s banks on the same regulatory structure, these critics argue, the typical business cycle will be accentuated by basel ii as perfectly reasonable estimates of probabilities of default and of loss given default decline in economic expansions and rise as the economy weakens. the resultant changes in the cost and availability of credit will be pro - cyclical, that is, will exacerbate cyclical patterns in the real economy. but we should recognize some important responses that have emerged from regulators and markets : flatter risk functions have been adopted in the basel ii proposal ; banks maintain buffer capital stocks ; basel ii requires that, under pillar 2, supervisors and banks discuss the size of the necessary buffer capital that each bank should carry for cyclical purposes ; and the proposed rules require stress - testing of risk parameters. perhaps a more important point is that, in evaluating the pro - cyclicality argument, we should not forget the cyclicality in bank credit flows that we see in history. if we are to truly evaluate the critics'concerns with post - basel ii pro - cyclicality in bank credit flows, we should be sure that it is compared with the pre - basel ii pattern. until quite recently, systematically and formally managing many of the key risks taken by banks, in particular their credit risk, was quite difficult. the techniques for quantifying and measuring risk, and the technology and instruments to manage and distribute it, simply did not exist. individual credit - risk decisions tended to be made by lending and credit officers who used their judgment to decide who was given credit and who was not. a characteristic of lending officers is that they are paid to make loans, and in competitive lending markets they want to make sure they maintain, if not increase, market share. this is not to say that lending officers are uninterested in risk management but rather that their focus is on finding a way to make the loan. in a world of judgment, the risk manager had considerable difficulty in persuading lending officers, indeed management, about excessive risk when quantitative procedures and systems did not exist. differences in judgment are difficult to resolve. that is probably the reason that bank credit availability has historically demonstrated a clear cyclical pattern that is consistent with the credit - making decision process i have just described and that, in turn, has exacerbated real economic cycles. during economic recoveries, bank credit officers would become more optimistic and willing to lend, an attitude that only strengthened during booms ; in such times the voices

not be required to apply basel ii - and thus will not see their capital requirements change at all. some of these entities fear they will face a rival that will get a capital break because the rival is following basel ii and has lower risk exposures recognized by the new accord. the extent to which regulatory capital requirements drive pricing or profitability is an empirical question. my own view is that in a world in which banks hold capital buffers and can securitize and sell assets, and with bank management increasingly allocating resources and making decisions on the basis of internal economic capital measures, the answer must be : not very much, if at all. rather, i believe that we are increasingly observing that pricing decisions reflect economic capital allocations that are risk based. we have tried hard to set risk - based regulatory capital requirements in basel ii below economic capital measures so that regulatory requirements will not affect the allocation of capital within the bank. if we make a mistake and set the regulatory capital requirements too high relative to market - based economic capital, we can read the effect of our error right away in the securitization of the exposure ; securitization is a release valve that relieves the pressure of our mistakes. to be sure, as better risk measurement and management results in more sensitive risk - based pricing, we may well see that exposures with higher capital charges are priced higher than those with lower capital charges. but such observations should not lead us to confuse cause and effect. the regulatory capital charges and price of credit will both be reflecting the same thing - risk ; the higher price won't be a reflection of the higher capital charge. u. s. scope of application no discussion on basel ii with a room full of global bankers would be complete without a discussion of the intended scope of application of basel ii in this country. in particular, i would suspect that you want to hear about the implications for the integration of your u. s. and worldwide operations. a week ago, i gave a rather full presentation on that issue to the institute of international bankers, and i call your attention to that statement, which is available at the board's web site. but this afternoon let me present the highlights of what i said. first, what do we plan to do? in this country, we intend to offer only the advanced approaches under basel ii : the advanced version of the internal ratings based approach ( a - irb ) for credit risk and the advanced measurement approach ( ama ) for