Solvency II review, internal models and the solvency capital requirements calculation Having mentioned the Solvency II review, I do not propose to try and cover the many topics that it encompasses. I do want to talk about one aspect which risks being overshadowed by the familiar headline topics of risk margin, regulatory reporting, and matching adjustment. That is, the overall approach to setting capital requirements, and the potential role of sector-wide stress testing in that. Under the existing implementation of Solvency II, there are many firms for which the standard formula is not appropriate, and internal models are the near-exclusive determinant of capital requirements for all or part of the business. And those models either have to be approved or, if not, rejected in their entirety, using a bottom up approach of assessing compliance with a large number of technical tests and standards. The philosophy is, in effect, that everything can be modelled, and that determining capital adequacy is essentially a technical exercise. This denies the reality: first that some risks are simply not conducive to modelling; and second that even for those that are, there will always be a chance that the model is wrong. It hinders supervisors in responding flexibly to risks not well captured by a specific model, or by modelling in general. And it has led to huge expenditure of effort by both firms and supervisors in the approval of models and model changes.
The more prolific the reporting, the more robust the risk assessment and the more widespread the return optimisation, the more rapidly this transition will happen, breaking the Tragedy of the Horizon. 12  All speeches are available online at www.bankofengland.co.uk/publications/Pages/speeches/default.aspx  12