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Fresh Perspectives | citi | Issue sixteen Coordinating the recovery Central banks globally are transforming from guardians of their domestic financial systems to architects of a coordinated global recovery. Commercial banks can assist central banks by providing operational and infrastructural support. writer Heather McKenzie Filippo Sabatini, global head of public sector, Global Transaction Services, Citi Called upon to play an even more critical role in financial systems, central banks are looking to commercial banking partners to provide operational and infrastructure support as they take on a strengthened role as defenders of the financial system. The creation of the c440bn ($545bn) European Financial Stability Facility (EFSF) special purpose vehicle for troubled eurozone members in June 2010 highlights the critical importance of governments and central banks in their new role as defenders of the financial system. While not directly involved in the set up of the facility, central banks have been an important driving force behind its formation, says Filippo Sabatini, global public sector head, Global Transaction Services, Citi. “There has been a coordinated effort by European governments – with the help of central banks – to continue to support the economy during the crises we have seen in Greece and elsewhere,” he says. “Central banks will continue to play a key role in driving efforts to stabilise the financial markets, stabilise liquidity flows and support the economy.” From guardian to architect This is the latest article in a series of Fresh Perspectives, sharing forward thinking across global transaction services, sponsored by Citi. This role as guardian of the financial system has evolved as central banks – traditionally tasked with setting monetary policy, maintaining the stability of a country’s financial system and acting as sovereign banker – are now playing an instrumental role in rebuilding the global economy. At the height of the financial crisis, central banks in the world’s major economies coordinated funding windows, pumping massive amounts of liquidity into the financial system in order to alleviate the credit squeeze. They also played a key, if background, role in the handling of toxic assets, via state-guaranteed institutions that take the risk of asset writedowns out of commercial banks’ books. While the focus in the early days of the financial crisis was on financial institutions and corporations, rescue efforts are now being aimed at the country level as concerns increase over sovereign debt in a number of eurozone countries. The EFSF will issue debt instruments backed by national guarantees from the euro area member states. To ensure the best possible credit quality and rating for the instruments a number of measures have been adopted including a 120% guarantee of each member-state’s pro rata share for each individual bond issue and the constitution of a cash reserve when loans are made to provide an additional cash buffer for the operation of the facility. The EFSF, which will run for three years, is the main part of a g750bn aid package that EU finance ministers devised to fight the sovereign debt crisis. The European Commission is providing g60bn while the International Monetary Fund will provide g250bn, and the balance will be raised through the capital markets. But preventing a sovereign debt crisis is not the only example of how central banks can help to defend the financial system. Mr Sabatini cites the Central Bank of Haiti, with which Citi recently hosted a one-day conference focused on how to modernise and improve the functioning of the Caribbean island’s financial system. The event was convened to aid Haiti’s rehabilitation after the devastating earthquake of January 2010, to assist with the challenge of managing the flow of international aid, to help the availability of credit to get businesses back on their feet and the application of new technology to create greater transparency, efficiency and con- Issue sixteen | citi | Fresh Perspectives trol of the nation’s public finances. The Haitian government is planning to create credit guarantee funds with its central bank to facilitate access to credit. The central bank is optimistic about Haiti’s ability to rebuild and “bounce back” but is concerned about inflationary pressures from large amounts of foreign aid entering the country, and fears that the banking system could collapse under the pressure of debtor losses. “central banks are playing a critical role in providing a reliable financial infrastructure” Operations and infrastructure Innovation and efficiency On a global level, governments are under severe pressure to reduce deficits and are seeking ways to be more efficient. This includes efficiency in deploying financial resources. “Governments want to reduce spending and control flows and central banks or ministries of finance are supporting financial innovation to develop instruments to do this more efficiently,” says Mr Sabatini. The new role for central banks has operational implications. “The bank bailouts, government stimulus packages and rescue funds have focused attention on the operational and infrastructure aspects of the financial system,” says Mr Sabatini. “Central banks and their commercial banking partners are playing a critical role in providing a reliable financial infrastructure for the global economy as it recovers.” In Haiti, for example, money is moved physically from one bank to the other. Citi is looking to help the country develop operational efficiency in the banking system as the country is reconstructed, Mr Sabatini explains. “We are looking at how to contribute to the efforts being made to ensure that the money and capital inflows to Haiti are effectively deployed in the interests of the people. A new system to efficiently distribute benefits and other remittances into the financial markets is very much a priority.” In a separate move, the concept of “charity aggregators”, which will serve as the linchpin of all non-governmental agencies in Haiti, is beginning to take shape. Such aggregators will focus on exploring mobile payment opportunities and microfinance initiatives so that payments and donations are disbursed in the most efficient way. Elsewhere in the world, operating under constrained circumstances with limited resources, central banks have looked to implement innovative solutions in order to improve efficiencies, the value of which can be redeployed to stimulus programmes. Mr Sabatini believes that as the world economy slowly emerges from recession, there will continue to be pressure on central banks and financial regulators to transform the financial system to deliver more efficiency to all participants. “Central banks do not directly sponsor all of the moves that are being made – for example, the development of prepaid cards for the distribution of social benefits – but in certain countries they have to regulate or support the development of new financial instruments,” he says. In the case of the EFSF, says Mr Sabatini, the European Investment Bank will execute the transactions made on the fund and manage all of the underlying aspects such as agency roles and collateralisation of the assets being taken by the borrowing governments. “There will be a significant debt capital market component to this facility and this will have implications for the middle and back offices of the underlying special purpose vehicle, be it the issuer or operator, as well as government borrowers – who will be the recipients of funding,” says Mr Sabatini. In meeting its fiduciary responsibilities for disbursing payments and acting as collateral agent, the EFSF will be supported by the European Investment Bank, which has confirmed its willingness to provide treasury management services and administrative facilities. This is where commercial bank partners come into the picture, says Mr Sabatini, as they can ensure reliability and competence in handling the operational aspects of such flows. “Central banks and finance ministries are the cross-roads of wider public sector efficiency,” he says. “But they need partners to help them to deliver that efficiency.” Highly qualified commercial banks can provide a range of operational services from cash and securities settlement, liquidity management through to securities lending. Action and regeneration For example, Citi GTS is working with various governments and central banks worldwide to advise on best practices in the creation of shared service centres (SSCs), which will provide standardisation, greater controls and better cost management for finance activities. Australia’s central bank, the Reserve Bank of Australia (RBA), established a SSC in conjunction with Citi that provides banking services for more than 90 federal government agencies. The system makes pension payments to 56,000 Australian citizens in more than 100 countries. The platform enables RBA to offer flexible payment options to the non-resident pensioners and to reduce the costs of delivering payments overseas, including FX and local clearing costs. In the UK, Citi helped to establish the Government Banking Service, which was launched in 2008. As part of HM Revenue and Customs, the service provides treasury management and banking transaction services to central government departments and wider public sector bodies, using structures and tools to increase efficiency and emulate best practice in the private sector. Users include HM Revenue and Customs, National Savings and Investments, executive agencies, non-departmental public bodies and NHS organisations. “The impact of the financial crisis highlighted the role central banks play in limiting the risks in the financial system,” says Mr Sabatini. “The world is changing and governments and central banks need to take rapid action to support the regeneration of the private and public sectors. While the economic landscape has changed, the need for central banks to improve operational efficiency and work with commercial bank partners has not.”