The evidence of the havoc that weak domestic financial systems can cause has led to a number of international initiatives to encourage governments and supervisors to strengthen their financial infrastructures. By far the most important has been the Basel Committee's Core Principles for Banking Supervision. Financial Sector Assessments led by the IMF and the World Bank reinforce this international effort.

In principle, the three-pillar structure of the new Accord will provide even stronger incentives to strengthen domestic supervision and for banks themselves to become more sophisticated in their management of risk, to `hardwire the credit culture'. But the supervisory authorities in several emerging markets and many developing economies are understandably concerned that Basel II sets a standard that they cannot reasonably hope to meet. Probably their greatest concerns relate to the reliance on external rating agencies in the standardized approach to calculating minimum capital requirements. Domestic rating agencies are not well developed in many non-OECD countries. This suggests that in the short-term, at least, most domestic credit risks will tend to end up in the unrated, 100%, category. This could reduce the risk-sensitivity of the new system relative to Basel I, although there would be other new elements of risk sensitivity, such as the higher capital requirement on past-due credits and new capital charge on all unconditionally cancelable loan commitments, which have themselves caused some complaints among banks in these economies.

These and related issues have led to an interim standard between Basel I and Basel II that would afford domestic banks in emerging markets' economies some of the benefits of Basel II but fewer of the costs. This raises two points. First, no non-BCBS countries is required to adopt the new standards, and those that prefer to use Basel I rather than the standardized approach of Basel II are free to continue to do so. Nor should emerging markets' economies be unfairly penalized in the short-term for failing to adopt Basel II.

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