And third, how to compensate for the democratic deficit of technocratic monetary policy decision-making. Concerning the first issue, empirical research has found out that greater central bank independence is on average associated with lower inflation, but not with higher volatility. This “free lunch” was a bit surprising in the light of the “conservative central banker theory”. It reflects the fact that the actual institutional and policy design has evolved over time to guarantee that the mandate to achieve low inflation is not interpreted rigidly. In fact, most central bankers pay attention to real economic developments in their policies. In the last decade, this fact has been formally and institutionally reflected in the “flexible” inflation-targeting regime. This regime is often described as “constrained discretion”, meaning that it aims at making the monetary policy-making constrained by understandable procedures and at the same time flexible in responding to unforeseen shocks. As far as the democratic deficit is concerned, this issue has been addressed by moving to greater transparency and accountability of central banks. The burden of proof in central banks’ communication has shifted over the last two decades. At present, it is necessary to give convincing arguments if one thinks that the central bank should not give out some information, rather than to argue why something should be revealed. This has been a significant shift in the central banks’ mentality. Regarding the issue of communication and co-operation between the central bank and government, no universal solution has been found so far.
Such testing is becoming an increasingly integral part of the risk management process within banks and, for that matter, the supervisory process. For example, if you have a good understanding of the extent to which your asset quality might be affected by an economic downturn, or how the value of your holdings of securities might be affected by changes in interest rates, this is valuable information in helping you manage your risks. So this is a technique that can be very useful indeed, and which I am sure many banks will want to explore further. All this talk of greater use of modelling and of quantitative techniques raises, of course, the question of whether there is sufficient availability within Hong Kong of the necessary expertise and skills. This, I would suggest, offers many opportunities - not the least, I would add, for our hosts and sponsors today, as both the academic fraternity and specialist service providers can potentially play an important role here. I hope that these thoughts on Basel II have been of interest, and possibly have brought out some aspects that may not have been picked up on before. From what I have said it should be clear, at the very least, that Basel II is not some abstract regulatory compliance issue of no real value to the banking industry.