- 1990s is the importance of prudent minimum regulatory capital standards. all the banking agencies are committed to this principle. at present, we cannot quantify precisely how much basel ii, once fully implemented, will affect banks'risk - based capital requirements relative to basel i levels. although our quantitative impact studies have been useful, they have been conducted using bank systems and measurements that generally would not be expected to meet the basel ii standards. we will learn more as the process moves forward, the standards and guidance come into sharper focus, and banks upgrade their riskmanagement systems. because of the irreducible uncertainty in this process, the implementation plan set forth in the npr incorporates extensive safeguards to limit the potential for unintended consequences, including any possibility of a large decline in required capital levels. these safeguards include a minimum one - year parallel run for each bank, during which the bank will calculate what its risk - based capital requirement would be under basel ii, even though its actual requirement will be determined using the basel i rules. following the parallel run, each bank will be subject to a transition period of at least three years during which capital floors based on the basel i rules will ensure that there is no sharp decline in regulatory capital. in addition, the agencies have committed themselves, throughout the transition process and beyond, to continually evaluate the effects of the new framework and to make any needed adjustments to ensure prudent levels of capital. finally, i would note that, even when basel ii is fully implemented, all banking organizations will continue to be subject to the current minimum leverageratio requirement and prompt - corrective - action rules. this step - by - step implementation plan, which all the u. s. banking agencies support, should ensure that banking organizations maintain strong capital positions throughout the transition years and after. moreover, safety and soundness depends not only on the absolute level of capital in the banking system but on how well that capital is deployed. the basel ii framework should make any given level of bank capital work harder, so to speak, by aligning capital more closely with risks taken, by providing incentives for banks to improve their risk management, and by enhancing market discipline through greater transparency. to reiterate, however, to make that framework achieve what is intended requires getting the details right. therefore, i once more urge the banking industry and other members of the public to review the npr and the draft supervisory guidance closely and to provide the agencies with constructive comments on all aspects

##imating such parameters. on the other hand, the diversity of practices across banking organizations, the absence of any single, definitive " best practice, " and the need to provide strong incentives for improving risk measurement and management require that the system be flexible enough to allow the exercise of judgment by supervisors and bankers. this need for flexibility and the use of judgment is the major reason that we have long emphasized that the supervisory reviews in pillar 2 are a necessary complement to the explicit minimum regulatory capital requirements set forth in pillar 1. naturally, we would like to see the framework implemented as cost - effectively as possible. the desire to avoid unnecessary regulatory costs is another reason why we have tried to build basel ii on what banks are already doing. however, basel ii does ask banks to make some infrastructure investments whose primary purpose is to help supervisors validate and compare banks'systems - - investments that many banks would not otherwise make. feedback from the industry regarding our proposals in this area would be very helpful. a key mechanism in basel ii for balancing the inevitable tensions that arise when attempting to achieve sometimes competing objectives is the so - called use test. under the use test, the systems and processes that a bank uses for regulatory capital purposes must be consistent with those used internally. note that i use the word " consistent, " not " identical. " for example, minimum regulatory capital need not equal the economic capital requirements computed internally by a bank, but our intent is that the two will be highly correlated. in addition, basel ii seeks to accommodate a range of riskmeasurement and risk - management practices, a range that can change over time. no regulator wants to impose a single definition of " best practice " or to set current practice in stone. in light of questions about the use test, i would highlight our desire for specific feedback on how best to implement this important principle. more generally, i hope the industry will work with the agencies to identify aspects of the framework that are neither cost - effective nor supportive of sound risk management. relative to the advanced notice of proposed rulemaking issued in 2003, the current npr incorporates many specific suggestions from the industry along these lines. important examples include the definition of default and the treatments of expected losses, loan - loss reserves, credit derivatives, and securitization. if more adjustments are needed, we are ready to listen and adjust. another concern that has been expressed regarding basel ii is that it will unfairly tilt the competitive playing field. this concern has two aspects. first