The Basel II framework makes it clear that a bank should be allowed to provide its own estimates of the risk components for the calculation of its regulatory capital requirement only on the basis of a sound internal control and oversight framework. From our experience, this represents the primary challenge for some banks as they may focus only on the quantitative aspects of adopting the IRB Approach, without taking necessary account of the qualitative aspects. Without a sound internal control and oversight framework, these quantitative tools might be employed improperly and generate incorrect information for credit and management decisions. As such, the drawbacks brought by the use of sophisticated tools could outweigh the benefits. Thus, validation standards for the internal rating systems adopted by banks will need to place as much emphasis on the qualitative as on the quantitative aspects of validation. Data issues are another critical challenge facing banks and involve both quality and quantity aspects. On the quality side, it appears that the awareness of data integrity generally remains low on the management agenda. Some banks may still have the misconception that data management only requires an IT system to keep the numbers, and does not require senior management attention. In fact senior management need to take the lead in improving data quality. Apart from making available the necessary IT infrastructure and resources, this includes establishing an appropriate data management program as well as policies, standards and control mechanisms, and from time to time, emphasising the importance of data quality to the relevant personnel.

These topics, as I understand, will be discussed this afternoon under the two scheduled working group sessions. To broaden the geographical reach of the large pool of useful reference documents on IRB-related issues produced for its meetings or contributed by the member jurisdictions, the AIGV has developed an electronic library on eBIS to store these documents for access by the supervisory community. The hosting of this event is well timed, as some jurisdictions have already entered into the implementation phase of the Basel II IRB framework and other jurisdictions, including many from Asia, are in the pipeline for the introduction of the framework for adoption by their banks. The event is therefore a good opportunity for representatives of jurisdictions which have yet to adopt Basel II to hear from jurisdictions already implementing the framework about the emerging issues, and to facilitate future communications on this topic among participants. As Chairman of the EMEAP Working Group on Banking Supervision, the HKMA certainly welcomes the opportunity to host this outreach event, and would like to thank the AIGV members who have stayed behind after the regular meeting to provide support. A major innovation of Basel II is that it allows banks to calculate their regulatory capital requirements using the output of their internal rating systems, subject to supervisory approval. Under the IRB Approach, banks employ internal rating systems to produce estimates of one or more risk components, which are then used as the key inputs to the calculation of regulatory capital requirements for credit risk.