The emphasis in the new Accord on improved data standards should not be interpreted solely as a requirement to determine regulatory capital requirements, but rather as a foundation for risk management practices that will strengthen the value of the banking franchise. In addition to building on the current state of risk management practices, Basel II also promotes continued improvements in those practices. As I emphasized a moment ago, bank supervisors now are heavily focused on critically assessing risk management and control systems - where we find shortcomings, we constantly urge banks to make risk management improvements. Those shortcomings can reflect individual firm failings, in which case, we press the individual firms to bring their approaches up to the evolving best practices of well managed competitors. But the shortcomings can also reflect more systematic problems across the industry - necessitating supervisory efforts to move the industry ahead more broadly to improve its standards. Clearly, both through the microjudgments for individual firms and through the issuance of broader public guidance to address crossindustry concerns, the supervisory process is critical in ensuring improvements in risk management practices. Basel II can materially reinforce these efforts by setting strong qualification standards and capital incentives for firms to measure risk more accurately. Historically, the supervisory method for evaluating credit risk at banks in the U.S. focused on the identification of individual commercial loans that were already troubled.
With these elements in place, comparability should be greatly enhanced. Moreover, unlike Basel I, the new Accord allows for the evolution of bank practice over time by building on the core elements of a bank’s internal methodologies - methodologies that are expected to continue to improve, particularly with supervisory and market encouragement. Basel II: Risk management improvements The second, and perhaps more significant, benefit I mentioned is the encouragement to improvements in bank risk management practices. Basel II has always had this objective in mind in addition to creating a stronger, more risk sensitive measure of bank capital. We are clearly already seeing this objective being realized. Basel II builds on risk measurement concepts that have emerged in the industry, although clearly the application of these leading practices varies within and across firms. There has been enormous progress as banks commit to programs that will bring their systems and practices into alignment with the standards articulated in Basel II. 2  BIS Review 35/2005  As I have emphasized, a major focus of our supervisory activities has been on ensuring that banks are actively engaged in advancing the linkage of quantified risk-taking to capital, as this is at the heart of both sound banking and Basel II. Let me offer some specific examples, beginning with credit risk and then turning to operational risk. An example can certainly be seen in the management of retail exposures.