areas. today, i would like to highlight these risks and focus on how important it is for banks to integrate their risk management and capital planning processes. also, i would like to focus on how the changing nature of banking is challenging supervisors to rethink their approach to capital regulation and supervision. despite changes in banking over the last few years, many of which already have been discussed today, credit risk remains the predominant risk for most banks. however, credit risk clearly extends beyond conventional credit products such as loans and letters of credit. today, banks are taking on credit risk in the form of margin lending and transactions in the over - thecounter derivatives markets that expose them to large amounts of counterparty risk and can be difficult to measure. they also may be engaged in taking on credit risk in its more subtle forms. the short - term credit risks in futures brokerage, where the clearing broker stands between the customer and the exchange, or the often underestimated, but substantial, credit risks that arise in settling foreign exchange contracts, are examples. credit risk also may exist in more complicated, less conventional forms, such as credit derivatives or tranches of securitized assets. market risk also remains prominent. the upheavals in both global fixed income and equities markets over the last year led to a great deal of volatility in spreads and asset prices and caused large swings in bank profitability. these events demonstrate that the world doesn ’ t necessarily work the way we thought it did, that there are correlations between markets that we had previously thought were unrelated. as banks continue to expand their global trading operations, the need to understand the relationships between markets increases. this challenge is amplified by technological advances and financial product innovations that contribute to ever - more complex market instruments. but clearly, banks are exposed to more than just credit and market risk. operational risk also is a growing concern for the banking industry. the looming issue of year 2000 remediation is just one example. with the continuing diversification of banking, the fast pace of financial innovation and the growing concentration of crucial payments, settlements and custody businesses, the importance of operational risk is rising, especially at many larger institutions. these institutions find that the probability of a financial loss resulting from a breakdown in internal controls or systems is greater than ever. as banks expand into new lines of business, such as electronic banking, this trend is likely to continue. for instance, consider the risk of a breach in electronic security controls that

leads to unauthorized access to confidential customer information. should this breach be severe and pervasive, it could lead to considerable legal and reputational problems for a bank. further, the overall rapid pace of technological change in this area means there is a substantial risk of obsolescence. these are just some of the risks that banks must manage, and clearly the list i have set forth is not exhaustive. in particular, consider banks in emerging market countries that are subject to a unique set of risks as a result of the financing and investment cycles in their countries. those banks that fund their domestic assets with foreign currencies may be particularly susceptible to liquidity risk when sharp fluctuations in exchange rates and market turbulence make it difficult to retain sources of financing. while i have presented to you some of the major risks as separate and discrete, we recently have discovered that they are, in fact, inter - related. for instance, we have seen that market risk frequently drives credit risk. in the second half of last year, we saw turbulence in fixedincome markets produce severe liquidity and solvency risks for hedge fund market participants. also, we have learned that credit risk may derive from operational risks, embedded in complex systems for managing collateral or intra - day funding, both of which require rigorous internal control environments. regardless of the nature or form of risk, the best way for all banks to protect themselves is to identify risk correctly, accurately measure and price it, appropriately control it and maintain high levels of reserves and capital, in both good times and bad. however, many banks are not finding it easy to develop a holistic approach to assessing and managing the many interrelated risks they face. a particular challenge is to relate such risk assessments to appropriate capital levels, especially given the dynamic nature of their businesses. before i discuss how some banks are tackling this issue, let me first consider the role of capital more generally and how it relates to risk and strategy. fundamentally, the role of capital is to act as a buffer against unidentified, even relatively remote losses that a bank may incur in the future. a bank must hold enough capital to cushion both depositors and senior lenders against losses, while leaving the bank able to meet the needs of its customers. banks must maintain capital commensurate with the amount of risks that they take and hold enough to weather financial storms, which can at times be severe and of considerable duration. banks with low equity capital ratios and a high variability of operating