I believe that banks adopting especially the advanced approaches to credit risk will increasingly take longer-term views of their international investments, as stress testing and other requirements will ensure that they consider how their risks would react to certain changes in the market environment. When banking systems are adequately capitalised, well-managed and risks are correctly assessed within the appropriate time horizon, the financial system becomes more stable, less procyclical, better able to promote sustainable growth, and more resilient during periods of distress. Risk assessment process that are more formalised and disciplined may facilitate early detections of deviations or mistakes, and that may facilitate making smoother corrections at an early stage, reducing the probability of sudden changes in investment decisions. This, in turn, should benefit emerging market economies by improving the degree of confidence that they can have in the future level of capital inflows. Procyclicality This is very much related to the discussion about procyclicality, an important issue that we at the Committee have taken up and addressed seriously. In particular, some have suggested that the internal ratings-based approaches will drive up the cost of credit for borrowers precisely at times when its supply is falling, namely during downturns in the business cycle. This has led to concerns that Basel II may exacerbate fragility in emerging markets. There is some degree of procyclicality inherent in banking behaviour. The question that we should consider is whether Basel II will unduly exacerbate this behaviour.
In fact, this is one of the key innovations of Basel II compared to Basel I. Basel II is about much more than just setting quantitative minimum capital requirements. It is about establishing incentive-based approaches to risk and capital adequacy management, within a framework of three mutually-supporting pillars: minimum capital requirements, supervisory review and transparency. I think that Basel II represents an unparalleled opportunity for banks to improve their business strategies and risk management systems. In my view, the combination of better risk management, a stronger capital structure and improved transparency standards in the banking system could significantly improve the access of emerging economies to financial markets. This raises two additional groups of relevant questions that I will also address later in my presentation: the first group relates to the transition by different jurisdictions to the new framework, and the second to the necessary cooperation between home and host countries to make its implementation more effective and consistent. BIS Review 33/2004  1  Our discussions on all of these topics will bear on the very well chosen title for this event: “the international banking system at the crossroads.” That wonderful image of a “crossroads” suggests two metaphors that we should keep in mind. The most immediate image that the term “crossroads” calls to mind is, of course, a place where four roads meet. It is where a traveller, having followed one road to this point, must reflect to select one of the next three roads to continue a journey.