indicated that this process indeed located further year 2000 problems that needed repair. thus, in spite of extensive repair efforts, some problems were not isolated until internal future date tests were performed. this underscores why every organization must build in a program of rigorous internal testing as a part of its year 2000 project schedule, even for applications designed to be year 2000 compliant. moreover, the internal testing process cannot wait until the last minute. experience has shown that testing programs overall typically consume over 50 % of the resources allocated to year 2000 projects. external tests are conducted by an institution to assess the risks in repaired and internally tested systems where they interface with systems of other institutions. external tests are particularly important where the interface is proprietary or specific to the particular business activity and the dependency on the external interface is critical. for the most critical systems, in particular payment and settlement systems, external testing must be done, and should be done carefully. external tests can take a variety of forms. point - to - point tests verify the ability of an institution to transmit and receive data with another entity. end - to - end tests take this one step further and verify the ability of an institution originating a transaction to transmit test data to a recipient through an intermediary which correctly performs business functions using that data. end - to - end tests are particularly appropriate for real - time, interactive applications. some organizations are using a series of point - to - point tests to effectively simulate an end - to - end testing process. with regard to fedwire, the federal reserve ’ s large - value funds transfer system, we have made the system available for external tests from july of this year. we have also begun a program of shared testing days that allows multiple customers to simultaneously perform endto - end testing over the system. these tests will cover the full range of payments and accounting applications that we provide and will address both the century date conversion and the leap year date in 2000, which many systems also may not handle correctly. one of the key lessons that has come out of our test process for fedwire is the importance of extensive planning for each aspect of the testing program. for example, both the testing schedule and test scripts required extensive efforts to develop. furthermore, without the very substantial amount of communication and advance planning by the federal reserve and the banks involved, we could not be confident that the tests would provide a meaningful output. naturally, appropriate internal testing must also be completed in order to derive maximum value from the external testing program. these

defined categories of credit. they also have enhanced the methods they use to assign internal risk ratings to individual credit exposures. the development of credit models by a number of banks has led to a deeper understanding and analysis of the relationship between risk and return in credit activities at the portfolio level. in addition, some banks are exploring the possibility of validating their internal ratings using information from the equities markets. – 4 – with respect to securities financing, several institutions have discussed and, in certain cases, already have implemented instrument specific collateral haircuts. many institutions also have acted to ensure the adequacy of their current collateral holdings and developed procedures for accessing additional collateral when necessary. finally, i applaud recent efforts by the securities lending community in the u. s. to begin publishing aggregated cash - collateral reinvestment data that reflect reinvestment return, interest - rate sensitivity, and liquidity and credit tiering. these are all positive developments. however, along with many of my colleagues in the private sector, i believe there still is a need for the market to develop and implement additional risk management techniques. let me give you some examples of what i am thinking about. first, financial institutions must have the discipline to consistently apply robust risk management techniques through all phases of the business cycle. a concern for supervisors is the tendency of credit markets to steadily bid down spreads in the optimistic phase of the cycle, often to the point where returns no longer seem commensurate with risk. then, as problems emerge, lenders in the credit markets pull back, causing spreads to reverse sharply. in addition to the most recent cycle, examples of such behavior include high - yield bond and leveraged buyout lending in the 1980s, and latin american investment and lending in the mid1980s. too often, management edicts to reduce risk occur during the latter phase of the credit cycle, after substantial losses have already occurred. second, i would argue that targeting returns commensurate with risk over an appropriately long time horizon probably is the single most important defense against violent swings in the credit cycle. individual banks can protect themselves if they recognize when margins become too thin to cover risk by restraining their credit activities at those rates. they can benefit by expanding their credit activities when returns have risen enough to cover risk once again. to limit credit cycle volatility, appropriate risk and return analysis must be practiced widely and consistently throughout the financial system. third, more attention must be directed at