so it seems sensible to link minimum capital requirements to a confidence level. in its work, the basel committee's approach has been to set those requirements equivalent to an investment grade rating. it is important that this rating level is maintained. first there is growing evidence that without it a large bank would have insufficient freedom of operation as their counterparties'limits on unsecured exposures stemming from interbank, swap and fx transactions to the bank concerned would be too small. second, the frequency of banking crises does not suggest that the current minimum level of regulatory capital is too high : four out of the g - 10 countries have suffered a banking crisis over the last decade. another important issue is the possible impact of any new capital requirements on the business cycle. it has been argued that capital requirements can potentially contribute to a credit crunch because in a period of severe downturn, they can become binding should write - offs and loan loss reserves reduce the amount of capital which a bank has available to back new lending. if banks are insufficiently forward - looking in their assessments of risk, more risk - sensitive capital requirements could lead to an added pro - cyclical effect to the extent that capital requirements would increase in recessions as the average riskiness of borrowers rose. it is therefore essential that banks take a longer term view of creditworthiness. we think, however, that such fears of procyclicality are exaggerated and are more than matched by the other benefits from the new regime - in particular, the reduced opportunities for regulatory arbitrage and the incentives given to banks to strengthen their risk management. moreover, a number of factors seem likely to mute the impact of the new proposals on the cycle. first, many banks have a buffer of capital well above the regulatory minimum. second, in a recession, demand for bank credit may anyway fall. third, to the extent that banks ( and ratings agencies ) assign assets to risk categories in a forward looking manner, it should be possible to avoid wholesale reclassifications to lower credit - risk categories during cyclical downturns, particularly those of normal amplitude. conclusion the new accord will make a significant contribution to strengthening the international system. but even under the current accord, banks should find themselves better placed than in the past to deal with any sudden downturn. a soft landing for the us still seems the most likely outcome but the system is in far better shape now than a decade ago to absorb, if necessary, a somewhat harder bump. i

by bill mcdonough, president of the new york fed, unveiled its'second consultative package'which sets out the details of a new accord. the intention is that this should be agreed by around the turn of the year, in order to allow implementation by 2004. we warmly welcome the new proposals and have played a major part in their negotiation alongside the uk financial services authority and other g10 central banks and regulators. we particularly support the proposed use of banks internal ratings to calculate capital. banks should know more about the riskiness of their individual borrowers than, for example, external rating agencies or supervisors and the new accord will provide them with the proper incentive to do so. the new accord also recognises that in today's complex banking markets, a focus on capital adequacy alone is not enough. this has to be reinforced by a rigorous review of banks'internal risk management processes, and also by greater transparency and market discipline. together, these three mechanisms - which are intended to be mutually reinforcing - are known as the three'pillars'of the new accord. a fundamental change within the first pillar - capital levels - compared to the original accord is that improved risk management in banks has allowed the proposed new accord to incorporate greater sensitivity of credit risk capital charges. there will be a menu of approaches, depending on the sophistication of the bank. a'standard'approach differentiates between credit exposures on the basis of external ratings. a'foundation'internal ratings based approach will allow banks to differentiate between credit exposures on the basis of their internal estimates of borrower default probabilities ; and an'advanced'approach allows other inputs required to assess credit risk also to be provided by the bank, rather than the regulator. in addition to all this, there will be for the first time an explicit capital charge for operational risk. systemic implications of the revised accord what i have described so far is how the accord is intended to be applied to individual banks. but given the bank of england's responsibilities for the stability of the financial system as a whole, our principal concern is with the overall impact on the system. the basel committee has said that the new accord is intended broadly to deliver the same level of bank capital on average across banks as at present. how should we assess the adequacy of this from the viewpoint of overall financial stability? as i suggested earlier, the role of bank capital is to provide a buffer sufficient to cover unexpected losses.