##mediaries. this suggests that the shift of risk from financial intermediaries to investors in financial markets has provided for a better, more dispersed allocation of risk. this leads me to the third aspect, the implication of it - related change on the assessment and management of credit risk. banks may face a rapidly evolving credit risk environment. the credit quality of individual firms and the correlation of risk factors among sectors will change quickly in the continuing process re - positioning of firms. as a consequence, issues related to sectoral exposures - as in the case of telecoms - or an increasing reliance on credit risk transfer tools, would become increasingly relevant. this is even more important as increasing firm - specific risk may require larger portfolios and a greater range of exposures than before. another fundamental issue is that technological change challenges the reliability of backward - looking indicators ( such as default histories ) for credit risk assessment. this would call for an intensified monitoring of high - tech sector firms, but also of “ traditional ” borrowers, who may be vulnerable to mistakes regarding the choice of technology. let me conclude. innovation is beneficial - and it can be particularly beneficial in the case of a general purpose technology such as it. this being said, public policy should have a genuine interest in promoting entrepreneurial spirit and innovation. however, if one sees innovation as a process of creative destruction, it is also important to contain the destructive forces that may threaten financial stability. the general challenge in this respect is to properly understand and manage the risks involved in the financing of innovation. from the perspective of central banks in their responsibility for financial stability, the report highlights two areas where individual central banks and the central banking community as a whole play a part : • to employ the research capabilities and the knowledge of the financial system combined in central banks to analyse issues such as accounting and transparency, or the impact of increasing reliance on credit risk transfer through securitisation or credit derivatives. • to use central bank expertise for the monitoring of the financial system. changing linkages between the real and the financial sphere, and across the different segments of the financial system, in particular the re - allocation of risk across the financial system, underline the need for such systemic monitoring.

rates ; estimating the impact of the combination of risks to which the insurer is exposed on its balance sheet across many different scenarios ; taking these outputs and converting them into a simpler set of equations – or proxy model – that relates the insurer ’ s net assets to a series of risk factor inputs. the purpose of estimating a proxy model is to make it tractable to run many more scenarios. the complexity of the underlying valuation models would make this impractical computationally. running hundreds of thousands of scenarios through the proxy model in order to generate a distribution of probable balance sheet outcomes over one year ; and this definition is based on the one in supervisory guidance on model risk management, sr letter 11 - 7, federal reserve board and office of comptroller of the currency, april 4 2011 all speeches are available online at www. bankofengland. co. uk / publications / pages / speeches / default. aspx focusing on the tail of losses and estimating the 99. 5th percentile of the distribution to identify the minimum amount of capital necessary to protect the insurer against a ‘ 1 in 200 ’ scenario. ( see chart 1 ) the use of models in solvency ii is more ambitious than in banking regulation. comparing use of models in banking and insurance regulation : the insurance capital model framework encompasses the whole balance sheet whereas banking models focus on particular risks ( market, credit, counterparty ). in the case of credit risk, models are built for particular portfolios ; insurance models estimate overall capital requirements taking account of assumed diversification benefits across different risks whereas bank capital requirements are determined risk by risk and added together, with no diversification benefits across risks, although diversification is taken into account within risks ; regulation determines or constrains more elements of bank than insurance models ; in banking regulation, the standardised approach is calibrated to give higher capital requirements than internal models for a typical bank whereas in insurance the two approaches are calibrated to the same confidence level ; and it is more straightforward for banking supervisors to top up capital requirements using so - called pillar 2 of the bank capital framework. once an internal model has been approved under solvency ii, supervisors have more limited scope to apply capital add - ons, which can only be temporary. i make no apology therefore for the exacting nature of our internal model approval and change processes for uk insurers. models must meet the tests and standards set out in solvency ii. these are both quantitative –