explicitly to quantify their credit, market, and operating risks, by estimating loss probability distributions for various risk positions. enough economic, as distinct from regulatory, capital is then allocated to each risk position to satisfy the institution ’ s own standard for insolvency probability. within credit risk models, for example, capital for internal purposes often is allocated so as to hypothetically “ cover ” 99. 9 percent or more of the estimated loss probability distribution. these internal capital allocation models have much to teach the supervisor, and are critical to understanding the possible misallocative effects of inappropriate capital rules. for example, while the basle standard lumps all corporate loans into the 8 percent capital “ bucket ”, the banks ’ internal capital allocations for individual loans vary considerably - - from less than 1 percent to well over 30 percent - - depending on the estimated riskiness of the position in question. in the case where a group of loans attracts an internal capital charge that is very low compared to the basle eight percent standard, the bank has a strong incentive to undertake regulatory capital arbitrage to structure the risk position in a manner that allows it to be reclassified into a lower regulatory risk category. at present, securitization is, without a doubt, the major tool used by large u. s. banks to engage in such arbitrage. regulatory capital arbitrage, i should emphasize, is not necessarily undesirable. in many cases, regulatory capital arbitrage acts as a safety - valve for attenuating the adverse effects of those regulatory capital requirements that are well in excess of the levels warranted by a specific activity ’ s underlying economic risk. absent such arbitrage, a regulatory capital requirement that is inappropriately high for the economic risk of a particular activity, could cause a bank to exit that relatively low - risk business, by preventing the bank from earning an acceptable rate of return on its capital. that is, arbitrage may appropriately lower the effective capital requirements against some safe activities that banks would otherwise be forced to drop by the effects of regulation. it is clear that our major banks have become quite efficient at engaging in such desirable forms of regulatory capital arbitrage, through securitization and other devices. however, such arbitrage is not costless and therefore not without implications for resource allocation. interestingly, one reason why the formal capital standards do not include very many risk “ buckets ” is that regulators did not want to

reserve requirements, have allowed european banks to lock in funding for up to three years, thereby alleviating concerns about their near - term prospects. with the benefit of this support, european banks in turn have increased their holdings of sovereign debt, contributing to lower borrowing costs for some countries. second, euro - area leaders, the greek government, and private - sector holders of greek debt are taking steps to put greece on a more sustainable fiscal path. its sovereign debt has been significantly reduced, the greek authorities are intensifying their efforts to implement fiscal and structural reforms, and the european union and international monetary fund have pledged a considerable amount of new funds as part of a second assistance package. the greek economy remains in a deep recession, however. third and finally, leaders of most of the members of the european union have approved a new fiscal compact treaty that strengthens fiscal rules and their enforcement. this treaty represents a positive step toward resolving the fundamental tension inherent in having a bis central bankers ’ speeches monetary union without a fiscal union, and thus should help bolster the viability of the euro - area economy in the longer term. although progress has been made, more needs to be done. full resolution of the crisis will require a further strengthening of the european banking system ; a significant expansion of financial backstops, or “ firewalls, ” to guard against contagion in sovereign debt markets ; and, critically, continued efforts to increase economic growth and competitiveness and to reduce external imbalances in the troubled countries. actions taken by the federal reserve the federal reserve has followed developments in europe closely, and we are in frequent contact with key european policymakers. we are particularly focused on protecting u. s. financial institutions, businesses, and consumers from adverse financial and economic developments in europe. to help calm dollar funding markets and support the flow of credit to u. s. households and businesses, the federal reserve acted in concert with major foreign central banks to enhance the u. s. dollar swap facilities that were originally put in place during the global financial crisis and reestablished in may 2010. use of the reestablished lines was limited until late last year. however, in late november, the federal reserve agreed with the ecb and the central banks of canada, japan, switzerland, and the united kingdom to extend the swap lines through february 2013 and to reduce their pricing, from a spread of 100 basis points over the overnight index swap rate to 50 basis points. 1 the lower cost to the ecb