Of course, to add value over and above the minimum capital standards, improved disclosure must go beyond the simple reporting of minimum capital ratios. When banks disclose timely and accurate information about their capital structure and risk exposures, market participants can better evaluate risks and act accordingly. The disclosure of timely and accurate information, in turn, is an incentive for banks to ensure that the market perceives them not only as effectively managing their risks, but also as being adequately capitalized. Market reactions to the public disclosures of banks can also play an important signaling role for supervisors in assessing the adequacy of a bank’s capital. A further reason to encourage disclosure beyond the reporting of regulatory capital ratios is that these ratios have become the primary focal point for investors and industry analysts. The result has been that bank managements have had an incentive to focus solely on improvements in these ratios, even when the ratios are not fully reflective of risks. More comprehensive disclosure could lessen this incentive. With these considerations in mind, the Basel Committee is seeking to design an expanded set of disclosure guidelines, taking into account the proprietary information needs of banks. I believe that fuller disclosure for all banks can take us a long way towards effective market discipline. We also encourage banks to include in their fuller disclosures information specific to their risk profile. The timeliness and the quality of disclosure are important. The frequency of disclosure should reflect the nature of the risks involved.
The Basel Committee’s report also showed that banks must develop approaches that better account for credit risk under distressed market conditions. A key lesson of the LTCM episode is that credit and market risk cannot be seen as completely distinct, but are liable to interact and reinforce each other under highly stressful conditions. The use of more rigorous stress testing, therefore, could have given banks better warning of the types of exposures they faced. Together with this January 1999 report, the Basel Committee issued a sound practices document setting forth guidance for banks and supervisors on these topics. For example, these sound practices called upon banks to: •  establish clear policies governing their involvement with highly leveraged institutions;  •  adopt credit standards addressing the specific risks associated with these institutions;  •  establish meaningful measures of potential future exposure as well as credit limits incorporating the results of stress testing; and  •  monitor exposure on a frequent basis. I am pleased to report that the Basel Committee’s recommendations on highly leveraged institutions have been reinforced by the recommendations of subsequent efforts, including reports by the President’s Working Group on Financial Markets and the Counterparty Risk Management Policy Group. There is clearly widespread agreement among both the private sector and the official community about the steps that firms need to take to address the weaknesses in risk management identified in the LTCM episode. The key remaining issue is the strength of the private sector’s resolve to implement these measures.