susan schmidt bies : implementing basel ii - choices and challenges remarks by ms susan schmidt bies, member of the board of governors of the us federal reserve system, at the global association of risk professionals'basel ii & banking regulation forum, barcelona, 16 may 2006. * * * thank you for the invitation to speak here today. i am honored to be with this distinguished group of risk - management professionals from around the world. in my remarks, i will focus primarily on the choices and challenges associated with basel ii implementation. in particular, i want to reaffirm the federal reserve ’ s commitment to basel ii and the need for continual evolution in risk measurement and management at our largest banks and then discuss a few key aspects of basel ii implementation in the united states. given the international audience here today, i also plan to offer some thoughts on cross - border implementation issues associated with basel ii, including so - called home - host issues. moving to basel ii by now most of you are aware that on march 30 the federal reserve board approved a draft of the u. s. notice of proposed rulemaking ( npr ) on the basel ii capital framework. the npr is expected to be issued in the federal register once all of the u. s. banking agencies have completed their individual review and approval processes, at which time it will be “ officially ” out for comment. we recognize the significance of this development to the industry, the u. s. congress, and others who have waited for greater specificity on the proposed revisions. but before commenting further on the npr and the u. s. basel ii process, i want to reiterate our rationale for pursuing basel ii. rationale for moving to basel ii the current basel i capital framework, adopted nearly twenty years ago, has served us well but has become increasingly inadequate for large, internationally active banks that are offering ever more complex and sophisticated products and services. we need a better capital framework for these large, internationally active banks, and we believe that basel ii is such a framework. one of the major improvements in basel ii is the closer link between capital requirements and the way banks manage their actual risk. the current basel i measures have very limited risk - sensitivity and do not provide bankers, supervisors, or the marketplace with meaningful measures of risk at large complex organizations. under basel i, a bank ’ s capital requirement does not adequately reflect gradations in asset quality and does not change over time to reflect deterioration in asset quality. further,

mission. the federal reserve was created in 1913, following the banking panic of 1907, with the goal of promoting financial stability and avoiding banking panics. responsibilities have evolved over the years. in the aftermath of the 2007 - 09 financial crisis, congress assigned the fed additional responsibilities related to promoting financial stability, and the board of governors significantly increased the resources dedicated to that purpose. events in recent years, including the pandemic, emerging geopolitical risks, and recent stress in the banking sector have only highlighted the important role central banks have in understanding and addressing financial stability risks. the federal reserve ’ s goal in financial stability is to help ensure that financial institutions and financial markets remain able to provide critical services to households and businesses so that they can continue to support a well - functioning economy through the business cycle. much of how we think about and monitor financial stability at the federal reserve is informed by our understanding of how shocks can propagate across financial markets and affect the economy. economists have studied the role of debt in the macroeconomy dating all the way back to irving fisher in the 1930s, and in the past 40 years it has been well established that financial disruptions can reduce the efficiency of credit allocation and have real effects on the broader economy. 3 when borrowers ’ financial conditions deteriorate, lenders tend to charge higher rates on loans. that, in turn, can lead to less overall lending and negatively affect the broader economy. 4 and in for example, bernanke ( 1983 ) showed how financial disruptions can reduce the availability of credit and reduce aggregate demand, and diamond and dybvig ( 1983 ) showed how bank runs can affect the real economy. in their articulation of the financial accelerator, bernanke, gertler, and gilchrist ( 1999 ) demonstrate concepts like this. - 3the wake of the 2007 - 09 financial crisis, we ’ ve learned more about the important roles credit growth and asset price growth play in “ boom - bust ” cycles. 5 fundamentally, financial stress emerges when someone is owed something and doesn ’ t get paid back or becomes worried they won ’ t be paid back. if i take out a loan from you and can ’ t repay it, you take a loss. similarly, if i take out a mortgage from a bank and i can ’ t repay it, the bank could take a loss. and if the bank hasn ’ t built sufficient ability to absorb those losses, it may not be able to