11. The Committee also wishes to highlight the need for banks and supervisors to give appropriate attention to the second (supervisory review) and third (market discipline) pillars of the revised Framework.

It is critical that the minimum capital requirements of the first pillar be accompanied by a robust implementation of the second, including efforts by banks to assess their capital adequacy and by supervisors to review such assessments.

In addition, the disclosures provided under the third pillar of this Framework will be essential in ensuring that market discipline is an effective complement to the other two pillars.

12. The Committee is aware that interactions between regulatory and accounting approaches at both the national and international level can have significant consequences for the comparability of the resulting measures of capital adequacy and for the costs associated with the implementation of these approaches.

The Committee believes that its decisions with respect to unexpected and expected losses represent a major step forward in
this regard.

The Committee and its members intend to continue playing a pro-active role in the dialogue with accounting authorities in an effort to reduce, wherever possible, inappropriate disparities between regulatory and accounting standards.

13. The revised Framework presented here reflects several significant changes relative o the Committee’s most recent consultative proposal in April 2003.

A number of these changes have already been described in the Committee’s press statements of October 2003, January 2004 and May 2004.

These include the changes in the approach to the treatment of expected losses (EL) and unexpected losses (UL) and to the treatment of securitisation exposures.

In addition to these, changes in the treatments of credit risk mitigation and qualifying revolving retail exposures, among others, are also being incorporated.

The Committee also has sought to clarify its expectations regarding the need for banks using the advanced IRB approach to incorporate the effects arising from economic downturns into their loss-given-default (LGD) parameters.

14. The Committee believes it is important to reiterate its objectives regarding the overall level of minimum capital requirements.

These are to broadly maintain the aggregate level of such requirements, while also providing incentives to adopt the more advanced risk-sensitive approaches of the revised Framework.

To attain the objective, the Committee applies a scaling factor to the risk-weighted asset amounts for credit risk under the IRB
approach.

The current best estimate of the scaling factor using quantitative impact study data is 1.06.

National authorities will continue to monitor capital requirements during the implementation period of the revised Framework.

Moreover, the Committee will monitor national experiences with the revised Framework.

15. The Committee has designed the revised Framework to be a more forward-looking approach to capital adequacy supervision, one that has the capacity to evolve with time.

This evolution is necessary to ensure that the Framework keeps pace with market developments and advances in risk management practices, and the Committee intends to monitor these developments and to make revisions when necessary.

In this regard, the Committee has benefited greatly from its frequent interactions with industry participants and looks forward to enhanced opportunities for dialogue.

The Committee also intends to keep the industry apprised of its future work agenda.

16. In July 2005, the Committee published additional guidance in the document The Application of Basel II to Trading Activities and the Treatment of Double Default Effects.

That guidance was developed jointly with the International Organization of Securities Commissions (IOSCO) and demonstrates the capacity of the revised Framework to evolve with time.

It refined the treatments of counterparty credit risk, double default effects, short term maturity adjustment and failed transactions, and improved the trading book regime.*

* The additional guidance does not modify the definition of trading book set forth in the revised Framework.

Rather, it focuses on policies and procedures that banks must have in place to book exposures in their trading book.

However, it is the Committee’s view that, at the present time, open equity stakes in hedge funds, private equity investments and real estate holdings do not meet the definition of trading book, owing to significant constraints on the ability of banks to liquidate these positions and value them reliably on a daily basis.

17. One area where the Committee intends to undertake additional work of a longer term nature is in relation to the definition of eligible capital.

One motivation for this is the fact that the changes in the treatment of expected and unexpected losses and related changes in the treatment of provisions in the Framework set out here generally tend to reduce Tier 1 capital requirements relative to total capital requirements.

Moreover, converging on a uniform international capital standard under this Framework will ultimately require the identification of an agreed set of capital instruments that are available to absorb unanticipated losses on a going-concern basis.

The Committee announced its intention to review the definition of capital as a follow-up to the revised approach to Tier 1 eligibility as announced in its October 1998 press release, “Instruments eligible for inclusion in Tier 1 capital”.

It will explore further issues surrounding the definition of regulatory capital, but does not intend to propose changes as a result of this longer-term review prior to the implementation of the revised Framework set out in this document.

In the meantime, the Committee will continue its efforts to ensure the consistent application of its 1998 decisions regarding the composition of regulatory capital across jurisdictions.

18. The Committee also seeks to continue to engage the banking industry in a discussion of prevailing risk management practices, including those practices aiming to produce quantified measures of risk and economic capital.

Over the last decade, a number of banking organisations have invested resources in modelling the credit risk arising from their significant business operations.

Such models are intended to assist banks in quantifying, aggregating and managing credit risk across geographic and product lines.

While the Framework presented in this document stops short of allowing the results of such credit risk models to be used for regulatory capital purposes, the Committee recognises the importance of continued active dialogue regarding both the performance of such models and their comparability across banks.

Moreover, the Committee believes that a successful implementation of the revised Framework will provide banks and supervisors with critical experience necessary to address such challenges.

The Committee understands that the IRB approach represents a point on the continuum between purely regulatory measures of credit risk and an approach that builds more fully on internal credit risk models.

In principle, further movements along that continuum are foreseeable, subject to an ability to address adequately concerns about reliability, comparability, validation, and competitive equity.

In the meantime, the Committee believes that additional attention to the results of internal credit risk models in the supervisory review process and in banks’ disclosures will be highly beneficial for the accumulation of information on the relevant issues.

19. This document is divided into four parts.

The first part, scope of application, details how the capital requirements are to be applied within a banking group.

Calculation of the minimum capital requirements for credit risk, operational risk, and market risk are provided in part two.

The third and fourth parts outline expectations concerning supervisory review and market discipline, respectively.

19(i). This comprehensive version of the revised Framework incorporates the additional guidance set forth in the Committee’s paper The Application of Basel II to Trading Activities and the Treatment of Double Default Effects (July 2005), the Amendment to the Capital Accord to Incorporate Market Risks (January 1996) as well as elements of the 1988 Accord that remain in effect.

This version is primarily aimed at providing banks with a comprehensive view of international solvency standards. It does not contain any new elements.

Each of the individual documents incorporated into this text (i.e. the 1988 Accord, the Amendment to the Capital Accord to Incorporate Market Risks, and The Application of Basel II to Trading Activities and the Treatment of Double Default Effects) will remain available on a stand-alone basis.

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