to more traditional bank lending. the wider use of internal ratings, coupled with greater transparency regarding their compilation and some assurance of quality control by the regulators, may in fact contribute to further'commoditisation'of bank loans. it is conceivable that this development could reduce the cost of due diligence on loan portfolios by rating agencies and buyers. and, in turn, it could mean a reduction in the costs of risk transfer through securitisation or credit derivatives, with beneficial effects on banks'balance sheets and liquidity. however for this to happen, banks'internal ratings will need to carry credibility in the market and, for this, transparency is essential. the transparency proposals from the basel committee have come under a certain amount of fire for their volume and detail. but i would like the critics to dwell for a moment on the alternative : a world in which banks effectively set their own capital, with no assurance of consistency or comparability from one bank to another. this is an important debate and we are keen to listen to others'views before the proposals are finalised. turning to the possible effect of basel on capital flows more generally, including bank lending, undoubtedly the new risk sensitivity will tend towards changing conditions for certain borrowers and issuers. this is particularly marked in the sovereign context, where, based on current ratings, approximately twenty seven sovereign borrowers will incur a lower bank capital charge versus eleven incurring a higher one. again i would stress that the cushion of capital which most banks maintain over and above their regulatory minimum will blur the impact of the basel changes, since in these circumstances banks'lending and pricing decisions will not be constrained by the regulatory standard. however, in some sense the basel proposals will have failed in their purpose unless the pricing of bank credit better reflects the riskiness of borrowers. by removing perverse incentives for banks, we also wish to establish better incentives for borrowers. greater risk sensitivity does, however, carry with it a possible danger, and that is the introduction of potential'procyclicality'into the capital framework. i have touched on this concern more than once in the past, and make no apology for doing so again. to counteract this danger, regulators should not allow banks'internal ratings to reflect the optimistic prospects of borrowers during an economic upswing : rather, ratings need to be genuinely forward - looking, and to factor in borrowers'likely performance during economic stress. long runs

david clementi : recent developments in securities markets and the implications for financial stability speech by david clementi, deputy governor of the bank of england, to the euromoney international bond congress, london, 21 february 2001. * * * introduction let me begin by saying how pleased i am to be giving the closing address at this conference. i know, in previous years, the governor has done the honours. while he is engaged elsewhere today, i am glad to keep up the association with the bank. especially now we have joined the ranks of issuers in the euro markets in our own name. if you did not have a chance to subscribe to our euronotes in january, the issue - the 4. 5 % of 2004 - will reopen in april, july and october. but i have not come to plug our paper. nor have i come to talk about monetary policy. the minutes of the february meeting, published this morning, are designed to set out the mpc's considered view as well as the vote itself. on the voting front, you will find there was a rare outbreak of unanimity in the committee with a nine to nothing vote for the recent ¼ % cut in rates. but there is little on this front that i can add that is not already in the minutes or in the inflation report we published last week. i want to talk instead about recent developments in bond markets that impinge on the bank's role in relation to financial stability. first i want to talk about credit derivatives and the new markets for the transfer of credit risk. second about the revised basel accord and what this implies for securities firms and securities markets. and finally about the implications of the shrinking share of government bonds in issue. the bank's financial stability role but i ought to start by saying something about the bank's role in relation to financial stability. as most of you will know, regulatory responsibility for individual uk financial institutions is now consolidated in the financial services authority. the bank is no longer a regulator of individual firms but as a central bank we retain a vital interest in the system as a whole. we are the ultimate provider of liquidity to banks and markets. this interest is reflected in a formal responsibility for the overall stability of the financial system set out in a memorandum of understanding between the treasury, bank and fsa. responsibility for the overall stability of the uk financial system as a whole sounds a huge and slightly fuzzy task. it requires the central bank to try to see the