overcapitalize the banking system relative to the base case scenario in order to ensure financial stability and an ongoing supply of credit to the real economy in a stress scenario. doing this makes the bad scenario less likely to materialize and the improvement in credit supply helps to engineer a stronger recovery than would otherwise materialize. 4 the third implication is that the stance of monetary policy needs to be assessed based on the state of the financial system and the real economy. how the monetary policy impulse is transmitted to the real economy is not immutable but changes depending on how monetary policy affects financial conditions and how financial conditions affect economic activity. during and following financial crises, problems in the financial system can impair the transmission of monetary policy to the real economy. when this happens, policy may need to be more accommodative than otherwise in order to achieve its objectives. the experiences of both japan and united states are cases in point. 5 in retrospect, we know that following the collapse of the property bubble and the investment boom in japan in the 1990s, the bank of japan ( boj ) did not follow a sufficiently accommodative monetary policy ideally, as was the case in the u. s. in 2009, the authorities should require banks to meet their stress scenario capital ratio standards by adding equity capital, with no credit given for reducing assets. this leans against the incentive to deleverage to meet higher capital ratio requirements. see my recent speech “ lessons at the zero bound : the japanese and u. s. experience ”, japan society, may 21, 2013. bis central bankers ’ speeches to prevent deflation. although the boj response was appropriate relative to the economic forecasts that prevailed at the time, those forecasts proved much too optimistic. thus, policy was insufficiently accommodative with the benefit of hindsight. to a lesser degree, the same critique also applies to the united states. despite an aggressive shift towards greater monetary policy accommodation in 2008 and 2009, and ongoing subsequent easing – which has supported a return to growth and helped to facilitate needed adjustments in housing and household balance sheets – the economic recovery has been consistently weaker than forecast. as a result, the federal reserve has fallen short of meeting its employment and inflation objectives. this suggests that with the benefit of hindsight, u. s. monetary policy, though aggressive by historic standards, was not sufficiently accommodative relative to the state of the economy. in this regard, i would

strong sense is that banks have both the desire and the commitment to continue to develop their internal ratings systems in a manner consistent with the requirements of the irb framework. the discussions with the industry have, however, highlighted various areas where banks may need to expand their efforts in preparing for implementation. i will offer comments on four areas where more work is needed : a. the design and structure of rating systems ; b. the necessary controls to ensure that ratings are accurate and up to date ; c. the availability and quality of credit data ; and, finally d. the overall corporate governance approach a. rating system design the first area concerns the design of a risk rating system, which is, of course, central to ensuring the effectiveness of the irb approach. the basel committee believes that banks ’ internal rating systems should accurately and consistently differentiate between degrees of risk. the minimum irb standards in this area build on the strongest risk management practices observed in the industry. to illustrate the point, many organizations either already have, or are in the process of developing a ratings system that captures both the risk of borrower default, as well as transaction - specific factors that shed light on the amount of loss that would arise if default occurs. in other words, these banks ’ systems are now oriented to capturing the several essential components in estimating credit risk under the irb approach. credit risk rating systems are clearly improving in various dimensions, including how finely they seek to distinguish differing degrees of borrower risk. to do so, banks typically look to expand the number of ratings categories into which they slot their exposures. however, just establishing more rating categories is not enough. the challenge is for banks to define clearly and objectively the criteria for these ratings categories in order to provide more meaningful assessments of both individual credit exposures and, ultimately, their overall risk profile. the clarity and transparency of the ratings criteria will be critical to ensuring that ratings are assigned in a disciplined and reliable manner. b. controls over the rating system of course, a ratings system is useless without the necessary system of checks and balances, or control structure, which is the second area i will discuss as needing banks ’ attention. banks must have the proper controls in place to ensure that the rating system is performing as intended, and that its ratings are accurate - that is, that a " 5 " rating really is a " 5 " and that a " 7 " really is a " 7. " there are at least three major structural elements that are