think are likely to be opt - in banks ), large regional banks, and community banks. some of the banks in the large regional group - - let's say those between the 25th and 100th largest - - have voiced the concern that even though they are well capitalized and well managed, they will be forced by market pressures, and especially by the rating agencies, to bear the high costs of moving to basel ii. the risk - management practices embedded in basel ii did not, of course, originate with the basel committee or with any of the g - 10 bank regulators. rather, to a significant extent, they represent the best practices of risk - management approaches developed in the marketplace. these practices are now being used by some banks in the tier just below the largest organizations. improved risk - management technology, supplemented by the adoption of basel ii advanced approaches at the largest banks, will accelerate the advance in risk - management sophistication that counterparties will increasingly expect to see at their banks. this market - driven change would have occurred without basel ii - - in fact, it is already in progress - - but basel ii will surely speed things up. in the near term, however, the cost - benefit ratio i referred to must be considered, and we believe that the benefits for most regional banks do not yet exceed the costs. it is our understanding that this is also the view of the rating agencies. the cost - benefit calculus may well change in the future, but, in the years immediately ahead, i do not believe that regional banks will be required by the market to adopt the more advanced approaches. we are also aware of concerns that the current competitive balance between basel i banks and basel ii banks might be upset in certain loan markets. the specific worry of the basel i banks is that the advanced approaches will yield lower capital charges for residential mortgage, retail, and small business loans. these arguments, it seems to me, require some careful thought. my own experience as a banker is that loan pricing and profitability - - and that must be what the issue is about - - are influenced little by regulatory capital levels. rather, rate setting on credits is determined by a complex web of factors, including local market competition from banks and other lenders, the cost of funds, the specifics of the bank - customer relationship, and internal capital allocation practices. for many types of retail loans, but particularly residential real estate loans, secondary market pricing has the strongest influence on rate setting. when capital

second tier banks and community size banks have also increased their access to secondary markets and have made great strides in managing their risk exposures, the changes implemented by these banks have not threatened the relevance of basel i. however, the same cannot be said about the nation's largest international banks. the largest institutions use the secondary markets for securitizing loans of all types and for a variety of other liquidity and investment needs. the largest institutions also use enhanced technology resources and risk - management tools to more carefully and specifically measure risks of all types. for banks that operate on a global scale in virtually all financial markets, basel i has become outdated. the current capital regime has not kept pace with either the complex nature of the operations of the largest banks or the substantial changes in both the concepts and technology of risk management. the current capital rules at these banks have been further undermined by arbitrage between regulatory and market measures of risk mainly through the use of derivatives and securitizations in the secondary markets. given these developments, the g - 10 bank supervisors have been designing a much more risk - sensitive regulatory framework that takes into account the evolution of the art of risk management. the latest version of the proposal ( basel ii ) will be published by the basel supervisors committee in a few weeks and an advance notice of proposed rulemaking by the u. s. supervisors is due by midsummer at the latest. an effective date of 2007 is now contemplated. the details of basel ii were described by my colleague, roger ferguson, vice chairman of the federal reserve board, in a presentation to a congressional committee in february. i have some copies with me today and can make others available. today, i thought it might be useful to provide a u. s. supervisors'view of how basel ii should be applied in this country and to address some of the concerns we have heard about the scope of application. given the needs of countries with a far different banking and regulatory structure than ours, basel ii contains three alternative approaches, which are described in the vice chairman's testimony. supervisors in this country have for some time contemplated that only the most risk - sensitive approaches, the advanced internal ratings based ( a - irb ) option for credit risk and the advanced measurement approach ( ama ) for operational risk, would be applied in the united states. these advanced approaches would be required for only our largest and most complex, internationally active banking organizations - - about ten u. s. banks. however, any other