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 Modernisation”. 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?


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 bank’s direct customers, and its wider stakeholders, now also require “policy functions” such as:

  • Management of the nation’s 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 bank’s 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 Parkinson’s 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 don’t know where you’re 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 bank’s 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 Manager’s 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 don’t know where you are now, it will be hard to confidently move forward.”

A central bank’s 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 system in Good Practice Accounting and Reporting)

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 program’s methods and results are outlined in IMF Study: Improving CB Management)

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!