But clearly, banks are exposed to more than just credit and market risk. Operational risk also is a growing concern for the banking industry. The looming issue of Year 2000 remediation is just one example. With the continuing diversification of banking, the fast pace of financial innovation and the growing concentration of crucial payments, settlements and custody businesses, the importance of operational risk is rising, especially at many larger institutions. These institutions find that the probability of a financial loss resulting from a breakdown in internal controls or systems is greater than ever. As banks expand into new lines of business, such as electronic banking, this trend is likely to continue. For instance, consider the risk of a breach in electronic security controls that leads to unauthorized access to confidential customer information. Should this breach be severe and pervasive, it could lead to considerable legal and reputational problems for a bank. Further, the overall rapid pace of technological change in this area means there is a substantial risk of obsolescence. These are just some of the risks that banks must manage, and clearly the list I have set forth is not exhaustive. In particular, consider banks in emerging market countries that are subject to a unique set of risks as a result of the financing and investment cycles in their countries. Those banks that fund their domestic assets with foreign currencies may be particularly susceptible to liquidity risk when sharp fluctuations in exchange rates and market turbulence make it difficult to retain sources of financing.

Inevitably, this aspect takes on greater importance. For one reason, supervisors expect banks to operate above minimum regulatory capital ratios included in the Basle Accord – and prudent assessments can help to inform by how much. For another, supervisors seek to intervene early enough to prevent capital from falling below prudent levels – and bank assessments can provide another useful tool in identifying key issues before they become major problems. With these thoughts in mind, supervisors are tackling the challenge of developing a more systematic approach to the review of capital adequacy. Supervisors also are discussing ways to enhance market-based discipline. Most agree there should be a greater role for private-sector monitoring of banks. Of course, there already exists a fair amount of market-based monitoring; however, the collection and use of these kinds of information usually are not systematic or complete. The first goal is to improve information available to the market. With enhanced risk disclosure, supervisors will be more able to rely on the opinion of market investors. These opinions are reflected quickly in the price of bank debt and share prices, and the ease with which banks can access capital. By relying more on these market signals, supervisors will be better able to identify and address waning capital levels at problem institutions. To the extent banks develop disciplined internal approaches to evaluating capital adequacy and capital plans, and enhance disclosures, supervisors will be able to place greater reliance on all three pillars and meet the challenges of a more complex financial marketplace.