On the quantity side, since the notions of internal rating systems and the quantification of credit risks remain relatively new to the industry, some banks may have kept the relevant default and loss data only for recent years. Insufficient data consequently becomes an obstacle to the implementation of the IRB Approach by banks, in particular that the data collected so far may not be long enough to cover a complete business cycle. As such, the stability of an IRB system under different economic conditions cannot be meaningfully evaluated. The problem is especially consequential in Asia, as economic fluctuations in the region have tended to be faster and greater in magnitude than those in more mature banking markets. The third challenge banks in Asia may face in adopting the IRB Approach is the paucity of internal resources necessary for rating system development and validation. Many banks have relied, or intend to rely, on external parties such as consulting firms and model vendors. Employing third-party services can be beneficial in respect of areas like professional expertise, knowledge transfer, the utilisation of a more comprehensive data set and assuring independence in the validation process. However, over-reliance on external parties does carry certain risks. One example is that banks may not have the internal expertise to assess the quality of the rating systems delivered by model vendors. And it is not just the banks that face resource issues, it is the supervisors as well.
In common with supervisors in the more developed markets, we face the challenge of limited internal resources and expertise with which to implement the IRB Approach. Moreover, banks and supervisors are often competing between themselves for the relevant expertise. In addition, the support to supervisors in Asia from external parties, such as academia, vendors, consulting firms and rating agencies, is more limited than in the developed markets. Finally, both banks and supervisors face a very steep learning curve in familiarising themselves with  2  BIS Review 120/2007  the basic concepts and techniques on which the IRB Approach relies, and need to become more conversant with these types of risk management technique. A particularly important issue to consider that is highly relevant to today’s event is the standards that bank supervisors will apply in deciding whether or not to approve a bank to use the IRB Approach. To ensure that the capital charges computed by the IRB systems are sufficient for banks to withstand the credit risks they have incurred and to absorb the potential losses resulting from borrower defaults, the estimates of the risk components must be accurate in capturing the relevant aspects of risk. As a consequence, validation of banks’ estimates of the risk components, and the underlying internal rating systems, is crucial to the implementation of the IRB Approach. This is one of the greatest implementation challenges confronting bank supervisors in Asia, where the development and understanding of the IRB Approach by banks is generally still at an early stage.