Let me turn first to updating you on the status of the Core Principles for Effective Banking Supervision. This is an initiative the Basel Committee embarked on in the mid-1990s in the belief that there was a need to foster more effective banking supervision throughout the global financial markets. In developing the Core Principles, the Committee sought to craft a document that would have the legitimacy, quality, and flexibility to meet the needs of bank supervisors around the world. To this end, the Committee made it a key point to consult broadly with other supervisors throughout the various stages of the project, particularly those from emerging market countries. The Core Principles document that resulted from this process brings together concisely in one place all of the fundamental elements needed to carry out effective banking supervision - a remarkable achievement in its own right. Equally important, in my view, the document also balances the desire to set high standards for supervisory practices with a pragmatic recognition that not all countries are in the same stage of financial market development. As such, the Core Principles document is of particular importance for emerging market countries because it establishes a clear set of standards against which each country’s current approaches and progress can be measured. I am convinced that the flexibility embodied in the Core Principles - combined with the valuable substantive guidance the principles provide - is the right model for achieving sustainable improvements in financial market practices.

In particular, we observed an imbalance among the key elements of the credit risk management process, with too strong an emphasis on the role of collateral to protect against credit loss. This undue emphasis caused many banks to neglect other critical elements of effective risk management, including in-depth credit analyses of counterparties, effective exposure measurement, and the use of stress testing. To make sound credit decisions, banks need to obtain sufficient information about the borrower to provide a comprehensive and timely picture of its risk profile and credit quality. This is true regardless of whether the extension of credit occurs via a loan or through a counterparty trading relationship. Yet the Basel Committee’s report found that banks did not obtain sufficient financial information to assess the types and extent of risk assumed by large, highly leveraged institutions. In particular, banks did not BIS Review 126/1999  2  obtain the information needed to assess leverage, risk concentrations in particular markets, or the liquidity risk profile of individual institutions. The Basel Committee report also concluded that banks should develop more effective measures of potential future exposure, which refers to the possibility that credit exposures can change over time as market conditions fluctuate. The ability to measure potential future exposure is critical when dealing with large trading counterparties such as highly leveraged institutions, especially in volatile market conditions. Unfortunately, methods for measuring potential future exposure have not kept pace with the growth and composition of trading activity.