Following this process, the Commission bancaire will take a formal decision as to whether or not to authorise the institutions in question to adopt the advanced approaches of Basel II on 1 January 2008. For institutions with foreign entities, this authorisation is granted, where appropriate, following an exchange of information with the host supervisors, i.e. where the institutions’ subsidiaries are established. While many counties, such as France, have entered into the effective implementation phase of Basel II, the recent financial turmoil has once again drawn attention to this framework, leading some observers to call into question its overall rationale. This turmoil has new characteristics as it is a credit crisis in a market environment with particular implications concerning contagion channels. Risk transfer operations, in particular securitisation, and the interaction between funding liquidity and market liquidity risks have played new or at any rate greater roles than before. I am nevertheless convinced that the reform of the capital adequacy ratio rightly remains a crucial element in the regulatory response to the problems facing us today. I would now like to explain why I am convinced of this. 2. The current financial turmoil confirms the need to concretely implement Basel II. This turmoil may very legitimately raise questions about several of the major provisions of Basel II, such as the use of rating agencies or the internal approaches developed by banks to assess credit risk.
In a more general way, it seems useful that supervisors should continue their analysis of the ways in which banks take account of the specific features of certain financial assets whose risk profile may be higher than that of the regulatory asset classes defined in Basel II;  –  We need also to deal better with the issue – crucial for some assets such as housing loans and specialised financing – of the correlation between probabilities of default (PD) and loss given default (LGD). This may be quite  4  BIS Review 11/2008  variable depending on the characteristics of housing loans in different countries. More generally, we need to analyse in greater depth the ways in which banks take into account the guarantees and collateral used and especially the correlation between the risk associated with the hedged instrument and that related to the collateral. This is all the more important given that Basel II increases very substantially the range of collateral eligible for prudential recognition. –  Lastly, it is important to improve the quality of stress tests relating to credit risk – including concentration risk – by including in them possible chain reactions and spillovers on different markets. The way in which the results of these stress tests are factored into risk management and assessment systems as well as, where appropriate, into the level of economic or regulatory capital required must also be closely examined, both by banks and the supervisory authorities.