Supervisors will review and respond to those internal assessments, thereby creating incentives for banks to evaluate their exposures thoroughly and to plan their capital strategies carefully. •  Finally, Pillar 3 - market discipline - seeks to make a bank’s risk profile more transparent to outside investors and market participants. This should better enable the market to reward banks that take a responsible approach to risk management and penalise those that do not. Market discipline can serve as a powerful incentive for prudent behaviour: indeed, markets are sometimes stricter than supervisors. Basel II’s combination of a process-oriented focus with incentives for banks to improve their risk management offers benefits both for individual banks and for the banking system as a whole. For an individual bank, Basel II encourages management to adopt approaches that are relevant to the risks the bank faces and that are appropriate for its level of sophistication. That, in turn, ensures that the bank takes prudent steps to protect itself against losses, including making appropriate use of its capital resources. The consequences are even greater at a macro level. I believe that, when risks are properly assessed and managed across all banks, our banking system becomes more stable, less sensitive to the swings of the business cycle, and better able to promote sustainable growth. This benefits not just individual banks, but also businesses and consumers alike. 3. Strengthening the foundation for Basel II  To achieve these benefits, supervisors must ensure that the foundation for Basel II is ready.

I mentioned earlier that the application of sound accounting and provisioning standards is a key element that we must build into the foundation for Basel II. When accounting rules are weak or poorly enforced, neither bankers, nor supervisors, nor marketplace participants can have much faith in their ability to evaluate the safety and soundness of a bank’s operations. No matter how sophisticated a bank’s risk management systems may be, they are ultimately worthless if we are unable to determine the worth of the bank’s assets and liabilities confidently. Even when standards are enforced nationally, substantial differences in accounting standards between jurisdictions can complicate the ability of global markets to exercise discipline effectively and to allocate capital efficiently across borders. In our efforts to strengthen financial stability, central banks and supervisors have a legitimate interest in the quality of accounting standards and their effective implementation. We believe that, in order to contribute to strengthening the banking system, accounting standards should support - or at least be consistent with - sound risk management and control practices in banks. In addition, they should  BIS Review 52/2004  5  facilitate market discipline by promoting transparent reporting of banks’ financial position and performance, risk exposures and risk management activities. Finally, accounting standards should facilitate the effective supervision of banks. Because of this view, the Committee has sought to participate actively and constructively in the international debates on accounting.