This would be a natural extension of the risk-based approach to supervision that is already applied and it should be viewed as a means of fostering closer interaction between the industry and the regulator, rather than an imposition of regulations. To enable the process, CBSL has begun to examine the legal requirements in this regard. The internal capital adequacy assessment processes (ICAAP) of banks should cover the identification and measuring of the risks and assessing how much capital is needed to support such risks. After implementation, the CBSL will review banks’ ICAAP as part of the risk-based supervisory process. In addition, there will be an ongoing evaluation of the capital adequacy of banks, including stress tests. In the process of evaluation, CBSL will review and evaluate the risk profile of the banks, the adequacy and reliability of the ICAAP, and identify any weaknesses or inadequacies and necessary prudential measures. Pillar III – market discipline The purpose of this Pillar is to complement Pillars I and II by encouraging market discipline through the public disclosure of key information on risk exposures and capital adequacy. Disclosures are applicable at the bank level as well as supervisory level. The level and content of Pillar III disclosures will vary according to the measurement and calculation approaches adopted by a relevant bank. In terms of Basel II, the disclosures would have to be made on an annual and semi-annual basis. The implementation process will be developed in 2007 along with the Sub-committee appointed for the purpose.

However, in order to avail of the preferential risk weight, banks have to prove that this regulatory retail portfolio meet the qualifying criteria. Operational risk Basel II introduces an explicit capital charge for a bank’s operational risk, i.e. the risk of losses caused by inadequate or failed internal processes, people and systems or by external events such as natural disasters which calls for increased capital requirements. Throughout this year, the Central Bank insisted on banks having comprehensive business continuity plans to ensure that there are alternative arrangements if the core-banking functions or payment and settlement functions of banks were to fail. We issued guidelines, discussed with banks on one to one basis and I believe that action has been taken or is being taken to ensure that business continuity plans are done with utmost care and dedication. As with credit risk, Basel II provides a choice of 3 approaches to the measurement of operational risk and initially, the simplest approach which is called the Basic Indicator Approach is recommended for use by all banks. Accordingly, the capital charge will be based on the gross income of the banks. The most complex Advanced Measurement Approach (AMA) can be made applicable at later stages as techniques for the quantitative measurement of operational risk are still not widely used by Sri Lankan banks. However, regardless of the approach used, all banks are expected to, in their own interest, have in place sound internal operational risk management systems that are commensurate with the nature of their business activities.