Members’ independence is crucial for checks and balances of an audit committee to be really effective. If the country circumstances so permit, an audit committee should be composed of and chaired by non-executive members to enable it to exercise truly objective judgment and ask the awkward and critical questions. There are two main aspects of independence, both related to the appointment procedures. One is derived from the duration of membership of the Audit Committee, and the other is the respect of strict qualification criteria to ensure that members have the required skills and expertise to exercise good judgment. Underlying independence is also the application of the safeguards against conflicts of interest that are already contained in many central bank laws for appointments to key positions.

The duration of members’ terms must strike a balance between building institutional knowledge and bringing in valuable external expertise. Rotation should not be too rapid since stability in Audit Committee membership supports consistency and the building of institutional knowledge. A minimum term of three years is usually considered appropriate. The duration of the terms of appointment should strike a balance between being long enough to allow members to become effective, making a useful contribution to the work of the committee, but short enough to ensure a representation of current best practice skills and knowledge and avoid a too cozy relationship with management. For a smooth transition, staggered terms may be considered, as well as a predetermined handover period during which both outgoing and incoming members attend the committee meetings.

Qualification requirements ensure that members are competent, though not necessarily experts, in the areas that fall within the committee’s responsibility. The basic procedure is for audit committee members to be nominated by the board, subject to specific criteria to reflect diversity in technical backgrounds. Audit committees are not necessarily composed of experts, although all members tend to be conversant in financial, accounting, or audit matters. The basic requirement for all members is to be sufficiently financially literate to be able to ask pertinent questions and form objective opinions on internal controls, financial reporting, and risk management. In general, the broader the scope of the audit committee is, the wider is the necessary skills mix. In this case, one member may act as the financial expert for the committee as a whole, drawing on his (or her) experience as a senior financial officer with oversight responsibilities.

Access to resources will also be a determining factor for the effectiveness of the Audit Committee. The Audit Committee may require access to external expertise if the issues at hand are particularly complex. A training budget should also be envisaged, as external members drawn from the private sector would benefit from induction into central bank objectives and operations.

 

 

The relationship between the audit committee and the board of directors is based on delegated authority. After all, one of the reasons for establishing the audit committee is to offset the practical difficulties that the board may have experienced in fulfilling this task due to alternative claims on its time and resources, especially if it does not operate on a full-time basis. A continuing dialogue between the board, management, and the audit committee, as well as more formal reporting at a pre-determined schedule is, therefore, an important element of effectiveness. Several audit committee guidelines recommend the creation of specific reporting protocols.

The chairperson of the Audit Committee plays a key role in maintaining an open dialogue with his (or her) counterparts in the central bank. He (or she) may or may not be a financial expert, but, as a focal point for communicating with the board and coordinating the internal and external audit, strong leadership qualities and the ability to establish good working relationships should also be considered among the qualification requirements.

The form of reporting depends on the relationship of the Audit Committee with other components in the central bank governance framework. The Audit Committee’s formal lines of reporting are such that all findings and recommendations are directed toward the board, since the latter can challenge the internal controls and reporting policies established by management. If it is established as an independent body, a statutory board of auditors for instance, the audit committee may release a full report to stakeholders summarizing its duties and findings. Several Audit Committees established as specialist sub-committees of the board are also issuing a separate summary report as part of the annual report disclosures.

Overlapping membership and the exchange of minutes between the board of directors and the Audit Committee strengthens the relationship between the two bodies. Common membership may be envisaged between the Audit Committee and the board if the latter includes non-executive directors. This may tighten the relationship between the audit committee and the board of directors, and would help the committee better understand the board’s priorities, thereby adding value to the governance system. The link between the two bodies may also be strengthened by virtue of the board secretary (rather than an internal audit official) acting as the secretary of the audit committee. Regardless of the composition of the two bodies, however, minutes of the audit committee meetings that include the rationale underlying any decisions taken should be readily available to all board members. A pre-announced schedule of meetings providing the core programme of seasonal work that the audit committee will be expected to carry out in the course of a financial year would also be helpful in terms of establishing a clear institutional allocation of responsibilities.

