Evaluating banks’ readiness  First, the member countries of the Basel Committee have begun to survey their banks’ preparation for the New Accord. Some are gathering information on how banks plan to benefit from the new framework, while others have already evaluated selected banks’ internal rating systems and databases to understand how close those banks may be to meeting the stringent requirements associated with the more advanced approaches. In all cases, we are working to understand the challenges that banks will face and are seeking ways to smooth the transition to the new framework. BIS Review 52/2002  5  2. Training and preparing supervisory staff  Likewise, supervisors in all of the Basel Committee’s member countries are laboring to make sure that they, too, will be ready for the new rules, which is a second area of focus. From the supervisor’s perspective, the New Basel Accord will require a heightened sense of the internal processes used to identify and quantify risk. This, in my mind, focuses our energy on exactly the right place – that is, how we can encourage improvements in risk management by critically evaluating current practices. Our supervisory assessments will encompass several relatively new elements – importantly, validating the integrity, accuracy and consistency of the bank’s process for assigning internal credit ratings. Since those ratings will feed directly into models used to manage credit risk, we will scrutinize more than ever their accuracy and integrity. If the initial inputs are wrong, the whole capital allocation system becomes faulty.

Nonetheless, we believe that this treatment helps to align regulatory capital more closely with the underlying risks. Procyclicality Another general concern expressed is that the New Accord’s increased sensitivity to risk will reinforce behavioral patterns in banking organizations that may increase the cost of credit precisely at times when its supply is falling, namely during downturns in the business cycle. While we are working to address this concern about procyclicality, it is not a reason to shy away from creating better risk management tools. Here, supervisors must articulate the need for banks to assess risks on the horizon. If banks fail to develop and manage to reasonable expectations about how their risk profiles may change over time, they may take on excess exposures today that they cannot administer responsibly tomorrow. At the same time, we should remember that the New Accord sets out the minimum amount of capital necessary to comply with banking regulations. All supervisors expect their banks to operate at levels above the regulatory minima, and nearly all banks manage to their economic capital needs, not to their regulatory capital requirements. So although deteriorating credit quality might drive up the minimum capital requirement, a bank should already be operating above that level, which should dampen the effects of a sudden downturn in business conditions and asset quality. Along those lines, the Committee recently agreed that banks adopting the "internal ratings based" approach to credit risk will be required under Pillar 2 to conduct meaningfully conservative credit risk stress testing.