What is the role of the central bank of the future (2024)

1. Supervision of new and innovative market participants

Central banks need to rethink how they supervise new market players, i.e., FinTechs with their disruptive business models. Unlike traditional banks, the new players don’t typically have large deposits or loans on their balance sheets. Instead, they often act as an intermediary in the market or provide new technologies, but show growing importance for the overall financial system.

As a result, there is a requirement for central banks to adjust their supervisory mechanics, by understanding the business models of the new participants and using technological tools to interrogate the data they provide. Central banks should consider entering into discussions with FinTech and other challengers early in their life cycles to gain knowledge of their platforms and to guide them toward compliant and sustainable growth by providing useful advice and support.

2. Visibility around nonperforming loans (NPLs)

As the recent European Commission’s action plan put forward, NPLs are a topical issue since they are widely expected to increase as a result of the pandemic, while at the same time EU households and businesses cannot afford to lose access to funding throughout the crisis. In this context, the European Central Bank (ECB) has said that “under a severe but plausible scenario”, NPLs could reach levels as high as €1.4 trillion by the end of 2022 for the banks under its direct supervision. Therefore, the EU listed urgent actions to further develop its secondary markets for distressed debt, reform the EU’s corporate insolvency and debt recovery legislation, support asset management companies at EU level, and implement precautionary public support measures to ensure funding is not interrupted.

In this context, technology can significantly help banks to analyze loan portfolios and predict the likelihood of NPLs arising, both within specific countries and specific sectors¹. Of course, for central banks to be able to quickly identify early patterns, it is key to embrace a massive – and rapid – ICT transformation. The ideal end goal is to allow the central banks to interpret real-time data and the deviations from targets to implement prompt actions to avoid a rise in NPLs morphing into a full-blown financial crisis.

3. Central bank digital currencies (CBDCs)

Central banks around the world are investigating the use of CBDCs – digital currencies that are issued and regulated by central banks. In Europe, the digital euro is a priority for the ECB. The bank has already said that a digital euro would be a digital version of the existing euro – it “would not replace cash, but rather complement it”, giving consumers more choice on how they pay.

Nevertheless, the adoption of CBDCs presents challenges for central banks in terms of operating procedures, monetary policy and process design. For example, central banks will need to ensure that cyber risk is mitigated and their CBDCs are compliant with data protection rules. They will also need to examine the probable effects of CBDCs on interest rates, exchange rates and asset prices, and consider whether CBDCs should be indexed to an aggregate price index instead of having a constant nominal value like cash and coins. In addition, the impact of the design of the digital currency on the banking sector has to be considered seriously.

4. Engagement with climate change issues

While central banks are not directly responsible for climate policy, they can play a determining role through monetary policy. As a matter of fact, they have opportunities – and the responsibility – to help drive a change by engaging with the climate issue. This is already happening: the ECB for example has already launched its new climate change centre and is taking action to help the financial system expand its understanding of climate risks. In the US, “Federal Reserve supervisors expect banks to have systems in place that appropriately identify, measure, control, and monitor all of their material risks, which for many banks are likely to extend to climate risks."²

In the future, as Europe strives to achieve the European Green Deal ambitions and as the ECB shall support the achievement of the EU’s objectives, accelerating on responsiblefinance and mitigating environmental risk will be an imperative for central banks across Europe. Let’s remember that climate change has a direct impact on the overall stability of the financial system. Therefore, incorporating climate in financial risk assessments, incentivize green finance, orient asset purchases towards “green” securities, defining models that can measure systemic risks caused by environmental developments are just a few key themes that will have to occupy an increasingly central role on the central banks agenda.

5. Diversity and inclusion

As cornerstones of our society and our economy, central banks face the same issues around diversity and inclusion as other organizations combined with the need of attracting the best talent in all its shapes. Indeed, central banks (and broadly speaking the banking environment) must become more diverse and inclusive. For example diversity in terms of geographical representation has always been important to the EU institutions. Yet, gender parity matters greatly as well, as it’s increasingly happening among corporations. To provide the right answers to the current challenges they face, central banks must be able to draw on a broad and diverse talent pool, looking at gender, age, capabilities, etc.

Looking ahead

As central banks are evolving towards the patterns just described, their roles, strategies and organizational structures will differ significantly in future compared with today. To begin with, the use of new supervisory and regulatory technological tools will support them to perform the task of supervision. They will also need to think about becoming more of a “sparring partner” to the institutions they supervise – whether those are traditional banks or disruptive FinTech.

Going forward, central banks will be stewards of secure digital currencies and use state-of-the-art technological tools to perform real-time analysis of financial data, including loan portfolios. They will also be an employer of choice for the best talent in the market and become adept communicators who can clearly explain their role in the market and what they expect from market players.

To meet the challenges of the future, central banks across Europe will undoubtedly work closely with authorities, policymakers and market participants. They will remain regulators, of course, but they will strive to become more innovative which requires not only massive digital transformation programs, but also a cultural shift to adjust communication, welcome technology and develop deep relationships with the broader ecosystem. To sum up, the central bank of the future will play a new role – maintaining monetary and financial stability while helping to shape a more sustainable, technological and inclusive world.