jaime caruana : making diligent preparations for basel ii opening remarks by mr jaime caruana, governor of the bank of spain and chairman of the basel committee on banking supervision, at the thirteenth international conference of banking supervisors ( icbs ), madrid, 22 - 23 september 2004. * 1. * * welcome and overview distinguished guests and friends : as the governor of the bank of spain, it is my pleasure to serve as your host at the thirteenth international conference of banking supervisors here in madrid. i am also privileged to serve in a second capacity at this event as chairman of the basel committee on banking supervision. in that regard, it is my honour to launch our dialogue on the two main themes selected for this conference. as you know, the committee reached agreement on an historic revision of the international capital framework just this past june. so naturally an important focus for this conference will be on preparing for its implementation. in addition, because basel ii relies increasingly on the quantification of risk exposures to understand a bank ’ s risk profile, it is more important than ever before to look behind the numbers and into the rules that define how exposures are measured. the second day of our conference will be devoted to the emerging issues in accounting and their relevance to banking supervision. i am indebted to the secretariat of the basle committee, the staff of the bis, as well as to my colleagues at the bank of spain, for choosing speakers who will encourage a lively conversation on these two themes. in my own remarks this morning, i would like to open with some thoughts first on the implications of “ basel ii ” for banking supervision worldwide. while much has been said about its sophistication, i believe that many have overlooked key principles in basel ii that are relevant to all supervisors and all banks in all markets. in that regard, it is important to remember that basel ii ’ s success depends on a broad range of other preparations and measures that we undertake to strengthen safety and soundness ; in the second part of my remarks, i will offer some views on the other mechanisms, that lie at the heart of a sound system of supervision more generally. as i will mention, many of our safety and soundness goals are more easily achieved when supervisors apply these mechanisms more consistently : this makes it critical for the basel committee to continue to expand its ties and seek greater cooperation with the broader supervisory community. finally, i would like to close with some brief thoughts on the rules that govern

we ascribe to developing and maintaining safe and sound control structures. a risk - focused approach thereby creates implicit incentives for bank management to understand and to find better ways to control its risks. what results is not just a more proactive risk management function, but also a greater commitment to sound corporate governance across the bank. 2. 2 second trend : incorporate incentives into supervision basel ii recognises this result and goes one step further by creating not just implicit but also explicit economic incentives for banks to improve the quality of their risk management. the inclusion of incentives directly in the regulatory framework represents the second important trend in supervision. the proper use of incentives can help to align a bank ’ s objectives more closely with public policy goals of safety and soundness. in recent years, supervisors have begun to move more generally toward a system of supervision that encourages prudent risk - taking through the offering of incentives rather than simply enforcing compliance with rigid rules. internationally, the 1996 market risk amendment to the existing basel accord represented the first time that banks received explicit capital benefits for developing more sophisticated measures of risk, in that case market risk. basel ii continues this trend by extending incentives to the treatment of credit risk and operational risk. 2. 3 basel ii embraces both trends by stepping back a bit from basel ii ’ s formulas, we can see that the new capital framework builds on two important trends to incorporate a new philosophy for banking supervision. it combines a riskfocused approach to supervision with incentives for prudent risk - taking into a coherent policy objective that seeks to promote adequate capitalisation. by incorporating in all three of its pillars clear incentives for banks to improve their management of risk, basel ii reinforces management ’ s focus on control structures. • for example, in basel ii ’ s minimum capital requirements - or pillar 1 - regulatory capital charges are aligned more closely to a bank ’ s own measures of risk. this creates immediate incentives for banks to improve those measures. • likewise, pillar 2 - supervisory review - emphasises that responsibility for evaluating capital adequacy lies with a bank ’ s management. supervisors will review and respond to those internal assessments, thereby creating incentives for banks to evaluate their exposures thoroughly and to plan their capital strategies carefully. • finally, pillar 3 - market discipline - seeks to make a bank ’ s risk profile more transparent to outside investors and market participants. this should better enable the market to reward banks that take a responsible approach to risk management and penalise those that do not