. as a result, changes to current accounting practice will also have a direct impact on the quality of accounting capital and on how supervisors assess that capital for regulatory purposes. 7. points of divergence from banking supervision accounting standards operate under a different time horizon than capital standards and have their greatest impact in the area of loan losses. under ifrs and us gaap, allowances for incurred losses must be based on the occurrence of a given loss event rather than historical trend information alone. for some banks at least, this means that allowances at any point in time are unlikely to be sufficient to meet full el requirements although, amazingly, we did see some excesses during our qis work. also, dynamic provisioning approaches that provide “ through the cycle ” accounting are unlikely to be acceptable. this means banks must take the credit risk premium charged to cover expected losses to income, even if the related losses cannot be recognised until a much later date. 8. points of divergence from banking supervision standard setters also don ’ t appear to give much consideration to the financial stability implications of their proposals. first, they seem indifferent to how much additional volatility could be created in banks ’ financial statements as a result of the wider use of fair values. second, they do not share the concerns of supervisors and many others that fair valuing changes in own credit risk is inappropriate, especially when this means recognising gains based on deterioration of one ’ s own credit. even if supervisors can make appropriate adjustments to these items for regulatory capital purposes, how users will react to what is published in the financial statements is a worry for both banks and banking supervisors. finally, supervisors are deeply concerned with the apparent disconnect between how banks manage portfolios of risk and the models produced by standard setters to capture these activities. the key issue is that international standards apply fair value to whole instruments rather than the underlying risks, and to single contracts rather than portfolios, and we believe that standard setters need help to better understand the business of banking. as chairman caruana noted, good accounting should support sound risk management practices. certainly the two pictures should not be in conflict. 9. additional challenges for banking supervision if these issues were not enough, supervisors must grapple with more subjective balance sheet measurements and what this means for the reliability of financial statement values. in this case, subjectivity takes two forms : the need to use models for instruments that do not have active local markets, and the potential for

an enterprise to choose from wide ranges of possible “ fair values ” in pricing a given instrument. also, financial statement disclosure is moving toward a generic approach for all types of entities. this is most evident in the new ed 7 proposals on disclosure that are intended to replace bank - specific disclosures found in ias 30. the key question for supervisors is how assets and liabilities of banks should be classified on the balance sheet - by measurement classification, or by type of product? 10. need for regulatory action : a mixed blessing despite these many challenges, banking supervisors are positioned to compensate through regulatory means. they can issue supervisory guidance ( for example, on provisioning, and on various aspects of fair value accounting ) at any one or all of the basel, regional and local levels. they are able to apply prudential filters to the accounting results, such as was done through two recent press releases on suggested capital treatments of certain ifrs items. developing supervisory reporting and disclosure frameworks, for example the current cebs initiative ) can also help to re - establish consistent and comparable information for supervisory use. 11. need for regulatory action : a mixed blessing at the same time, these additional measures create additional administrative burdens for banks, and supervisors are very sensitive to the need to keep this additional burden to a minimum. also, as the basel committee supports the use of sound ifrs for supervisory as well as public reporting, applying prudential filters to these standards could create the perception that we do not have full confidence in the quality of ifrs - based financial information. now, let ’ s turn to auditing trends and issues. 12. significant recent developments in auditing recent accounting scandals - enron, worldcom, parmalat and others - have raised fundamental questions concerning auditor responsibility, auditor independence and audit quality. since that time, auditing standard setters and others have been hard at work on improvements needed to restore public confidence in the profession. for example, the u. s. sarbanes - oxley act and revision of the eu ’ s eighth directive have been designed to address several important elements related to standards development and approval, auditor independence and standards compliance. also, the international profession is dealing proactively with a number of initiatives designed to promote improved audit quality and much more transparent quality control processes. these important developments are very similar to approaches found in pillars 2 and 3 of the revised framework. auditors are also revising the scope of their work in ways that speak to