that the capital ratios, however calculated, meaningfully reflect the bank ’ s ability to absorb losses. the second stage, then, is to consider how the second and third pillars of the new framework can be implemented. supervisors do not need to wait for the formal adoption of basel ii to start introducing or using the principles of the three pillars. on the contrary, incorporating these principles is excellent preparation for adopting basel ii in the future. for example, supervisors might choose to move towards a more risk - based approach to supervision, developing skills in assessing the quality of a bank ’ s risk management and its ability to assess risk exposures. at the same time, banks could be reminded of their responsibility to develop their own processes for evaluating their capital needs and a strategy for maintaining their capital levels, consistent with the principles of pillar 2. with regard to the principles of market discipline in pillar 3, supervisors may wish to focus initially on ensuring a baseline level of disclosures across all banks. this might include discussing with banks, investors, and other users of financial information their information needs and the tools available so that supervisors can tailor requirements accordingly. in my view, these two preliminary stages provide an excellent preparation for the “ final ” stage of moving to basel ii. with a strong foundation in place, supervisors can then select the alternatives within basel ii that are most appropriate for their own circumstances. conclusion to conclude, let me insist on the general principle on which i think supervision should be built, which i mentioned before. supervision needs to consider a broader analysis of the vulnerabilities internal and external to the banking sector, including the necessary macroeconomic and institutional elements, and those relative to the stability of financial markets on which banks operate. i think that basel ii recognizes the importance of a combination of micro and macro factors for achieving greater financial stability. furthermore, i would say that basel ii incorporates some of the key basic principles that are also built in modern approaches to monetary policy : a flexible and forward - looking approach, anticipatory rather than reactive behaviour to risk, and the need to take into account market views. looking into the future, we must direct our resources to ensure that banking supervision in the 21st century is more dynamic, more preventive, more flexible, more inclusive, and more transparent. we should continue adapting and learning. i believe the ultimate objective of financial stability increasingly requires co - operation and properly aligned incentives on the part of the industry, markets, and supervisors. thank you.

jaime caruana : overview of basel ii and its reflections on financial stability speech by mr jaime caruana, governor of the bank of spain and chairman of the basel committee on banking supervision, at the international conference on financial stability and implications of basel ii, central bank of the republic of turkey, istanbul, 16 may 2005. * * * introduction and overview thank you, governor serdengecti, for your kind words of introduction and your opening remarks on what promises to be a timely and interesting conference. i am honoured to have the opportunity to share with you some thoughts on two related topics that are near and dear : financial stability and the basel ii capital framework. as i will be discussing this morning, the financial sector and banking supervisors are in the midst of a period of great change. change and growth must be second nature to this great city on the bosphorus, where the remains of the roman, byzantine, and ottoman empires reside within a modern, forward - looking city. istanbul has thrived over the centuries in the face of constant evolution, and today serves as a bridge between europe and asia, east and west, ancient and modern. of course, the challenges of basel ii cannot truly compare to the development of a city with almost 3, 000 years of history, but certainly istanbul seems to me a very appropriate place in which to discuss the role of banking supervisors in a rapidly changing world. my talk this morning will address several issues. first, i will talk about why the basel committee developed the basel ii capital framework and what it intends to accomplish. second, i will share some thoughts on how prudential banking supervision contributes to the stability of the financial system. next, i will discuss how i see basel ii contributing to financial system stability. finally, i will offer some thoughts on steps countries can take in preparation for adopting basel ii. but let me advance the main conclusion of my presentation : in a nutshell, i think that the new capital framework represents a significant step towards achieving a more comprehensive and risk sensitive supervisory approach. basel ii is about much more than just setting better quantitative minimum capital requirements. it is about establishing incentive - based approaches to risk and capital adequacy management, within a comprehensive framework of three mutually - supporting pillars. in my view, the combination of better risk management, a stronger capital structure and improved transparency standards in the banking system can significantly improve financial stability. why basel ii? let me begin with an overview of the basel ii capital