Lastly, it introduces a requirement for regulatory capital to be tailored for certain off-balance sheet exposures, particularly liquidity facilities associated with these transactions, which under Basel I were generally exempted of any capital charge. Second, by reinforcing the link between the capital base and the risks actually incurred, Basel II encourages banks to improve their systems for managing these risks as well as their due diligence procedures. Beyond reminding banks of the basic caution required when extending credit, this encouragement is all the more useful in that banks now often play a role in securitisation transactions for which the underlying assets, for example housing loans, may be initiated by unregulated entities, that are not always  BIS Review 11/2008  3  accountable for their risk analysis and pricing. In other words, the weaker the discipline surrounding the granting of a loan the stronger banks’ diligence procedures needs to be. Thirdly, Basel II gives banks and supervisors a vital tool, Pillar 2, with which to assess the risk profile of institutions and in particular to take account of certain risks that are sometimes difficult to quantify but whose impact can be great. By way of example, I shall merely mention refinancing risk and reputational risk. Pillar 2 thus enables banks, through the determination of the level of economic capital and supervisors, via for example an increase in capital requirements, to ensure that all of the risks incurred are appropriately covered.

This also means that supervisors should not carry out a mechanical assessment of these risks and their management by banks such as would result for example from the simple observation of a statistical confidence interval. The assessment must be more refined. In addition, Pillar 2 should ultimately serve to improve risk management in the areas that supervisors, at a given moment, deem to be crucial for financial stability, using a forwardlooking approach. Lastly, the recent financial turmoil has highlighted the difficulties and risks associated with the valuation methods used for certain financial instruments, particularly complex structured products but also some products regarded as more straightforward. Indeed, a sometimes very great disparity has been observed between the theoretical valuations derived from models and market values. However, the issue of the accurate estimation of the price of complex transactions has taken on particular importance with the gradual adoption across the board of fair value assessments since the entry into force of the new accounting standards (IFRS). In this respect, it seems necessary to include in risk assessments assumptions of an erosion of liquidity and a rise in volatility as well as, more generally, to ensure that processes for monitoring valuations within banks are strengthened. In particular, it is vital to reinforce critical, independent and regular analysis of valuations obtained for certain complex positions, which appear to have relied too often on external data supplied by external rating agencies or service providers, without real analysis of the characteristics of the underlying and collateral.