Relying more extensively on banks' internal risk-management systems can also be used to enhance prudential assessments of a bank's capital adequacy. As the Basel consultative document suggests, over time our examination process for assessing bank capital adequacy would try to use the same techniques that banks are, and will be, using to evaluate their risk positions and the capital needed to support these risks. To spur this process in the United States, the Federal Reserve in June issued new examination guidance encouraging the largest and most complex banks to carry out self-assessments of their capital adequacy in relation to objective and quantifiable measures of risk. A key component of these self-assessments will be each bank's internal risk evaluations of the credit quality of its customers and counterparties. Currently, such internal risk ratings are beginning to be used by a small number of banks in their risk-management, pricing, internal economic capital allocation, and loan loss reserve determinations.
Some banks are further along in the process than others.
Virtually all large banks are moving in that direction. The supervisory policies and procedures being contemplated will build on the increasingly sophisticated management and control systems that are rapidly becoming part of banks' best practice risk-management mechanisms. They will, as well, require both good judgment and sophistication on the part of bank examiners in order to avoid a cookie-cutter application of policies and to develop skills at evaluation that will match those available to the banks. Each LCBO team is directed by a senior Reserve Bank official. Jointly, these teams will represent the Federal Reserve supervisory pillar as it applies to LCBOs.