and other elements of operational risk is not necessarily easy, as many of you randall s. kroszner ( 2008 ), “ the importance of fundamentals in risk management, ” speech delivered at the american bankers association spring summit meeting, washington, dc, march 11. see also president ’ s working group issues policy statement to improve future state of financial markets, and report of the financial stability forum on enhancing market and institutional resilience. here can attest. but the ama is designed to make that determination more risk sensitive and more accurate. in this manner, basel ii represents a major step forward in banking regulation. while the existing basel i capital regime was a significant advance when introduced in 1988, it has become outdated for large, internationally active banking organizations. retaining basel i for these institutions would have widened the gap between their regulatory capital requirements and their actual risk profiles. that is one reason why the federal reserve supports basel ii so strongly. with regard to credit risk, the advanced approaches of basel ii improve regulatory capital measures by requiring banks to distinguish among the credit quality of individual borrowers. generally speaking, banks holding riskier credit exposures are required to hold more capital. similarly, the ama framework requires a more systematic approach for assessing the operational risk to which a bank is exposed and ties an explicit regulatory risk - based capital requirement to these exposures. under basel i, this charge was indirect and embedded in credit and market risk measures. in contrast, under the ama, banks with higher levels of operational risk – such as those more heavily involved than others in activities that have elevated loss potential from fraud, business disruption, or systems failure – generally should have higher capital requirements. by establishing a much more refined approach that requires banks to hold capital commensurate with the actual risks of their exposures and activities, basel ii should lead institutions to make better decisions about assuming, retaining, and mitigating risks. not only does basel ii establish more risk - sensitive and meaningful regulatory capital requirements, it also encourages ongoing improvements in banks'risk management practices. the u. s. final rule for basel ii includes extensive system and process requirements and u. s. supervisors have high standards for banks seeking to qualify. one reason for such high standards is that the framework will only function as intended if basel ii banks have solid risk management infrastructures and robust quantification methods on which to base capital requirements. another reason for such high standards is that the risk management improvements in basel ii offer broader safety and

capital to support its entire risk profile, and it should provide a cushion against the potential impact of periods of financial or economic stress. in its icaap, for example, an institution may choose a solvency standard for overall capital adequacy that is higher than the 99. 9 percent implied by the ama – for example, a solvency standard of 99. 95 or 99. 97 associated with a certain credit rating. as most of you know, estimating capital needs in the tail of a loss distribution becomes more and more difficult the farther out one goes, so simply " scaling " the ama measure will likely not suffice for truly assessing capital adequacy against a higher solvency standard. more broadly, one of the supervisory expectations surrounding the icaap is that institutions should understand the limitations of models and conduct stress testing and scenario analysis to provide greater information about potential losses and capital needs. even good models have their limits – such as incomplete data or assumptions that have not been tested across business cycles – and need to be supported by more qualitative measures and sound judgment. put another way, pillar 2 is not just about using " one number, " but requires institutions to develop a robust process to evaluate the full range of potentially adverse outcomes that could affect capital adequacy. this process certainly includes considering the potential for operational risk losses becoming correlated with losses in other risk areas. recent events provide ample evidence that underestimating the potential for concurrent losses in multiple risk areas can put pressure on capital levels. pillar 3 plays an important role in providing greater information on banks'risk profiles and their ability to manage them. in addition to disclosing their capital requirements for operational risk under the ama, banks will have to provide a description of their ama process, including their measurement approaches and relevant internal and external factors considered. they will also have to provide information about the use of insurance to mitigate operational risk. as a strong believer in market discipline and the importance of information in market transactions, i believe pillar 3 will improve bank disclosures about risk profiles and enhance discussions between bankers and market participants about risk - management practices. next steps with basel ii implementation in the united states, basel ii has been an official regulation for just over a month. but the full implementation process will take time. while i believe that expeditious application of basel ii will have significant benefits, it is of the utmost importance that the implementation be undertaken thoughtfully and deliberately. as you know, following a