incorporate into their operations the most sophisticated techniques for the measurement and management of risk. as i have noted, these entities use financial instruments and procedures that are not adequately captured by the basel i paradigm. they have already begun to use - or have the capability to adopt - the techniques of modern finance to measure and manage their exposures ; and because substantial difficulty at one of the largest banking organizations could have significant effects on global financial markets, all of the largest banks should be using these procedures. in our view, prudential supervisors and central bankers would be remiss if we did not address the evolving complexity of our largest banks and ensure that modern techniques were being used to manage their risks. the u. s. supervisors have concluded that the advanced versions of basel ii - the advanced internal ratings based ( a - irb ) approach for measuring credit risk and the advanced measurement approaches ( ama ) for measuring operational risk - are best suited to achieve this last objective. under the a - irb approach, a banking organization would have to estimate, for each credit exposure, the probability that the borrower will default, the likely size of the loss that will be incurred in the event of default : and - where the lender has an undrawn line of credit or loan commitment to the borrower an estimate of what the amount borrowed is likely to be at the time a default occurs. these three key inputs - probability of default ( pd ), loss given default ( lgd ), and exposure at default ( ead ) - are inputs that would be used in formulas provided by supervisors to determine the minimum required capital for a given portfolio of exposure. while the organization would estimate these key inputs, the estimates would have to be rigorously based on empirical information, using procedures and controls validated by its supervisor, and the results would have to accurately measure risk. those banks that are required, or choose, to adopt the a - irb approach to measuring credit risk, would also be required to hold capital for operational risk, using a procedure known as the advanced management approach ( ama ) to establish the size of that charge. under the ama, banks themselves would bear the primary responsibility for developing their own methodology for assessing their own operational risk capital requirement. to be sure, supervisors would require that the procedures used are comprehensive, systematic, and consistent with certain broad outlines, and must review and validate each bank's process. in this way, a bank's " op risk " capital charge

the basel committee. then, of course, the u. s. banking agencies will need to implement basel iii through domestic capital regulations. basel iii is not a perfect agreement, of course. there are things we would have done differently if we were writing a capital regulation on our own. there will surely be some technical challenges in implementing it. it does not really address some pre - crisis problems in capital regulation such as pro - cyclicality. but it is a major step forward for capital regulation. it will raise minimum requirements substantially, ensure that regulatory capital is truly loss absorbing, and discourage some of the risky activities for which the pre - crisis regime required far too little capital. basel iii was also a major step forward in international cooperation. in all candor, as recently as this past spring i was concerned that we might be unable to agree in basel on such key issues as a distinct common equity requirement. however, under the strong leadership of nout wellink in the basel committee and jean - claude trichet in the ghos, we concluded a good agreement in timely fashion. i believe that another factor in turning things around was that, unlike at some times in the past, the u. s. banking agencies spoke with a single, unified voice in basel. obviously, the benefits of basel iii for financial stability will be realized only if they are implemented rigorously. in this regard, it is important to draw a distinction between, on the one hand, implementation in the sense of enacting national regulations that incorporate the basel standards and, on the other, implementation in the sense that firms are actually holding the amounts of capital called for by the internationally agreed rules. the basel committee must be able to monitor effectively implementation of, and compliance with, these new capital standards. a number of market analysts have noted that, even under current market risk capital rules, there is considerable apparent variation in the riskweightings apparently applied by different banks. we are urging the committee to explore mechanisms for ensuring that these strengthened capital standards lead to a consistency in application, as well as in the provisions of relevant domestic regulations. along these lines, we have heard complaints from a few other countries that basel ii is not yet operative for our large, internationally active banking organizations in the united states. as we have explained, despite the substantial resources devoted by both banking organizations and supervisors to the tasks of developing and validating the advanced internal ratings - based approach in those institutions, we continue to encounter significant difficulties. the suggestion that u