The international financial system and the global economy are still facing significant challenges and downside risks. So far, prompt action by financial authorities in the US and Europe has helped avert a wider crisis. But financial markets remain uncertain and volatile. 11. Singapore banks have limited exposure to US mortgage related securities, and they remain well capitalised. Over the past year, MAS has intensified our monitoring of financial markets and our supervision of financial institutions. We have also conducted stress tests of Singapore banks and the domestic operations of the large foreign banks here, and the results reported by the banks showed them to be resilient. Nevertheless, there is no room for complacency. The current crisis provides important lessons on the areas we have to work on to enhance the resilience of the Singapore financial system. MAS is also participating in several international working groups that are reviewing ways to strengthen supervisory practices and standards. 2  BIS Review 94/2008  Strengthening resilience: Basel II, liquidity management and standing facilities 12. As new international regulatory standards and practices are finalised, MAS will consider strengthening our standards and market infrastructure where appropriate while taking care to avoid a disproportionate response. Let me highlight three areas, where we had started reviewing our regulatory framework before the crisis and have proceeded to implement these new measures to further strengthen the resilience of our financial system. 13.
In particular, to quote Solvency II directly, “the Matching Adjustment must not include the Fundamental 9  Spread, reflecting the risk retained by the insurance or reinsurance undertaking” . Since the credit rating is the main driver of the Fundamental Spread, this means the credit rating must reflect the risk retained by the insurer. One key characteristic of illiquid assets is that they are not usually externally rated. Instead, Solvency II permits insurers to use internal ratings to determine the Fundamental Spread. Since illiquid assets will often not have market valuations, insurers will often also base the asset valuation on the internal rating by mapping to equivalent traded assets of the same rating. The internal rating may therefore drive both determinants of the Matching Adjustment: the spread over risk-free rates and the Fundamental Spread. Getting it right is important! The PRA set out its views on this subject in a supervisory statement (SS 3/17) last year. 10  We said that  internal ratings must lie within a plausible range of the ratings that would be given by external rating agencies. Individual ratings may vary, depending on credit judgements, but there should be no overall upward bias in internal compared to external ratings. Supervisors are reviewing insurers’ internal ratings and may seek greater assurance where assets have spreads that look large for the rating, leading to a large matching adjustment in absolute or relative terms. We will also consider the complexity of the assets and their materiality to the overall solvency position of the insurer.