the current supervisory and regulatory framework - taking into account the capital accord currently in effect and how it is used in our supervisory processes. the original basel capital accord was itself a landmark event, revolutionary in providing a common capital assessment approach, now used by over 100 countries. however, it has obvious limitations that have become more significant over time. it has become less and less reflective of the risks of our largest organizations, and, accordingly, has become less and less integral to our ongoing supervision of them. basel i, as we all know, includes such shortcomings as : a ) its failure to recognize differing credit quality within the same general asset type ; b ) its varying the capital charge with the credit exposure ’ s legal form, such as whether it is on or off balance sheet ; and c ) its simplistic approach to risk transference and credit risk mitigation. more generally, basel i was not structured to keep pace with the rapid rate of financial innovation that we have seen in internationally active banks. it clearly has created incentives for capital arbitrage, with banks able to structure transactions with the primary goal of minimizing regulatory requirements without a commensurate reduction in risk. similarly, it has resulted in distortions in bank activity, by creating a tax on certain activities while understating the risk for others. these have combined to make the regulatory capital metric less informative to investors, supervisors and counterparties, and have eroded the principle of adequate risk - based capitalization that the basel accord was designed to promote. i should emphasize that the weaknesses of the current regulatory capital framework are much more relevant to the supervision of the largest and most sophisticated banks than they are generally across the industry. for the vast majority of the thousands of u. s. banks, the existing regime largely works. in recognition of this, among other considerations, we expect that in the u. s. most banks will stay on basel i while the largest and internationally active banks will adopt the advanced basel ii approaches. we are considering some simple adjustments to basel i to ensure that the framework is up to date and that there is competitive equity with basel ii adopters. in any event, the lack of risk sensitivity and incentives for arbitrage have made basel i less relevant in our supervision of the largest banks - it is a benchmark requirement to be met, but not, in practice, a critical discriminating factor as we judge their financial condition. as supervisors, we have focused increasingly on assessing

the same assessment of their inputs. individual banks will still have different methodologies for arriving at the inputs based on their reasoned assessment of risk, and banks ’ estimates will clearly vary according to their business strategies and the nature of their portfolios. concerns that basel ii will be destabilizing for emerging markets another charge leveled at basel ii is that increased capital requirements for lending to emerging market economies will cause banks to reduce credit extensions. here i think it is particularly important to consider the current reality of banks ’ decision - making processes. internationally active banks are not currently making lending decisions primarily on the basis of basel i capital requirements - rather, they are using their internal risk ratings systems and economic capital models for pricing and lending decisions. these internal models and capital requirements are far more constraining than basel i requirements. therefore, when we try to gauge the impact that basel ii will have on emerging market lending, the pertinent comparison is not with basel i, but with the internal risk ratings and economic capital systems that internationally active banks now use. as such, we do not expect major changes in international lending as a result of basel ii requirements. additionally, basel ii will bring stabilizing benefits to emerging markets that are often overlooked. the sharp distinction in capital charges for longer - term lending versus short - term loans under basel i has created some distorted incentives, particularly with regard to emerging market lending. the new rules will remove these incentives for short - term lending - a form of lending that can be especially destabilizing to emerging markets during financial stress. the adoption of basel ii internationally will have the benefit of spreading stronger risk management practices to all countries, including emerging market nations. this is not to say that basel ii is the right answer for all banks or all countries at this time, but rather that all countries should work to adopt various of its underlying principles in assessing banks ’ risk management systems and in promoting transparency and disclosure. investors and rating agencies would then have a better understanding of the risk profile of emerging market banks, which could result in a reduction of the risk premium currently applied to some emerging market lending. conclusion in wrapping up, i would emphasize that implementation of basel ii should help supervisors and market participants better detect increases in risk in individual institutions and across the financial system through a more risk sensitive capital measure. basel ii also promises to reinforce and accelerate improvements in bank risk management globally, as well as promote future innovations through its reliance on banks ’ internal methodologies. how well these improvements un