basel ii, supervisors are becoming even more involved in understanding the emerging best practices in risk measurement and management. bridging the gap between internal capital measures and regulatory capital as i alluded, supervisors are focused on setting minimum levels of regulatory capital at individual banks that is sufficient for safety and soundness in the institution and the banking system more broadly. successful individual financial institutions, on the other hand, generally strive for a higher level of capital that is tied to their individual circumstances and allows them to effectively implement their business strategies. as a result, the capital goals of supervisors and institutions are not necessarily identical ( nor should they be ) - - but they are complementary. even though the capital goals of regulators and bankers may differ, supervisors can still use the internal information produced by large, complex institutions to augment the risk - sensitivity and overall meaningfulness of regulatory capital measures. basel ii - - particularly the advanced approaches - - is an attempt to do just that. increasingly, the measures produced by basel i are no longer accurate representations of the risks to which large, complex institutions are exposed. these institutions have moved away from the traditional banking strategy of holding assets on the balance sheet to strategies that emphasize redistribution of assets and active management of risks. they have significant, complicated exposures off the books that need to be considered more explicitly in determining minimum regulatory capital. among these are operational risks, which in some recent instances have been the source of substantial losses far exceeding credit - or market - related losses. basel ii, by tying regulatory capital to bank inputs, offers greater transparency about what stands behind the inputs provided by banks and exactly how they are calculated. as i noted earlier, successful institutions understand that calculating internal capital measures is a serious and challenging undertaking, with many moving parts. supervisors, through their analysis of bank inputs to basel ii, will develop an even better assessment of institutions ’ risk - measurement and riskmanagement practices. furthermore, the added transparency in pillar 3 disclosures is expected to provide market participants with a better understanding of an institution ’ s risks and its ability to manage them. perhaps most importantly, basel ii ’ s advanced approaches create a link between regulatory capital and risk management. under these approaches, banks will be required to adopt more formal, quantitative risk - measurement and risk - management procedures and processes. the new accord ’ s emphasis on improved risk management should not be interpreted solely as a requirement to determine regulatory capital standards, but rather as a foundation for risk - management practices to benefit the institution more broadly

us to move forward. in general, we were pleased to see that qis4 showed that progress is being made toward developing more risk - sensitive capital measures. in fact, it was quite interesting to see the range of practice employed by institutions in developing their qis4 estimates. as noted, a fair portion of the dispersion among institutions stemmed from their assignment of risk parameters, with differences in portfolio composition playing some role. the institutions participating in qis4 use a variety of credit - rating systems. rating philosophy is an area in which rating systems can differ, with some focused more on “ through the cycle ” ratings, and others on “ point in time ” ratings. choices made in rating philosophy can have an impact on how assessments of risk translate into required capital. additionally, it is quite interesting to see institutions continually working to upgrade their rating systems and incorporate innovations where possible ; for example, many systems have recently been enhanced for greater granularity. so although work remains, we believe real strides are being made. in analyzing institutions ’ estimates of default probabilities, we saw that some firms used internal data, others external data, and some a combination of data sources. we also saw that differences in the use of reference data could affect capital outcomes. similar results were seen with estimates of loss given default, as firms again used both internal and external data. furthermore, we saw significant differences across banks in the discounting of recoveries, assumptions for workout costs, methods for incorporating downturn conditions ( or lack thereof ), and the treatment of collateral. these differences appear to have had significant effects on banks ’ loss given default estimates and to have contributed to the dispersion in required capital levels across firms. so what does it mean that institutions estimated different parameters for similar exposures? it could mean that not all practices are entirely robust or producing accurate results - - understandable given that qis4 was a done on a “ best efforts ” basis without close supervisory oversight, that the u. s. agencies need to issue their proposals, and that banks are still in the process of implementation. differences in parameter estimates could also mean that institutions have varying interpretations of risks or methods to estimate those risks - - all of which could be perfectly acceptable. in fact, today we see different interpretations and assessment of risks in financial markets as counterparties assume different probabilities of default, estimates of loss, or forecasts of prices. as you know, u. s. supervisors are still developing their