roger w ferguson, jr : basel ii - a case study in risk management speech by mr roger w ferguson, jr, vice - chairman of the board of governors of the us federal reserve system, at the risk management workshop for regulators, the world bank, washington, d. c., 28 april 2003. * * * i am pleased to join you this morning as you begin your conference on risk management in banking. as many of you may know, i have been spending time on the initiative to increase the risk sensitivity of the basel capital accord - the subject of your first panel discussion. in the last analysis, our basel ii efforts are geared to improving risk management - measuring risk more accurately ; communicating those measurements to management, to supervisors, and to the public ; and, of course, relating risk both to capital requirements and to the supervisory focus. this morning i will not discuss the details of the basel proposals. tomorrow, the basel supervisor's committee will publish its third consultative document describing the proposal in its near - final form, and i urge you to review it and provide your comments and suggestions to the committee. it is not too late to shape the details. this morning, however, in keeping with the theme of the conference, i will spend my time talking about the objectives of the proposed basel ii, particularly as they relate to risk management. risk in banking any discussion of risk management in banking must start with the understanding that banks exist for the purpose of taking risk, and the objective of supervision is certainly not to eliminate, and perhaps not even to lower, risk - taking. rather, the objective of supervision is to assist in the management of risk. we cannot lose sight of the fact that banks'willingness and ability to take risk, in turn, has allowed them to contribute significantly to economic growth by funding households and businesses. nonetheless, this economic function, especially when conducted with a relatively small capital base and using mainly funds that have been borrowed short - term, has historically led to periodic rounds of bank failures and changes in credit availability that have exacerbated macroeconomic cyclical patterns and inflicted losses on households and businesses alike. such a history has often led to proposals to change dramatically the business of banking ; it clearly has been a major reason for central banks and for the regulation and supervision of banking. these developments, however, did not change the risktaking function of banking nor the need for risk management. banks, from the very beginning, have, to be sure, managed risk

guarantee that there will not be any problems. in fact, the turmoil generated by the international crisis has fed through to the spanish economy and impacted it at a time when it was beginning to adjust the imbalances which had built up during fifteen years of continuous high economic growth. all these factors led spain into an economic recession which is reflected most significantly in the sharp rise in unemployment. this, together with high corporate and household debt, in the framework of what had been excessively lax financing conditions, has now resulted in a weakening of households ’ and firms ’ spending capacity and of their financial position. and the consequence has been a rise in bad debts in the spanish banking system. although the recent trend in interest rates is a considerable relief for many debtors, the rise in bad debts, which will continue over the next few quarters, poses a risk which deposit institutions must manage with great caution. this results in the gradual weakening of the income statements of credit institutions, which requires them to react decisively. thus, it is of paramount importance that business models and income statements are in step with the new reality. in simple terms, in order for spanish deposit institutions to remain in a sound position, they will have to face the new challenges of the current situation by finding levers for change which allow them to counter the adverse developments currently putting pressure on their income statements, and incorporating such levers into their business models. let me give you some figures on the recent trend in income statements. the consolidated profit of spanish deposit institutions fell at a rate of approximately 20 % in december 2008 with respect to december 2007, while in june 2008 it had declined by slightly less than 3 % on june 2007. two general remarks can be made about these figures. first, comparison with the results posted by institutions in other banking systems in developed countries is favourable for spanish institutions ; practically all of them continued to post positive results, mainly due to the factors i mentioned earlier. the complex and rather opaque products that caused notable losses at institutions in other countries were avoided. at the same time, the banking model in spain is less reliant on developments in financial markets and on investment banking activities. second, the data mentioned previously show that spanish institutions ’ income statements have been affected by the gradual deterioration of the economic situation. although it is natural to some extent that, in more adverse conditions, results and profitability have not increased as notably as in recent years, there is a clear and pressing need for resolute action by managers aimed