If an AI is able to demonstrate to us that it has a better way of allocating capital against these risks than our own SRP model, then we will be open to discuss with it a corresponding adjustment to its capital ratio. Thus one aim of this approach is to give banks an incentive to come up with a better mousetrap. There will be capital benefits from having a good internal capital allocation process. 3/5  Implementation challenges I'd like to say a few words next about the implementation challenges associated with Basel II. Although preparations for the implementation of the new capital framework are well advanced in a large number of jurisdictions, including in Hong Kong, the process has not been without its critics. It has recently been claimed that too much regulation is now itself the greatest source of risk in the global financial system, and the implication that is supposed to be drawn is that regulators are somehow engaged in a self-defeating exercise. At the root of this criticism is the compliance burden that arises from Basel II implementation taken in combination with other recent developments, such as the adoption of International Accounting Standards. The first point I should make is that the timing of these various initiatives is not completely under our control: the accounting profession, for example, has tended to plough its own furrow independently of any of the banking regulators. This has been the case in many leading international financial centres, not just in Hong Kong.
Thus Hong Kong will adopt Basel II at the same time as other major international financial centres, such as London, Frankfurt and Tokyo. From a regional perspective, the implementation timetable in Hong Kong is broadly similar to that being adopted by Australia and Singapore. For several years now the HKMA has been developing its supervisory approach along Basel II lines, and this is leading to some significant changes in how supervision is conducted. Central to this is the issue of "process versus rules". Process versus rules The original Basel Capital Accord was developed when risk management was still very much in its infancy. It reflects what might be called a "rules-based" approach to regulation in the sense that it sets prescriptive standards that banks are required to follow. It relies largely on the application of simple, mechanical formulas for assessing how much capital a bank should hold. The essence of the old Capital Accord was that it represented an attempt to monitor the prudential soundness of banks by using a standardised risk measurement framework, which was applied to all institutions and which employed data based on a snap-shot of their balance sheets at certain specified reporting dates. The approach was standardised since regulators specify the precise form in which the calculation of capital adequacy is to be performed - for example, the specific risk categories into which assets are to be assigned.