as a whole. this is because banks play a pivotal role in our economy as providers of credit. if banks make poor credit decisions with respect to a borrower, including a hedge fund like ltcm, the financial system and our economy will suffer. basle report findings as you know, i chair the basle committee on banking supervision, comprised of bank supervisors from the g - 10 countries who coordinate supervisory policy for internationally active banks. while the committee does not have formal legal enforcement powers, its conclusions and recommendations are widely implemented, both in g - 10 countries and many others. in late january, the committee issued a report dealing with the relationship between banks and highly - leveraged institutions, or “ hlis ”. the committee ’ s report provides a framework for addressing the broader issues raised by the ltcm episode, the policy responses of supervisors, and some key risk management challenges for the banking industry going forward. in the united states, the federal reserve system, the new york state banking department, and the office of the comptroller of the currency have conducted target reviews of a number of large - bank dealings with hedge funds. these reviews contributed to the committee ’ s work, to the federal reserve system ’ s issuance on february 1 of new guidance to financial examiners and banks, and to similar guidance from the comptroller of the currency issued in january. these new standards emphasize the need for improvements in the credit risk management process at banks. the new standards will likely be complemented by a study of the implications of the ltcm episode by the president ’ s working group on financial markets. because the basle committee ’ s jurisdiction is limited to matters of banking supervision and regulation, its primary emphasis has been on ensuring that the major banks prudently manage their risk exposures to hlis. the best way to achieve this is through the adoption of sound practices by the industry, perhaps supplemented by incentives created through capital requirements. while it is primarily the responsibility of each banking organization to manage its risks, sound practice standards give banks and supervisors a tool to measure industry progress. if banks themselves do not follow sound practices, then supervisors must step in and take the necessary action. the committee ’ s report revealed a number of deficiencies. in particular, the committee observed an imbalance among the key elements of the credit risk management process, with too strong a reliance upon collateral. this undue emphasis, in turn, caused many banks to neglect other critical elements of effective credit risk management,

banks carry forward the lessons of the ltcm experience to all potentially high - risk trading activities. in this regard, our examiners will devote particular attention to the risks associated with rapidly growing, highly profitable and potentially high - risk activities and product lines. they will assess the adequacy of banks ’ reviews of counterparty creditworthiness, exposure measurement and monitoring techniques, stress testing, limit setting, and the appropriate use of collateral and other credit enhancements. our examiners will also look at internal policies and the degree to which behavior conforms to stated policies. we have already conducted meetings with the major banks to reinforce these messages and our examiners will conduct follow - up reviews in the course of this year. other possible policy responses over the past few months, there has been significant debate about other measures that could be taken to limit the potential risks to the financial system arising from the activities of large, highly leveraged, unregulated financial institutions. the basle committee carefully considered all the ideas that have surfaced. our report discusses a variety of options beyond the implementation of sound practice standards. one possibility is to require higher capital charges for bank exposures to hlis. indeed, a primary objective of our current review of the basle capital accord is to determine how to align regulatory capital charges better with the economic risks of different classes of counterparties. we also recognize the critical need to enhance market transparency for the activities of hlis and other major market participants. the committee already is working to enhance accounting and disclosure practices at banking institutions worldwide. extending these efforts to all global players that have the potential to destabilize the financial system, including hlis, is of particular importance. an international group of central bankers is now studying various approaches to strengthening disclosure in this area. the committee also considered the advantages and disadvantages of imposing direct regulation on the hli industry. there are a number of critical obstacles that would have to be overcome before a direct regulatory approach could be implemented. to be effective, any regulation would have to extend to jurisdictions around the world where hlis are chartered, some of which have more highly developed and more stringent supervisory structures than others. this would require a high level of coordination involving the political, legislative, and judicial bodies of many countries. there is also the difficulty of establishing a regulatory regime for hlis that is not easily circumvented. for these reasons, i believe the most practical approach is to focus on financial institutions ’ lending activities,