is very similar to the existing framework or basel i and requires very little modifications to the existing risk management systems by banks. the key to the success of this approach is the rating of counterparts. the banks should, as far as possible, encourage developing a culture of credit ratings. cbsl will consider the representations made with regard to reducing the risk weight applicable to below bb - rated entities initially in order to inculcate the rating culture, but this should not be taken as the norm as we expect higher ratings to be considered for the purpose. the basel ii framework provides a preferential risk weight of 75 % for claims that fall within the regulatory retail portfolio. the qualifying criteria for retail and sme loans that would fall within this portfolio have been modified to suit the local conditions and agreed with the banks. however, in order to avail of the preferential risk weight, banks have to prove that this regulatory retail portfolio meet the qualifying criteria. operational risk basel ii introduces an explicit capital charge for a bank ’ s operational risk, i. e. the risk of losses caused by inadequate or failed internal processes, people and systems or by external events such as natural disasters which calls for increased capital requirements. throughout this year, the central bank insisted on banks having comprehensive business continuity plans to ensure that there are alternative arrangements if the core - banking functions or payment and settlement functions of banks were to fail. we issued guidelines, discussed with banks on one to one basis and i believe that action has been taken or is being taken to ensure that business continuity plans are done with utmost care and dedication. as with credit risk, basel ii provides a choice of 3 approaches to the measurement of operational risk and initially, the simplest approach which is called the basic indicator approach is recommended for use by all banks. accordingly, the capital charge will be based on the gross income of the banks. the most complex advanced measurement approach ( ama ) can be made applicable at later stages as techniques for the quantitative measurement of operational risk are still not widely used by sri lankan banks. however, regardless of the approach used, all banks are expected to, in their own interest, have in place sound internal operational risk management systems that are commensurate with the nature of their business activities. from the regulator ’ s point of view, it is difficult to leave risk evaluation entirely to each bank ’ s discretion particularly because of the need to assess how best each bank uses its capital efficiently in dealing with general and specific risks. for market risk, the present

aimed at by the euro countries in 2 to 3 years for a given interest rate path, norges bank will consider adjusting the interest rate. in this narrow sense, one could say that the conduct of monetary policy in norway has some similarities with “ inflation forecast targeting ”, in lars svensson ’ s terminology. in addition to economic forecasts, we aim to develop tools that can supplement the use of our large macroeconometric model. at the moment we are working on the construction of simple calibrated models that will be presented at this workshop. the calibrated models can be employed, for instance, to test the performance of simple indicator rules. how does the norwegian system differ from inflation targeting? the institutional arrangement for monetary policy in norway does differ in some respects from that in countries with an inflation target. some central banks with explicit inflation targets have to give an explanation to the government or other authorities if the inflation target is not being met. our mandate, however, refers to an exchange rate target as opposed to an inflation target. if a situation arises in which norges bank is not able to return the krone to its initial range, as defined in the mandate, without triggering inflation or a deflationary recession, the bank will inform the authorities that measures other than those available to the central bank are required. one possibility could then be to recommend fiscal measures that make it possible to bring the krone exchange rate back to its initial range and stabilise it. some observers have argued that the possibility that such situations can arise creates an uncertainty that may weaken the credibility of norwegian monetary policy. however, norges bank has declared that it cannot with open eyes contribute to higher inflation or a deflationary recession. financial market indicators show no evidence of monetary policy lacking credibility. although the actual conduct of monetary policy is similar to inflation targeting, there are a number of institutional differences between the norwegian system and inflation targeting regimes. 1. norway has a long tradition of cooperation between the political authorities and the social partners. income and wage determination is fairly centralised, and the social partners evaluate the effects of wage outcomes on employment. 2. in a number of countries that have switched to a monetary policy regime based on inflation targeting, fiscal policy is oriented towards reducing government debt and deficits. in norway, fiscal policy has traditionally played an important role in demand management. this task is facilitated by the fact that the norwegian government has greater financial leeway than most other countries, due to its oil revenues