to lend ; and the expected loss given default, taking into account any collateral or other loss - mitigating features of the credit agreement. combined, these measures reveal the expected loss, which a bank must know to underwrite and price a credit correctly, as well as to establish adequate loss reserves. however, it is the volatility of this loss and the contribution of the credit to the volatility of the bank ’ s cash flow on a firm - wide, portfolio basis that is crucial to evaluating capital adequacy. as you can imagine, the process of modeling credit risk is still as much art as science for most banks, requiring many assumptions and subjective judgments as well as substantial amounts of data. testing the sensitivity of a model ’ s results to these decisions and maintaining the integrity of the process from start to finish will be a constant challenge. nevertheless, leading institutions around the world have made substantial progress in measuring risk in recent years, and we expect much more progress in the years ahead as both the regulatory and banking communities devote more attention and resources to the topic. the continually declining cost of technology for storing and analyzing data will help greatly to encourage firms to create the databases necessary to understand credit risk better. this decade may see a watershed for risk management as institutions make far greater use of information. indeed, i fully anticipate that the revised basel capital accord now under development will link capital requirements more closely to a bank ’ s own internal evaluation of risk. for most institutions, though, success in risk management does not require sophisticated models, nor will models alone suffice. clearly, all banks must take advantage of new technologies and keep pace with market innovations to remain competitive and to survive. that need points to ever more sophisticated risk measurement and management practices. nevertheless, adhering to the fundamental principles of risk management and adapting sound practices to one ’ s own situation will remain key. as i indicated earlier, the experience throughout the world with bank failures and other financial crises demonstrates time and again that violations of traditional and long - known management principles produce the largest losses. i gave some examples of this earlier. technology and financial innovation facilitate risk management and accommodate more sophisticated risk exposures. financial models are tools and the environment around them must still be properly managed and controlled. i cannot overstate that point. the most sophisticated risk management techniques are useless if the operating environment and management incentives are deficient or if fundamental risk management principles are ignored. fundamental elements of sound risk management the fundamental elements

##s, along with greater pressures on the exchange rate and higher chances of imbalance buildups in the future. for the real economy, it may delay some of the necessary adjustments. finally, fx intervention is not costless. we have to fund the intervention with local interest rates that are higher than what we would earn from our international reserves. bis central bankers ’ speeches experiences have also shown that, even after a large appreciation of the currency, capital inflows could still seep in and fuel speculative activities in markets such as real estate and equity. to help deal with specific pockets of the economy showing signs of potential bubbles, macro - prudential measures could be used. a recent example is the risk - weights adjustment related to the loan - to - value ( ltv ) ratio of loans made to property purchases. while macro - prudential measures aim to help lessen the effects of capital that has already flowed into the economy, capital account regulations can be used to deal directly with the size and type of incoming and outgoing flows. with an aim of creating more balanced capital flows, the bank of thailand has continued to liberalize our capital outflows, while on the inflow side we at times resort to tighter regulations when the situation deems necessary. implementing a capital account regulation, or less of it, requires a delicate balancing act. for outflow liberalization, on the one hand allowing more thai resident outflows is beneficial as it helps lessen upward pressure on the currency as well as improve the investment profile of the thai private sector toward a more diversified and possibly more efficient one. on the other hand, if risk assessment capacity of local investors remains low, too rapid outflow liberalization could make the country ’ s balance sheet more vulnerable rather than more robust. a balancing act is even more difficult when applying re - regulation on capital inflows. a measure that is too mild would lack effectiveness, while too drastic a measure would be too costly. for one thing, its distortionary effects would be large ; for another, increased policy uncertainty could turn away productive investors and raise the country ’ s risk premium. aware of these undesirable side effects of controls, we would limit their use to only when absolutely necessary and only on a temporary basis. on the use of interest rate policy, some may view the policy interest rate as another tool to deal with capital flows, and there have been public debates whether the recent hikes in the policy interest rate by the bank of