. while this outcome may be inevitable, we do need to think carefully about the possible consequences. first, given that we have to have a simple alternative to the internal ratings approach, it is important that the new accord provides the right degree of capital incentive for banks to progress over time to using internal ratings. it is the committee's firm intention to ensure that the final accord provides modest incentives for banks to adopt the internal ratings approach. there is a conservative bias in the standard approach ; and internal ratings in measuring risks more accurately should, for lower risk business, result on balance in lower capital requirements. the objective of ensuring some capital incentive for banks to progress to risk sensitive measurement does, of course, have to be balanced against the objective of roughly maintaining the overall amount of capital in the financial system. it would be dangerous to financial stability if we gave so large a capital carrot to banks to use the internal ratings based approach that many of the world's most important financial institutions, which account for the vast bulk of global and g10 domestic banking activity, saw a significant reduction of their regulatory capital requirement. it is the need to balance incentives with the maintenance of overall capital levels which makes this issue a difficult one. this, along with a large number of other questions about the impact of the proposals, will be further examined by the committee in the course of a quantitative impact study to be carried out before finalising the proposals. the bank of england has been asked to co - ordinate this work calibrating the impact of the new accord on individual institutions and on the system as a whole. i recognise that the time allowed for this exercise is short, but i hope very much that we can count on the contribution and co - operation of the banking community. turning to the second possible consequence of maintaining a risk insensitive alternative approach, we may find that the combination of having some banks on the irb approach and some on the standard approach will, perversely, introduce a financial stability risk that is not present with all banks on the standard approach. this is that the more sophisticated institutions would have to hold more regulatory capital against weak loans than banks that remain on the standard approach. over time, therefore, we could find that the worst - quality credits could gravitate to those banks which are the least able to assess, price or monitor them. however, i do not wish to suggest such a scenario without also highlighting how we may guard against it. first, of course, the

downturn. this is clearly an issue of major concern to central banks. the risk is not a theoretical one ; there is evidence that external ratings to some degree behave procyclically, while banks'internal ratings are liable to be even more so. clearly here again a balance has to be struck between our desire to have the new framework incorporate and reflect current practice at banks, and ensuring that these current practices do not lead to economic volatility. the committee's statement that ratings should not be'point in time'but'must represent a conservative view of a long run average probability of default for the borrower grades'attempts to introduce such a balance. such ratings ought to be reasonably robust to the normal ups and downs of economic activity. the committee has backed this up with requirements for minimum lengths of data histories to underlie the internal ratings, so helping to ensure that they incorporate some experience of economic low points. over - optimism by banks in allocating ratings could also induce procyclicality. the committee proposes several checks on this. in particular, supervisors will look at the ratings allocated to some individual loans, and also compare the distribution of loans across rating bands with those of different banks. ultimately, of course, we will have to rely on those charged with daily supervision of banks, backed up by the pillar 3 disclosure requirements, to ensure that ratings are not set in a way which risks undue procyclicality. impact of the basel accord on smes leaving aside the issue of how the risk sensitive capital requirements will behave over an economic cycle, i would also like to touch on the question of how they may affect the supply and pricing of finance to certain types of borrower. if risk sensitivity means a greater distinction between different types of borrower, we need to consider carefully whether the right outcome has been achieved. a specific concern, which i know has occupied a number of members of the basel committee, is how small and medium sized enterprises might be affected, given their importance to economic activity and their reliance on bank finance. it is not yet clear how the proposed new accord would affect the pricing of finance for smes. many factors are relevant, including whether banks are on the standard or irb approaches, what types of collateral or guarantees smes can offer, whether the borrowers are classed as part of the retail portfolio ( as very small enterprises will be ), whether the regulator sets the bank's overall target capital ratio ( which in the uk is