To address these issues, the Basel Committee has proposed a new Accord which would allow firms to use externally or internally generated credit risk ratings to differentiate more precisely between different risks. There would also be a significant expansion in the recognition of collateral, credit derivatives and guarantees as means of reducing overall risks. These proposals are currently under discussion by central banks, regulators and market practitioners. Given our financial stability responsibilities, the Bank of England has been closely involved in this process. A team led by Patricia Jackson at the Bank has been providing technical and policy support to the Basel Committee, and we hope to have an agreement in the course of next year. The new Accord does not, however, go to the point of recognising VaR-type models for measuring credit risk on portfolios as whole. At present, these models are not judged to be sufficiently robust to form the basis of a regulatory regime. A central issue is the sheer lack of information. Many types of loan have no publicly visible price, so the models lack a large and reliable data base. The behaviour of loans under different scenarios, and the correlations between different assets - both key inputs to any VaR model - have in many cases to be assumed rather than measured. And testing the ex post performance of the models is difficult. Where credit instruments lack market prices, model predictions can only be compared to data in the event of defaults, which are relatively rare.
Monetary and fiscal policy must be complementary in order to curb cyclical fluctuations. BIS Review 20/1999  16  Fiscal policy must be credible in the long term. The welfare society is dependent on solid government finances. The authorities must exercise caution in establishing fixed long-term priorities in the government budget. Measures aimed at countering an increase in unemployment must not be irreversible and undermine long-term credibility. The conditions for addressing the challenges are favourable. Employment is high and the population is well educated. However, our economy is also exposed and vulnerable. In recent years fiscal policy has been too expansionary. This year the fiscal stance is appropriate. A continued tight fiscal policy can contribute to restoring credibility and confidence so that interest rates can gradually be reduced. Let this be my hope for future developments. 17  BIS Review 20/1999