100, 000, but was turned down. similarly, guglielmo marconi initially overlooked the radio ’ s value as a public broadcast medium, instead believing its principal application would be in the transmission of point - to - point messages, such as ship - toship, where communication by wire was infeasible. a second source of technological uncertainty reflects the possibility that an innovation ’ s full potential may be realizable only after extensive improvements, or after complementary innovations in other fields of science. according to charles townes, a nobel prize winner for his work on the laser, the attorneys for bell labs initially refused, in the 1960s, to patent the laser because they believed it had no applications in the field of telecommunications. only in the 1980s, after extensive improvements in fiber optics technology, did the laser ’ s importance for telecommunications become apparent. it ’ s not hard to find examples of such uncertainties within the financial services industry. the evolution of the otc derivatives market over the past decade has been nothing less than spectacular. but as the theoretical underpinnings of financial arbitrage were being published by modigliani and miller in the late 1950s, few observers could have predicted how their insights would eventually revolutionize global financial markets. this is because, in addition to their insights, at least two complementary innovations had to fall into place. the first was further conceptual advances in contingent claims theory, such as the black - scholes option pricing model. the second was several generations of advances in computer and communications technologies that were necessary to make these concepts computationally practicable. given the high degree of uncertainty inherent in the development of new products and processes, policymakers should be cautious when attempting to anticipate the future path of innovation, or the effects new regulations may have on innovation. there are several aspects to this interaction between government policies and market innovation. first, banking organizations may develop new products or innovations to exploit regulatory “ loopholes ”, or they may decline to develop new products whose likely regulatory treatments are viewed as burdensome or unclear. another unintended consequence is that a policy action may establish an inappropriate unofficial government standard for how certain activities should be conducted. in contrast to government standards, which can be extremely difficult to change, when the private sector adopts a standard that subsequently becomes outmoded, market forces generally can be expected to remedy the situation. the history of retail electronic payments provides a useful illustration. in the 1970s, when many were heralding

fdic improvement act. of course, the value of these initiatives will depend on the credibility of regulators in implementing the legislative mandates consistently over time. a second guiding principle is that, to the extent possible, our regulatory policies should attempt to simulate what would be the private market ’ s response in the absence of the safety net. such a principle suggests that supervisory and regulatory policies, like market responses, should be capable of evolving over time, along with changes in institutional practices and financial technologies. almost certainly, such a principle implies that we avoid locking ourselves into formulaic, one - size - fits - all approaches to measuring and affecting bank safety and soundness. for example, as a bank ’ s internal systems for measuring and managing market, credit, and operating risks improve with advances in technology and finance, our supervisory policies should become more tailored to that bank ’ s specific needs and internal management processes. recently, we have taken several steps that attempt to operationalize this concept, including the introduction of an internal models approach to assessing capital for market risks in large banks ’ trading accounts. also, as i am sure most of you are aware, the board is currently pilot - testing with the new york clearing house association an alternative capital allocation procedure for market risk, called the “ pre - commitment ” approach. the pre - commitment approach would permit capital requirements for market risk to reflect not only the estimates of risk derived from a bank ’ s internal market - risk model, but also other features of the bank ’ s trading risk management system that help limit its overall risk exposure - - such as the effectiveness of its internal controls and other risk - management tools. conclusions over the last three decades, the folly of attempting to legislate or regulate against the primal forces of the market is one of the most fundamental lessons learned by banking regulators. if those market forces are driving financial firms toward centralized decisionmaking regarding risk, pricing, and other operational issues, it will be difficult, at best, to implement a decentralized approach to prudential regulation, however attractive its apparent simplicity. similarly, in the face of continual market - driven innovations in banks ’ risk measurement and management systems, regulatory approaches based on rigid, one - size - fits - all rules are likely to become quickly outdated, ineffectual, and, worse, potentially counterproductive. incentive - compatible regulation, flexibly constructed and applied, is the logical alternative to an increasingly complex system of rigid rules and regulations that inevitably have unintended consequences