AUDIT COMMITTEE IN CENTRAL BANK LAWS: Audit committees have a formal authority that is either delegated by the board of directors, directly derived from the central bank statute, or reaffirmed in a charter. This section discusses the range of possibilities for formally establishing audit committees, whether explicitly in central bank legislation, if this is appropriate in the country-specific legal tradition, or implicitly, by giving the board of directors the authority to appoint specialised committees. Either way, a useful complement to formal and informal authority is a carefully drafted audit committee charter or mission statement. At a minimum, the board should have the power to establish audit committees and, if appropriate, to delegate authority to them. It should be clear whether the audit committee is constituted in a purely advisory capacity, whether specific authority has been delegated to it and whether the board will still be ultimately responsible for oversight. Further operational and organisational details may be included in secondary legislation.

A more explicit reference to the Audit Committee, either in the central bank statute or in by-laws of the board, may be helpful where corporate governance principles are less developed. If a government or the central bank decides to formally establish an audit committee—in case these functions are perceived as not being adequately performed by an existing governing body—the first stage is to determine whether it is an implied responsibility of the board or whether there should be a specific legal provision referring to these functions. In the first case, it might not be necessary to amend the statute. In the second case, it may be necessary to create the legal basis for assigning explicit financial oversight responsibilities to the board. Whether this is done in the statute or the by-laws should be carefully considered; indeed, a more detailed statute might require more frequent amendments, potentially changing the balance between the central bank’s autonomy and accountability, to the detriment of its credibility.

While including an explicit mandate within the central bank statute may contribute to its credibility, it could also undermine the operational flexibility of the Audit Committee. Resorting to by-laws may be preferable, since this leaves more flexibility to adjust the operations of the Audit Committee without having to amend the central bank statute. The Audit Committee would then be able to engage in regular self-assessments to evaluate whether its terms of reference are adequate for the pursuit of their duties. The by-laws would provide further details on the committee’s objectives, tasks, functions, and composition, as well as qualification and appointment criteria for its members.

Regardless of the extent of the reference to the audit committee in central bank legislation, a charter is instrumental in defining the scope of an audit committee. It serves to clearly establish features such as the objectives of the Audit Committee, the source of its authority and its relationship with other parts of the organisation. A charter defines its operational procedures and provides a yardstick for self-evaluation. Various handbooks and guidelines on audit committee terms of reference have been issued, both in the private and public sector. A critical factor in drafting the charter is to strike a balance between being flexible enough not to restrict the scope of oversight, yet specific enough not to lead to unreasonable expectations. Indeed, an open-ended mandate might lead to unrealistic claims on the Audit Committee members, conflicts with other governance functions within the central bank or unwarranted involvement in operational or management decisions.

Compiling the survey demonstrates that the terminology varies widely, and is to a large extent misleading. In some countries, the body discharging the functions of an Audit Committee is referred to as an audit sub-committee, an audit unit, an audit council, an accounting commission, an audit board, or a board of auditors. However, the term ‘Audit Committee’ is the most widely used with some variation due to translation. The focus of the paper is on functions, rather than form: when organisational units are referred to as Audit Committees, they effectively discharge the duties of an internal audit department, or when they are referred to as supervisory bodies and are also attributed policy responsibilities, the central banks were excluded from the survey.

When an Audit Committee exists, it is directly or indirectly referred to in central bank legislation. This is the case for the majority of countries, notwithstanding a bias towards statutory references. Eighteen out of the 39 central bank statutes include an explicit provision on their Audit Committees, and a further two establish the Audit Committee in by-laws of the board of directors. Eight of the remaining 19 statutes that do not refer to the Audit Committee directly still provide the board of directors with the authority to establish such a committee.

