As the activities of commercial banks have become increasingly diverse and complex, internal controls have become critically important to the sound and successful execution of banks’ strategic objectives. I want to stress this point as strongly as I can. As a former commercial banker myself, I know there is a powerful temptation for management to focus its attention and resources on the front office - those areas and individuals that generate profits for the institution. But if something goes wrong in the back office, it can quickly become the most important aspect of a bank’s operations. It is essential that sufficient resources, staff and managerial attention are devoted to the back office and internal audit functions. Firmly rooted on the foundation of good corporate governance and rigorous internal controls is the central importance of effective risk management. As I mentioned earlier, banking by its very nature is a business of taking calculated risks. If they didn’t take risks, banks could not perform their essential functions in a market economy. But sound banking also entails the prudent management of those unavoidable risks. Each banking institution must have in place the technical systems and management processes necessary to identify the risks associated with its activities - lending and otherwise - and to effectively measure, monitor and control those risks.
The flexibility of credit and liquidity that banks provide - stemming from this unique capacity to create transaction account liabilities - is vital to the smooth development and growth of market-based economies. Other essential functions This money-creating capacity also enables banks to perform other essential functions. For example, banks serve as the primary and back-up source of liquidity for other classes of institutions, financial and non-financial. Even in advanced financial systems, the capital markets rely heavily on the banking system to meet day-to-day cash flow needs and to provide standby financing facilities. In addition, the banking system is the mechanism, or transmission belt, by which the policies of the central bank regarding money and credit creation are implemented, and the pace of economic activity determined. Simply stated, without an effectively functioning banking system for encouraging, collecting and deploying society’s savings, providing the means for quick and reliable payment, and performing these other essential functions I’ve just mentioned, there would be little hope for any economy to mobilize the real resources necessary for economic growth and stability. If money and credit are the lifeblood of a market economy - and they are - the banking system is its beating heart. Public confidence - the key to intermediation But banks’ ability to collect and mobilize society’s savings by attracting deposits is only half of the story. Their ability to retain those deposits is just as critical. This may seem an obvious point, but the retention side of the banking equation is too often forgotten or overlooked.