In common with supervisors in the more developed markets, we face the challenge of limited internal resources and expertise with which to implement the IRB Approach. Moreover, banks and supervisors are often competing between themselves for the relevant expertise. In addition, the support to supervisors in Asia from external parties, such as academia, vendors, consulting firms and rating agencies, is more limited than in the developed markets. Finally, both banks and supervisors face a very steep learning curve in familiarising themselves with  2  BIS Review 120/2007  the basic concepts and techniques on which the IRB Approach relies, and need to become more conversant with these types of risk management technique. A particularly important issue to consider that is highly relevant to today’s event is the standards that bank supervisors will apply in deciding whether or not to approve a bank to use the IRB Approach. To ensure that the capital charges computed by the IRB systems are sufficient for banks to withstand the credit risks they have incurred and to absorb the potential losses resulting from borrower defaults, the estimates of the risk components must be accurate in capturing the relevant aspects of risk. As a consequence, validation of banks’ estimates of the risk components, and the underlying internal rating systems, is crucial to the implementation of the IRB Approach. This is one of the greatest implementation challenges confronting bank supervisors in Asia, where the development and understanding of the IRB Approach by banks is generally still at an early stage.
While there is a case for Asian regulators to perhaps concentrate their Basel II implementation efforts initially on the Standardised Approach, they would eventually like to see their banks, those large ones in particular, adopt the IRB Approach over time as adopting the IRB Approach can substantially enhance the quality of risk management of banks. Moreover, Asian regulators including the HKMA find ourselves in the position of playing host to many large and internationally active banking groups that propose to adopt the IRB Approach globally, including their operations in our jurisdictions. In consequence, we need to develop plans for the adoption of the IRB Approach in our domestic banking  BIS Review 120/2007  1  environment. In doing so, we need to balance the readiness of the industry and other supervisory priorities versus the desirability of implementation of the IRB Approach. On readiness of the industry, we believe that there are three key challenges facing banks in Hong Kong and probably other jurisdictions in Asia. First, the adoption of the IRB Approach by banks does not merely involve the use of sophisticated quantitative tools, but also corresponding advances in banks’ risk management practices, culture, internal control and corporate governance. This is essentially the underlying and overarching principle of the IRB and other advanced approaches provided under the Basel II framework.