Our report discusses a variety of options beyond the implementation of sound practice standards. One possibility is to require higher capital charges for bank exposures to HLIs. Indeed, a primary objective of our current review of the Basle Capital Accord is to determine how to align regulatory capital charges better with the economic risks of different classes of counterparties. We also recognize the critical need to enhance market transparency for the activities of HLIs and other major market participants. The Committee already is working to enhance accounting and disclosure practices at banking institutions worldwide. Extending these efforts to all global players that have the potential to destabilize the financial system, including HLIs, is of particular importance. An international group of central bankers is now studying various approaches to strengthening disclosure in this area. The Committee also considered the advantages and disadvantages of imposing direct regulation on the HLI industry. There are a number of critical obstacles that would have to be overcome before a direct regulatory approach could be implemented. To be effective, any regulation would have to extend to jurisdictions around the world where HLIs are chartered, some of which have more highly developed and more stringent supervisory structures than others. This would require a high level of coordination involving the political, legislative, and judicial bodies of many countries. There is also the difficulty of establishing a regulatory  BIS Review 27/1999  4  regime for HLIs that is not easily circumvented.

Because the Basle Committee’ s jurisdiction is limited to matters of banking supervision and regulation, its primary emphasis has been on ensuring that the major banks prudently manage their risk exposures to HLIs. The best way to achieve this is through the adoption of sound practices by the industry, perhaps supplemented by incentives created through capital requirements. While it is primarily the responsibility of each banking organization to manage its risks, sound practice standards give banks and supervisors a tool to measure industry progress. If banks themselves do not follow sound practices, then supervisors must step in and take the necessary action. The Committee’ s report revealed a number of deficiencies. In particular, the Committee observed an imbalance among the key elements of the credit risk management process, with too strong a reliance upon collateral. This undue emphasis, in turn, caused many banks to neglect other critical elements of effective credit risk management, including in-depth credit analyses of counterparties, effective exposure measurement and management techniques, and the use of stress testing. Credit Approval Process For a bank to make sound lending decisions, it needs to obtain sufficient information about the borrower. Supervisors routinely stress the need for banks to have an effective credit approval process consisting of formal policies and procedures, accompanied by documentation of actual credit decisions. When dealing with an HLI, a bank also must obtain comprehensive and timely financial information about that HLI’ s risk profile and credit quality, and it must engage in an ongoing credit analysis of that HLI.