The Audit Committee’s core functions and operations are remarkably similar, in spite of differences in legal tradition and terminology. The Audit Committee’s interaction with the board of directors and/or the internal audit department is frequently discussed in the central bank publications, many (at least 7) of which also refer to the existence of a charter. In spite of the fact that the number of members and the frequency of meetings vary from country to country, the existence of cross-membership with the board of directors is widespread (14 cases), as most of the central bank boards include non-executive members.

Many Audit Committees are actively engaged in the central bank’s reporting strategy, upholding accountability. Nearly all the central banks discuss the role of their Audit Committees in a section of their annual report which describes the activities they carried out during the year. The external auditors frequently refer to the work of the audit committee within the notes to the financial statements. Three central banks issue corporate governance statements, giving special prominence to the discharge of their Audit Committees’ duties. Such disclosure is either based on the information compiled by the audit committee for the purpose of reporting to the board of directors throughout the financial year, or on the statement issued for discharging their own statutory obligations. Indeed, in three of the countries surveyed, the Audit Committee present separate reports to stakeholders, reporting directly to the prime minister and/or the president, the minister of finance, or the general assembly of shareholders.

THE BANGLADESH SCENARIO: Presiding over meeting: The Governor presides over Board and Executive and Monetary Policy Committee meetings. However, in line with provision of Section 11(3) BB Order, the Deputy Governor is empowered with equality of votes and casting votes to preside over the Board Meeting in the absence of Governor, and in the absence of Deputy Governor for any reason, any other Director, authorised by the Governor, shall preside over the meeting.  Compared to many other countries, the Bangladesh Bank Order does not include provision for Audit, Risk Management, ICT, HR and Corporate Governance Committees at the Board level for making effective oversight process. However, by a Board decision, there is a provision of Board Audit Committee working since a few years.

STRUCTURE OF THE BOARD AND COMMITTEES: The Board shall consist of— (a) the Governor; (b) a Deputy Governor to be nominated by the government; (c) four Directors who will not be government officials to be nominated by the government, from among persons who, in the opinion of the government, have had experience and shown capacity in the field of banking, trade, commerce, industry, or agriculture;  and (d) three government officials to be nominated by the Government (Section 9). There shall be a Council hereinafter called the Co-ordination Council (section 9A), consisting of— (i) Minister for Finance as Chairman (ii) Minister for Commerce- Member (iii) Governor, Bangladesh Bank- Member (iv) Secretary, Finance Division - Member (v) Secretary, Internal Resources Division-Member (vi) Member (Programming), Planning Commission Member for co-ordination of fiscal, monetary and exchange rate policies.

 

EXECUTIVE COMMITTEE: There shall be an Executive Committee consisting of (a) the Governor; (b) the Director nominated under sub-clause (b) of clause (3) of Article 9; (c) one Director elected by the Board from among the Directors nominated under sub-clause (c) of clause (3) of Article 9; and (d) one Director appointed by the government from among the Directors nominated under sub-clause (d) of clause (3) of Article 9. 

 

POWER OF EXECUTIVE COMMITTEE: Except when the Board is in session, the Executive Committee shall deal with and decide any matter within the competence of the Board and shall keep minutes of its proceedings, which shall be submitted to the Board for information at its next meeting. Time has come to review the Bangladesh Bank Order whether this goes in line with the developments taking place within the country and elsewhere in the world in the changing economic scenario of the digital World. For Bangladesh, it is more important to reassess its current position with a changing political economy of development philosophy and bring central bank order in tune with the changing economic perception. We shall have to recognize the reality of difference between the situations of 1972, 1982, 1992, 2012, and 2021 and onwards and redesign our central banking and financial system to elevate Bangladesh’s journey from agro-economy to industrial economy, from industrial economy to service economy and from service to knowledge economy. The central bank is the key institution that advises the government to implement its economic policy to get the demographic and digital dividend. 

 

 

Jamaluddin Ahmed PhD FCA

General Secretary, Bangladesh Economic Association

Member, Bard of Directors, Bangladesh Bank

Email: jamal@emergingrating.com