one year time horizon. so the banker sets an internal corporate goal to allocate enough capital so that the probability of losses exceeding capital is less than 0. 1 percent. in the language of statistics, this means that allocated capital must “ cover ” 99. 9 percent of the estimated loss probability distribution. once the banker estimates risk and allocates capital to that risk, the internal capital allocations can be used in a variety of ways - - for example, in so - called raroc or risk - adjusted return on capital models that measure the relative profitability of bank activities. if a particular bank product generates a return to allocated capital that is too low, the bank can seek to cut expenses, reprice the product, or focus its efforts on other, more profitable ventures. these profitability analyses, moreover, are conducted on an “ apples - to - apples ” basis, since the profitability of each business line is adjusted to reflect the riskiness of the business line. what these bankers have actually done themselves, in calculating these internal capital requirements, is something regulators have never done - - defined a bank soundness target. what regulator, for example, has said that he wants capital to be high enough to reduce to 0. 1 percent the probability of insolvency? regulators have said only that capital ratios should be no lower than some number ( 8 percent in the case of the basle standards ). but as we should all be aware, a high capital ratio, if it is accompanied by a highly risky portfolio composition, can result in a bank with a high probability of insolvency. the question should not be how high is the bank ’ s capital ratio, but how low is its failure probability. in sharp contrast to our 8 percent one - size - fits - all capital standard, the internal risk - capital calculations of banks result in a very wide range of capital allocations, even within a particular category of credit instrument. for example, for an unsecured commercial credit line, typical internal capital allocations might range from less than 1 percent for a triple - a or double - a rated obligor, to well over 20 percent for an obligor in one of the lowest rating categories. the range of internal capital allocations widens even more when we look at capital calculations for complex risk positions such as various forms of credit derivatives. this great diversity in economic capital allocations, as compared to regulatory capital allocations, creates at least two types

host supervisory authorities are working to identify specific issues and barriers to coordinated action that may arise in handling severe stress at identified firms. this process should culminate in recovery plans – developed by the individual firms – that outline options for an institution to recover from a severe distress without extraordinary official sector actions, and resolution plans – developed by the official sector – intended to identify options that would result in an orderly wind - down. domestically, we have formed crisis management groups to cover the key internationally active u. s. banking organizations. in addition to the federal reserve, the groups include representatives from the office of the comptroller of the currency, federal deposit insurance corporation, securities and exchange commission, and relevant foreign supervisors and central banks. the firms are each internally identifying and assessing their options and strategies to lower risk in the event of stress, including selling portfolios or business lines, restructuring liabilities and implementing contingency funding plans. the objective is to ensure that each firm has a concrete and viable plan to reduce riskiness, ensure the continuity of critical financial services, preserve liquidity, and make up cash flow shortages under severely adverse conditions. they are individually working with their own crisis management group to isolate key impediments to recovery and are focusing on work that should be undertaken in the near term to enhance recovery options. these plans will have to be dynamic to ensure they remain relevant and appropriate in light of changing business and economic conditions. despite the progress that is being made through the fsb work and domestic efforts, comprehensive solutions to cross - border crisis management difficulties will not be easy to achieve. enhancing cross - jurisdictional synchronization of resolution options and recovery processes would be a meaningful step in the right direction. at least for the foreseeable future, a focus on regulatory coordination and supervisory cooperation and planning before a large firm ’ s failure becomes a real possibility is likely to yield the greatest benefit. incentive compensation in the last two years, compensation has been a regular topic of discussion at meetings of international regulatory groups, culminating in the fsb ’ s agreement last year on principles to guide incentive compensation. 2 the principles specify that compensation practices at major financial institutions should properly account for risk, that boards of directors and risk managers at such firms should ensure they do so, that supervisors should provide effective oversight, and that firms ’ disclosures should be sufficient to inform stakeholders about compensation and risk. in addition to these principles, a number of specific projects are in progress or have recently been completed by international