That was why Basel II provided not only for the use of internal models in Pillar 1 of the regulatory framework, but also for the Pillar 2 and 3 requirements so as to provide a second view on banks’ solvency (Pillar 2), including one based on stress tests and performance measurement, and to facilitate market discipline via disclosure (Pillar 3). Unfortunately, the financial crisis and subsequent analysis have shown that bank and supervisory practices are not as consistent as they could be. For example, the risk weights of some banks that introduced internal models under Basel II have been trending downwards in recent years, when experience and intuition say they should have been moving in the opposite direction. Many people worried that Basel II would be procyclical. It would seem that those fears are largely unfounded, but for reasons that may be far from satisfactory! Increasingly, this has led to questions about the credibility of internal model-based capital ratios. Therefore, alongside the assessment of national regulations, the RCAP has also started studying the consistency of outcomes at individual banks. As with the introduction of a rigorous peer review programme, the significance of this initiative should not be underestimated. Never before have we had international teams of supervisors looking at the modelling practices at individual international banks. I think this is a quite telling example of the regulatory community’s commitment to improving the consistency, comparability and reliability of bank capital ratios.
At that time, the long “fiscal dominance” history of the Turkish economy that severely restricted the efficiency of monetary policy and shallow financial markets that were not well developed were the primary characteristics of the Turkish economy. All these limited the economy’s room for maneuver on the eve of the adoption of the new monetary policy regime. Independence of the Central Bank of Turkey that came in 2001, was almost the only institutional factor in hand at that time on the way towards the ultimate objective of price stability. Given this overall framework and conditions, the Central Bank of Turkey preferred a smooth transition towards inflation targeting whereby it would wait until all these factors that restrict the efficiency of monetary policy would weaken. In early 2002 following the achievement of relative stability in financial markets after the 2001 Crisis, the Bank announced its new monetary policy regime in a public statement as implicit inflation targeting. As it was emphasized in the same now historical statement, the final aim was to adopt the full-fledged inflation targeting regime, once the preconditions were met. This ‘new’ regime was defined as inflation targeting since the central bank announced a numeric target for annual inflation jointly set by the government according to its law and price stability was now its primary objective. Furthermore, it was similar to inflation targeting in the sense that the decision making process was shaped in a forward looking manner by exploiting the broadest set of information available.