More generally, we have concluded that making the capital requirements more risk sensitive will help ensure that borrowers are charged a more appropriate price for their debt, and limit the build up of unsustainable volumes of debt. This seems to us a better system than the current, extremely risk-insensitive framework of risk weights, where in the sovereign context nothing short of a rescheduling results in any change in capital requirements for exposures to OECD sovereigns, while for non-OECD sovereigns the charges are completely invariant. It is worth noting here that a similar kind of argument applies in the context of public disclosure by banks, which is also one of the key planks of the proposed new Accord. There is a risk that in some circumstances there are drawbacks associated with this, since disclosure could make a troubled bank’s position worse at a difficult moment. But overall, we think the likely behavioural changes induced by greater transparency offer more benefits than risks. By this I mean that the prospect of having to disclose more about positions to the market will reduce banks’ willingness to take on highly risky positions in the first place. BIS Review 132/1999  2  Benefits and drawbacks of complexity A number of other commentators have questioned the effectiveness of introducing greater complexity into the Basel rules, on the grounds that the framework will always be inadequate to cope with innovation and arbitrage.
Future challenges Finally, before I close, I would also like to stress that many challenges will remain for the Basel Committee even after it has completed its current review of the Capital Accord. I have referred at various points to bank provisioning policies. This has traditionally been an area where internationally there has been little attempt at harmonisation (except at the level of very broad principles). But the systematic use of internal ratings by possibly quite a large part of the banking population will arm supervisors with valuable information about expected losses, and ought to focus attention on the adequacy of provisions to cover such losses. Indeed, more generally, the whole question of the appropriate accounting valuation framework for the banking book may have to be re-examined in the light of any recommendations that come from the Joint Working Group of accounting standard setters that is currently looking at accounting for financial instruments. Also looking to the future, the issue of recognising full scale portfolio credit risk modelling will inevitably resurface. The resulting recognition of diversification effects could result in quite a large reduction of capital for well-diversified banks - who are also of course in many cases the largest, most systemically significant banks. At this point we will have to think very hard about what level of capital we really feel comfortable with in our systemic organisations, and in particular whether an individual firm’s capital requirement ought to reflect the systemic externalities it poses.