capacity of banks to undergo an extreme, but plausible, financial stress event. With respects to credit risk, in general banks losses are modeled as a function of bank specific (types of credit, loan portfolio quality and concentration, etc.) and macroeconomic variables (GDP growth, unemployment, etc.) behaving in accordance with the agreed scenario, which may be deterministic (historical or subjective) or stochastic (typically, derived by Monte Carlo). Regardless of how the scenarios are assembled, the effect on banks’ loan portfolio quality can be obtained with a top-down analysis, directing the impact of the shock to the bank portfolio as a whole, or bottom-up, assessing the effect on each market segment or business line and aggregating the results across the bank. The latter type of analysis is much more precise and detailed, and therefore requires a rich set of data. Much of this necessary information is normally collected by PCRs as part of their normal operational business procedure. Detailed PCR data can also allow supervisors to perform a precise analysis tracing the impact on banks largest borrowers, who typically account for a large share of their assets and thus may have systemic relevance. In all these cases, detailed loan data will allow bank supervisors to better model the impact on banks portfolios of the shock as well as banks’ capacity to remain solvent.

These and other off-site techniques require detailed credit information of banks’ loan portfolio to evaluate their underlying risk. Although some of these data may be obtained from the bank themselves by means of regulatory reports or from the latest on-site report, PCRs usually contain updated data of practically all borrowers in the loan portfolio and consequently outperform other sources of information.

# **IV. PCRs and the implementation of Basel III**

Published in 1988, the former Basel I Accord became obsolete as the banking industry developed new financial products to circumvent its capital requirements.<sup>27</sup> Most sophisticated larger banks had gone through a rapid evolution of their risk management. Financial innovations had found mechanisms to evade or arbitrage away the Basel I capital standard, mainly through securitizations, masking the true riskiness of the bank. Therefore, there was an increasing debate as to whether institutions were adequately capitalized given the nature and extent of the risks they were exposed to. With this knowledge, the Basel Committee on Bank Supervision issued in 2006 the Revised International Capital Framework (Basel II), attempting to better align bank capital requirements to economic risk by associating more precise estimates of risks. However, in hindsight, Basel II was ill equipped to handle the new _disaster myopia – disappointing, but perhaps unsurprising? Or network externalities – we understood how difficult these were to capture?_

> _No. There was a much simpler explanation according to one of those present. There was absolutely no incentive for individuals or teams to run severe stress tests and show these to management. First, because if there were such a severe shock, they would very likely lose their bonus and possibly their jobs. Second, because in that event the authorities would have to step-in anyway to save a bank and others suffering a similar plight._ ”  (Haldane, 2009). 27 For small, simple institutions Basel I-based prudential arrangements are probably still suitable. This is in fact reflected in Basel II (now part of Basel III), to the extent that the standardized approach is similar in its philosophy  to Basel I.

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