Lessons learned That brings me to my second broad topic, which is the lessons we have learned over the years as we have developed Basel II. I am not looking back simply for the sake of nostalgia. Rather, in looking to the past, I would like to share some thoughts on how the things we have learned and reflected in the process of developing Basel II will help to make Basel II successful in the future, to stand the test of time and to have the impact that we intended. Focus on risk management First, Basel II is fundamentally about establishing incentive-based approaches to risk and capital within the three-pillar framework. We should never lose sight of the fact that Basel II is built around both qualitative and quantitative risk management elements. Why is this so important? As a bank supervisor and central banker, what most concerns me is financial stability. When I review the various reports on this subject that cross my desk, one thing they almost always have in common is an emphasis on the link between sound risk management and financial stability. It is my hope—indeed, it is my belief—that the incentives for risk management in Basel II will therefore promote greater financial stability in the future. Improved and more formalised risk management, as fostered by Basel II, will bring more awareness of risks and better quantification of these risks. To the extent that risk assessment and control methods become more formalised and rigorous, this will lessen the likelihood of making bad decisions.
Looking ahead, one of the benefits of this transparent process is that it has set the tone for discussions between banks and supervisors as industry practices evolve going forward. We have also greatly benefited from the dialogue we have maintained with our supervisory colleagues outside of the Basel Committee. I believe that it is in many countries’ best interest to adopt the new Framework when they are ready, so it is critical that supervisors in these countries be part of the Basel II conversations. The Basel Committee has established several mechanisms for heightened dialogue with our fellow supervisors, and we are fully committed to further enhancing this dialogue. Principles versus rules A third lesson I have learned is that it is important to strike the right balance between principles and rules. Of course, we want to ensure that banks apply principles in the same manner and that supervisors interpret them in the same way even in different jurisdictions. 4  BIS Review 46/2006  But while the temptation is to do this through ever more detailed rules, I am reminded of the words of the famous Surrealist painter Salvador Dalí, who said: “Have no fear of perfection—you’ll never reach it.” We have learned from the Basel II process that adding detail to the rules does not guarantee a level playing field or equal application. The marginal utility of adding detail falls rapidly as you move ahead in a process such as Basel II, so we need more than detail and prescriptiveness.