With a deepening process of financial globalisation that we are now seeing, supervisors and central banks are faced with increased challenges to analyse and manage risks, especially in the context of more complex interlinks between financial institutions and financial markets, as well as between domestic and the global economies. In such an environment, the risk management ability of financial firms and supervisors is important and rests crucially on the ability to assess quantitatively and in a forward-looking manner, the possible impact of each risk scenario on the economy and its financial sector. In this light, a sound and practical approach to integrate the quantitative assessment into financial stability and into risk-based supervision is most crucial, as it will allow the potential key risk affecting the financial sector to be identified, to be assessed, and to be ranked in order of importance. Through this, the approach will help focus policy dialogue and facilitate communication between all the key stakeholders, namely – the supervised financial institutions, the home and host supervisors, other related supervisory agencies especially in the case of complex financial conglomerates, and between the monetary authority and the Finance Ministry. In moving forward, it is important to recognize that, while these quantitative techniques are valuable tools, they are no substitute for a thorough understanding of the overall risk dynamic of financial institutions, the related systemic implications, as well as the behaviour of institutions and markets.

The emphasis here is that a good macro-surveillance framework must balance technical excellence and technical complexity with sound rationale and good qualitative judgment in order to make real contribution to policy decision. The robust framework of risk-based supervision such as Basel II places a strong technical demand on supervisors not only on Pillar I but also for the Supervisory Review work in Pillar II, which requires dynamically assessing on-going risk and changing risk profile of financial institutions. Therefore, macrosurveillance, stress-testing, as well as model validation, will fast become the norm for good risk management. BIS Review 98/2007  1  Macro-surveillance and its parallel policy framework – especially macro-prudential policy – are now exciting fields for central banks and supervisory agencies. But in my view, the needed pioneered framework is yet to be developed. The quantitative models and tools so far are at its early stage of development compared to those more established in monetary policy, such as the inflation targeting framework. The frontier work currently undertaken by central banks of advanced economies are, for example, developing macro-stress testing model which incorporates interlinkages between financial and real sectors. Such work is quite demanding due to the complexity of the evolving linkages and behaviour linked to rapid developments in economic and financial sector, and all the more so with globalisation. In response, community of experts are emerging, and many such experts are now using virtual network such as stress-testing internet platform to share knowledge and experience.