The benefits of developing more aggregated measures of risk across diverse business lines are especially appealing to complex financial organisations whose activities span many kinds of activities. As a result, it is not surprising that large, mixed financial conglomerates have tended to invest most in the development of economic capital estimates. Using the concept of economic capital and its elements, banks can develop sound policies for monitoring exposure limits, risk-adjusted pricing policies and sound provisioning practices based on the inherent risks of the portfolios. They can also measure returns and assign capital on a riskadjusted basis. Let me add a word of caution. Despite the significant progress made in the banking industry in the use of models and new technologies, banks still depend largely on risk managers’ expert judgement. Quantifying risk involves making assumptions and judgements. And no model, and no software package, no matter how sophisticated, can ever replace the skills of a trained, experienced and conscientious risk manager. That is why we have made sure that the Basel II framework is much more than numbers and models. Such judgement should be reinforced, however, with the best possible information, techniques and tools for processing that information. To the extent that risk assessment and control methods become more formalised and rigorous, this will lessen the likelihood of making bad decisions. It will also contribute to the prompt detection of errors and deviations from targets, allowing banks to implement corrective measures at an early stage.
I do not claim that Basel II covers all the areas and refinements needed to complete the framework for financial stability, but it does make a landmark contribution by incorporating a new forward-looking approach, to banking regulation and supervision, which is, at the same time, consistent with the lessons of the past. 3. Framework for financial stability. Beginning with my first topic - the framework for financial stability - allow me to make a final reference to the hypothetical book that might be written in 2046. I would not be surprised if the author of that future book noted an interesting contrast that existed at the beginning of the twenty first century. Although we have a well-developed framework for debating and conducting monetary policy, our thinking on financial stability is less advanced. 2  BIS Review 8/2005  As an example, in the monetary field we have agreed on a definition of monetary stability – namely price stability. We have a framework of analysis that allows the causes and consequences of price instability to be studied. And, moreover, we have a highly developed decision-making framework for pursuing monetary policy, which has almost universally adopted the principles of central bank independence and primacy of price stability as the goal of monetary policy. In comparison, and despite significant progress during the last decades, we are not nearly as far along with financial stability, and there are areas where we still have something to learn.