From the very moment that a loan is granted, and before any impairment on this specific loan appears, there is a positive default probability (no matter how low it might be) following a statistical distribution with an expected loss. The expected loss is known in a statistical sense but not yet identified in a specific loan operation or borrower. As the risk appears at the beginning of the operation, so does the statistical provision requirement. With this system, provisions run in parallel to revenues and are therefore distributed through the cycle allowing for a better mapping between income and costs in the profit and loss account. The statistical provision that we have established works in practice as an addition to the “old” existing provisions: when “old” provisions are well below expected losses, the “new” dynamic provision is added. In good years the net “specific” provisions are very low (or even negative, if there are substantial recoveries), so the new provision accumulates. But in bad years the “specific” provisions increase sharply, eventually exceeding the gross burden of the statistical provision. The net result is that with this system provisions are distributed over the cycle, providing a better recognition of expected losses. More specifically, the amount of the statistical provision is the difference between the measure of latent risk (i.e. expected losses) and the specific provision (that covering impaired assets). In good times the specific provision is low and the statistical provision is positive.

Ladies and Gentlemen, The global financial crisis that erupted in 2008, or 2007 if you count the U.S. sub-prime crisis as its first incidence, has brought fundamental changes to how central banks approach economic and financial stability. In particular, the crisis has led to a general reorientation of central bank policies in three major directions. The first is the reorientation of monetary policy to take into account financial stability concerns. The second is the shift from “deregulation” to “re-regulation”. And the third is the supplementation of traditional microprudential regulation with macroprudential one. In the realm of monetary policy, the pre-crisis consensus was that the attainment of price stability, or low and stable inflation, was enough to ensure a smooth progress of the economy. While central banks were well aware that financial disruptions could have a serious negative impact on the economy, they were of a view that financial stability was the job of prudential regulation and that monetary policy should focus on inflation and output stabilization. The dichotomy between monetary policy and financial stability policy was well observed across the central banking community. Central banks like the Bank of Thailand, which also looks at financial imbalances when making monetary policy decisions, represented only a small minority before the crisis. The global financial crisis has prompted a fundamental rethinking of central banks’ monetary policy conduct. Now it is recognized that price stability alone does not guarantee economic and financial stability and that there exists an intricate relationship between monetary policy stance and financial stability.