to host this outreach event, and would like to thank the aigv members who have stayed behind after the regular meeting to provide support. a major innovation of basel ii is that it allows banks to calculate their regulatory capital requirements using the output of their internal rating systems, subject to supervisory approval. under the irb approach, banks employ internal rating systems to produce estimates of one or more risk components, which are then used as the key inputs to the calculation of regulatory capital requirements for credit risk. while there is a case for asian regulators to perhaps concentrate their basel ii implementation efforts initially on the standardised approach, they would eventually like to see their banks, those large ones in particular, adopt the irb approach over time as adopting the irb approach can substantially enhance the quality of risk management of banks. moreover, asian regulators including the hkma find ourselves in the position of playing host to many large and internationally active banking groups that propose to adopt the irb approach globally, including their operations in our jurisdictions. in consequence, we need to develop plans for the adoption of the irb approach in our domestic banking environment. in doing so, we need to balance the readiness of the industry and other supervisory priorities versus the desirability of implementation of the irb approach. on readiness of the industry, we believe that there are three key challenges facing banks in hong kong and probably other jurisdictions in asia. first, the adoption of the irb approach by banks does not merely involve the use of sophisticated quantitative tools, but also corresponding advances in banks ’ risk management practices, culture, internal control and corporate governance. this is essentially the underlying and overarching principle of the irb and other advanced approaches provided under the basel ii framework. the basel ii framework makes it clear that a bank should be allowed to provide its own estimates of the risk components for the calculation of its regulatory capital requirement only on the basis of a sound internal control and oversight framework. from our experience, this represents the primary challenge for some banks as they may focus only on the quantitative aspects of adopting the irb approach, without taking necessary account of the qualitative aspects. without a sound internal control and oversight framework, these quantitative tools might be employed improperly and generate incorrect information for credit and management decisions. as such, the drawbacks brought by the use of sophisticated tools could outweigh the benefits. thus, validation standards for the internal rating systems adopted by banks will need to place as much emphasis on the qualitative as

yiu - kwan choi : basel ii implementation in asia introductory remarks by mr yiu - kwan choi, deputy chief executive ( banking ) of the hong kong monetary authority, at the bcbs / fsi / emeap : basel ii implementation in asia, hong kong, 17 october 2007. * * * dear colleagues, good morning. on behalf of the hkma, i would like to extend a very warm welcome to you all here today to take part in this outreach event organized jointly by the basel committee, the fsi and emeap, focusing on the irb validation aspect of the basel ii framework. the event coincides with one of the regular meetings of the validation subgroup of the basel committee ’ s accord implementation group, which was held here over the last two days. the validation subgroup, or the aigv as it is commonly called, is one of three subgroups under the aig that share information and discuss specific issues related to basel ii implementation. the aigv specifically explores issues related to the validation of systems used to generate the ratings and parameters that serve as inputs into the internal ratingsbased approach to credit risk. the aigv has done some excellent work, using the regular aigv meetings as an information dissemination platform for members of this subgroup to explore various irb validationrelated issues. the aigv has also published several high quality supervisory guidance papers covering topics on validation of low - default portfolios, use of vendor products, use test and control expectations for validation under the basel ii irb framework. these topics, as i understand, will be discussed this afternoon under the two scheduled working group sessions. to broaden the geographical reach of the large pool of useful reference documents on irb - related issues produced for its meetings or contributed by the member jurisdictions, the aigv has developed an electronic library on ebis to store these documents for access by the supervisory community. the hosting of this event is well timed, as some jurisdictions have already entered into the implementation phase of the basel ii irb framework and other jurisdictions, including many from asia, are in the pipeline for the introduction of the framework for adoption by their banks. the event is therefore a good opportunity for representatives of jurisdictions which have yet to adopt basel ii to hear from jurisdictions already implementing the framework about the emerging issues, and to facilitate future communications on this topic among participants. as chairman of the emeap working group on banking supervision, the hkma certainly welcomes the opportunity