4  BIS Review 3/2007  V.  Involvement of boards, senior management and governance issues  Basel II requires the involvement of the senior management in the process of identification, evaluating and mitigating risks. Does this mean that the senior management and the board members should use some supervisory and monitoring powers to ensure that the technical and other officers continue to engage in risk mitigation activities and that the board is satisfied with action taken by them? When there are several layers of supervision, you might need a liaison officer to communicate with the management and the board. The bank management should address this issue early and avoid serious governance issues. VI. Capturing new risks  When financial market innovation takes place globally, new products such as derivatives, securitization will be introduced and they are likely to bring in new risks including operational risks. How do we balance these new risks with other internal risks, systems, processes and also with supervisory prudence? It is evident that Basel II enables banking to be based on more market driven systems which is conducive to financial innovation and it requires setting aside risk mitigation processes to deal with ever increasing financial innovation. VII. Handling of operational risks  Should banks use stress testing or best practices in handling operational risk? Stress testing is merely a tool which gives results on a reliable set of data.
We have witnessed a process, with no practical solution in sight, involving nationalisations, bankruptcies, bank interventions, the creation of new investor guarantee schemes and considerable curbs on market practices, such as those affecting the short-selling of equities. The list of institutions affected includes most notably: the major investment banks, whose business model has succumbed to the turmoil; the US government-sponsored mortgage agencies; one of the biggest worldwide insurers; and major US credit institutions. In Europe, UK, Danish and Icelandic banks have been involved, as have more recently those from euro area countries such as Belgium, the Netherlands, Luxembourg, France and Germany. Moreover, several European governments have announced their readiness to guarantee their banks’ deposits. The foregoing developments pale into insignificance in the face of the importance of the US Treasury’s decision to propose a far-reaching programme whose stated aim is to tackle globally the serious problems besetting the American financial system. The initial appropriation of $ billion for this programme, and its dramatic presentation by the US Treasury Secretary, illustrate the scale of the problem. As you are aware, the plan was finally approved following heated debate in the House of Representatives and in the Senate. Clearly, beyond its effects on specific banks, this unprecedented crisis is profoundly shifting some of the key coordinates that have framed global financial developments in recent decades. An economy such as Spain’s, which has been financing a substantial proportion of its expenditure abroad, can hardly isolate itself from the consequences of such deep-seated changes.