European governments have begun to take steps towards fiscal consolidation, and must convince markets that these steps are credible. Unfortunately, the private sector is not ready to take over the slack in public demand. Private sector debt-to-GDP ratios exceed 250% in the G3 economies. In the United States, where the household debt-to-disposable income ratio reached an unprecedented 135% in 2008, deleveraging is already underway with the recovery in private consumption well below historical rebounds. While Eurozone households are less leveraged than US households, disposable income is likely to grow more slowly in the Eurozone and hence be a bigger drag on consumption. A third source of deleveraging is the banking system. Banks in the Eurozone have to strengthen their capital adequacy position to meet new regulatory requirements as well as buffer against potential losses on their sovereign debt holdings. With uncertain prospects for raising fresh capital in equity markets and facing funding shortages in wholesale markets, some of them are looking to scale back their risk-weighted assets. The resultant crunch in credit could further exacerbate the slowdown in the economy. With governments, households, and banks all having to deleverage at the same time, we are looking at a prolonged period of sub-par growth in the advanced economies. In many advanced countries, debt-to-GDP ratios are not expected to stabilise until 2015 to 2020. BIS central bankers’ speeches  1  Asia: neither decoupled nor derailed What does deleveraging in the G3 mean for Asia? Asia is not immune to developments in America or Europe.
This challenge is not unique to Sri Lanka, but common to all countries which have opted to comply with Basel II requirements. To address this issue, banks in other countries have created a dedicated post in their institutions, i.e. Chief Risk Manager, who will not only look into the risks in the bank’s own portfolios, but also to the clients’ portfolios. The job of the Chief Risk Manager is to identify, evaluate risks and make recommendations to set out appropriate processes in managing the relevant risks. The processes should be acceptable to the senior management and the boards of the banks and also to the external auditors and the regulators. II. Appropriate risk evaluation techniques  Application of appropriate techniques for risk evaluation is an implementation issue. This is where the modeling comes into play. Modeling is used as a popular technique for identifying, quantifying and analyzing risks to enable the management of banking and financial institutions to decide on the allocation of capital. But one need not entirely depend on modeling and be out of reality as modeling will produce a statistical outcome depending on the data you feed into a set of equations or a simulation model. Modeling also involves issues such as focus on loss data, validation, calibration and issues on floors and ceilings. A practical issue on loss data is a different reporting system by banks, especially when it comes to large losses. Secondly, some institutions may not reveal large losses at all, but there are implications for operational risks. III.