jaime caruana : presentation of the annual report address by mr jaime caruana, governor of the bank of spain, at the presentation of the annual report to the governing council of the banco de espana, madrid, 18 june 2004. * * * ladies and gentlemen, the recovery in the international economy - which was described as modest, hesitant and uneven in the speech presenting last year ’ s annual report - progressively gathered momentum during 2003 and early 2004, as well as extending to other regions. adding to the initial buoyancy of the us economy was the considerable dynamism of a large number of east asian countries, including most notably china. the japanese economy, flagging in a marked depression during the previous decade, picked up clearly, and the central and eastern european countries sustained relatively high growth rates. only the euro area, among the industrialised economies, and latin america, among the emerging group, showed a more hesitant recovery in activity. the favourable developments in the international economy were compatible with continuing low inflation, despite the notable rise in oil and other commodity prices. the risk of deflation which, at times, it was feared might affect some of the main economies, including the united states, faded as the recovery firmed. the sound behaviour, on the whole, of the financial markets and the trend of confidence indicators seem largely to indicate that expectations about the future course of the world economy are now brighter again. the firming of the recovery is attributable in no small measure to markedly expansionary macroeconomic policies which, in many countries, have resulted in significant increases in public and private debt levels. against a background of very generous monetary policies and ample global liquidity, the financial markets saw asset price rises and very low interest rates, which also helped anchor the pick - up in demand. risk premia diminished on both private - sector bonds and on the sovereign debt of emerging markets, which received greater capital flows. as a result, the economic recovery and the soundness of financial markets fuelled one another, in a virtuous circle that has broadly been maintained in the opening months of 2004, although recently a rise has been seen in long - term interest rates and in emerging markets ’ sovereign risk premia. latin america was the emerging region which encountered most difficulty in joining the upturn in the world economy in 2003. crises in certain countries and bouts of financial instability in others have prompted heavy exchange rate depreciations and upward price pressures in recent years. against this

to justify the need for a response by supervisors and regulators. the focus of our concern is currently the promotion of the stable functioning of the financial system, and the need to boost the incentives offered to ensure that it continues to enhance the scope and quality of the services that it has traditionally offered to society. the new capital accord is undoubtedly a significant step in this direction and represents a great opportunity for the banks to review, update and improve their capital strategies and risk management systems. it is, therefore, a suitable framework for boosting financial stability. the new capital accord proposes a comprehensive approach based on the combined operation of a number of complementary elements and considering a broader set of risks than its predecessor. it is, moreover, a model for regulation based on the introduction of the incentives needed to stimulate prudent and responsible action by the institutions. these incentives will promote the establishment of appropriate risk measurement and management systems, such that the better they are, the lower the capital requirements applied to the institutions in recognition of this superiority. the desire to offer alternatives and incentives is clear in the design of the accord. for example, it proposes that institutions should have various alternatives for calculating their regulatory capital, ranging from the simplest possibilities based on the use of external rating systems, to other more complex ones based on internal rating systems designed by the institutions themselves. the requirements to gain access to the most advanced methodologies are, undoubtedly, considerably more demanding. that said, it is up to the institutions themselves to decide, on the basis of their specific operations and of their needs in general, which methodology they wish to apply. in fact, it is not clear that small and medium - sized institutions should opt, at least initially, to use the most advanced approaches. in particular, the banco de espana foresees that, both on account of the type of operations carried out by spanish institutions and owing to the minimum requirements for access to the different methodologies, the number of those adopting the most sophisticated methods ( i. e. the advanced irs approach ) will be limited and will be the result of a gradual process over time. in short, the adoption of the advanced basel ii models should be seen from a perspective of realism and the pursuit of excellence. as far as the banco de espana is concerned, quality takes precedence over any consideration of timing in the adoption of the advanced approaches. as i have already mentioned, the implementation of the new capital accord will pose serious challenges for the institutions, which will be expected to step up the