the opposite. for basel ii is an attempt to mould supervisory capital requirements to the ways in which banks actually manage their business. moreover - and this is the crucial point - it aims to relate the capital requirement not only to the amount of risk they undertake, but also to how well they manage that risk. so, in other words, not only will banks get lower capital requirements in respect of lower risk credits ; but they ’ ll also get lower capital requirements if they can demonstrate that they manage risk well. it is for this reason that basel ii might perhaps be better thought of not as the second “ capital accord ” but rather the first “ risk management accord ”. because it focuses attention not only on the more accurate measurement of risk, but on the management of risk. banks looking to reduce their capital charge will have two choices : either reduce the risk, for example by substituting better risk credits for lower risk credits, or by reducing positions ; or simply manage the risk better. and this will apply not only to credit risk. again, to take the example of operational risk, banks will have the option of investing in more advanced approaches which will translate into lower capital charges. you may have noticed that i just mentioned banks having options, having choices. this is another key feature of basel ii. no longer will there be a “ one size fits all ” approach whereby banks of varying shapes and sizes are shoehorned into one inflexible system of capital charges. instead, banks will be able to choose what approach they take ; for example, whether they adopt the standardised approach or irb approach for credit risk, and which of the various approaches to operational risk they adopt. having said that, the hkma will of course have its own views on what levels of sophistication of risk management we would expect to see in different types of banks. while we won ’ t mandate particular approaches, we will expect to see levels of risk management that are commensurate with the types and levels of risk being run. so, for example, we won ’ t necessarily expect even a large bank with significant credit risk to implement advanced irb. but we would expect a bank of such a type to have a fairly advanced internal credit rating system. as another example, we would generally expect banks with a significant level of market risk to implement a models based approach to measuring the risk. this flexible approach - in contrast to the approach being adopted by some other supervisors, who are mandating

where we can expect to see banks making greater use of credit scoring models, and in particular models to estimate probability of default. it seems likely that only a very small number of banks in hong kong will decide, on the basis of their assessment of the costs and benefits, to invest immediately in a fully - fledged irb - compliant system. however, very many more, i am sure, will want to test the water by starting to make greater use in their credit risk management process of models to assess pd, and this is something that we in the hkma will welcome and, indeed, encourage. rather than build an elaborate in - house model, many banks may start by purchasing and adapting a system from an external vendor. or they may join together with other banks to share the cost of building models and databases, or establish a relationship with the academic fraternity. with so many banks, we will probably see a variety of approaches, but i think the direction is clear. models are here to stay. the second important area in which the use of quantitative techniques will, i believe, increase, is the area of stress - testing. one lesson we have all learned from the asian financial crisis is that the level of economic activity, asset prices and currency values can fluctuate quite widely, and this can obviously have a big affect on banks ’ profitability, capital position, and, ultimately, ongoing viability. one way of trying to ensure that banks can stand up to such stresses is to conduct regular stresstesting, in other words to assess how they would be affected in hypothetical stress scenarios. such testing is becoming an increasingly integral part of the risk management process within banks and, for that matter, the supervisory process. for example, if you have a good understanding of the extent to which your asset quality might be affected by an economic downturn, or how the value of your holdings of securities might be affected by changes in interest rates, this is valuable information in helping you manage your risks. so this is a technique that can be very useful indeed, and which i am sure many banks will want to explore further. all this talk of greater use of modelling and of quantitative techniques raises, of course, the question of whether there is sufficient availability within hong kong of the necessary expertise and skills. this, i would suggest, offers many opportunities - not the least, i would add, for our hosts and sponsors today, as both the academic fraternity and specialist service providers can potentially play an important role here