which contains rules how institutions have to calculate regulatory capital, principle 1 of pillar 2 focuses on banks ’ internal methods and processes. thus, banks have, apart from some qualitative requirements, which i will address next, significant leeway to design their internal capital adequacy process. conversely that also means, that there are no standardised methods or specific guidelines for institutions. the basel ii paper elaborates the main features of a rigorous process, which have to be in place in order to fulfil principle 1 of pillar 2. namely they are • board and senior management oversight. the ultimate responsibility for the risk management processes and the internal capital adequacy assessment process is with the senior management. it has to set the strategic goals for capital needs, capital levels and so forth. • sound capital assessment. this is the core feature of the internal process and states the requirement to relate capital to the level of all material risks not only as of today but also for a certain planning horizon. • comprehensive assessment of risks. different to pillar 1 the list of risks under pillar 2 is not limited but should be adequate to fit the individual needs of every institution. a bank would have to cover liquidity risk and interest rate risk in the banking book or even further types addition - ally to the well known risks covered under pillar 1 ( credit risk, market risk and operational risk ), e. g. reputational and strategic risk. the remaining two features are “ monitoring and reporting ” and “ internal control review ”. taking into account the comprehensiveness, the internal process has to guarantee, and its planning function, obviously, the requirements will be best met by implementing an economic capital model. such a mathematical model relates the capital of an institution to the risks it takes within its business activities taking into account diversification effects between risk types. only internationally active banks have the resources to set up a system as complex as that. and indeed, some of the largest german banking groups are using already an economic capital model. i am turning to the relevant requirements for supervisors in basel ii. while principles 3 and 4 are related to regulatory capital ratios, the qualitative part of the supervisor ’ s duty under the supervisory review process is formulated in principle 2 of pillar 2. it states : principle 2 : supervisors should review and evaluate banks ’ internal capital adequacy assessments and strategies, as well as their ability to monitor and ensure their compliance with regulatory capital ratios. supervisors should take appropriate action if they are not

the implementation of basel ii? the main conclusions are twofold : first, for level playing field reasons basel ii will be made available for all banks, not only for the internationally active ones. second, although german banks compete to each other, they differ significantly in size and risk management. in order to allow them appropriate flexibility in implementing basel ii we are going to implement the full set of credit risk and operational risk approaches that is available in basel ii. we do not require the big banks to use either the foundation or the advanced irb - approach. it is up to the banks to make their choice. of course, we think that for those banks the advanced irb approach would be adequate without having any legal instruments to require certain types of approaches. a survey amongst all german institutions performed last summer indicated that most of our internationally active banks ( deutsche, dresdner, hvb, commerzbank, westlb, dz bank ) are preparing for implementing the advanced approach at least on a sub - portfolio level by implementation date. as far as the smaller banks are concerned we expect about 460 of them to use an internal ratings approach right from the beginning of basel ii. you might ask yourself how there can be such a big number of institutions using the internal ratings approach. the answer is that banking associations are providing centrally developed risk measurement methods, it services, default information etc. to member institutions. this turned out to be a very efficient way for the institutions to avoid development cost and to share information, e. g. default data. this combined effort of the institutions and their associations contributes to en - sure the credit supply all over the country. let me compare our case with the situation in the united states where about 20 of the largest us banks will have to use the most advanced approaches to measuring their credit and operational risk. the rest of the us banking system, which are thousands of smaller banks, have to remain under the existing 1988 accord. recent developments in the united states show the importance of taking into account the structure of the banking market when implementing basel ii. many of the smaller us banks fear that they may be left at a competitive disadvantage after the adoption of the basel ii by their larger rivals. in - deed, a recent federal reserve study revealed for some types of small business loans unintended competitive advantages and disadvantages. us regulators therefore signalled their readiness to adjust the basel i provisions to protect smaller us banks from unintended problems. i will now focus on the implementation