Likewise various aspects of the internal audit function may well be centralised. So for global groups, the control of the activities in the various legal entities scattered across the planet will hinge on the adequacy of controls located not in those particular countries but centrally. In a way it is simply an extension of the vulnerability of banking entities to problems arising elsewhere in the group. But in this case solvency of the individual entities will depend on the adequacy of systems and controls located in another part of the group. Massive intra-group transactions to move risk between entities will also affect the position of the various subsidiaries. One obvious question is why firms do not dispense with such a plethora of legal entities and operate a simpler branch structure. The answer seems to be that differences in tax structures and even regulatory requirements in some countries still encourage the use of legal entities in different jurisdictions. In that case should regulators try to lean against this BIS Review 21/1997  - 12 -  centralisation? Here I think the answer must be that the regulators should not try to discourage greater central control of risk. Where a firm is running one type of risk in different locations it must make sense for the total risk to be controlled centrally. But this does create a problem for supervisors because supervision has to be structured along legal entity lines (given that it is legal entities which fail). Responsibility for legal entities cannot be transferred between supervisors.
The value-at-risk approach is an attempt in that direction. It recognises that there is a crucial role for judgement in supervision, and that one size really will not fit all. It does not prescribe the key qualitative factors in legalistic detail. But it does set out the parameters so as to ensure that there is a framework in place which will deliver broad consistency and also some degree of prudence. Some have argued that regulators should go further than the value-at-risk approach: rather than defining the key parameters and endorsing particular model types, why not leave it to the banks, and give them an incentive to improve their internal models as much as possible? Under this pre-commitment approach a bank would specify the maximum portfolio loss on its trading activities and this would become the institution’s market risk capital requirement. Banks exceeding their pre-committed maximum loss (that is breaching their capital commitment) would be penalised in one way or another. Such penalties could be financial, or could entail corrective supervisory action. In some ways pre-commitment can be seen as an extension of the model-approval approach we already adopt. The aim, which we endorse, is to ensure that supervisors work with the grain of the business, and monitor ratios which are seen as meaningful by those who run banks themselves. To that extent, we support it. But there are potential drawbacks.