This choice to carry out on-site inspections of internal risk measurement systems and approaches and the importance attached by the Commission bancaire to such checks is mainly due to the fact that, in 2008, 17 institutions (accounting for almost 95% of the total assets in the French banking system) are set to use an IRB approach to measure their credit risk and 5 institutions (accounting for almost 60% of the total assets in the French banking system) are expected to adopt an advanced operational risk measurement approach. As institutions have the possibility under Basel II of using their IRB approaches to calculate regulatory capital requirements, supervisors must ensure that these approaches are reliable. Following these on-site inspections and the examination by the Commission bancaire of the corresponding inspection reports, 26 Memoranda of Understanding (MoU) were signed  2  BIS Review 11/2008  with the institutions concerned. Improvements were requested mainly in the following areas i) the different classes of risk held by the institutions, sometimes also ii) the definition of default used by them, iii) the estimate of certain parameters such as Loss Given Default (LGD), iv) the operational integration of the approaches implemented in the daily management of risks and v) the governance principles applicable to these approaches. Until the end of 2007, the Commission bancaire will monitor the implementation of the corrective measures requested of the institutions.
Lastly, it introduces a requirement for regulatory capital to be tailored for certain off-balance sheet exposures, particularly liquidity facilities associated with these transactions, which under Basel I were generally exempted of any capital charge. Second, by reinforcing the link between the capital base and the risks actually incurred, Basel II encourages banks to improve their systems for managing these risks as well as their due diligence procedures. Beyond reminding banks of the basic caution required when extending credit, this encouragement is all the more useful in that banks now often play a role in securitisation transactions for which the underlying assets, for example housing loans, may be initiated by unregulated entities, that are not always  BIS Review 11/2008  3  accountable for their risk analysis and pricing. In other words, the weaker the discipline surrounding the granting of a loan the stronger banks’ diligence procedures needs to be. Thirdly, Basel II gives banks and supervisors a vital tool, Pillar 2, with which to assess the risk profile of institutions and in particular to take account of certain risks that are sometimes difficult to quantify but whose impact can be great. By way of example, I shall merely mention refinancing risk and reputational risk. Pillar 2 thus enables banks, through the determination of the level of economic capital and supervisors, via for example an increase in capital requirements, to ensure that all of the risks incurred are appropriately covered.