but by the requirements of doing business in an increasingly complex financial environment. in any event, the anpr will include questions designed to quantify the cost of implementing basel ii. competitive equity a second key concern is competitive equity. some are concerned that the u. s. supervisors would be more stringent in their application of basel ii rules than other countries and would thereby place u. s. banks at a competitive disadvantage. to address this concern, the basel agreement establishes an accord implementation group ( aig ), made up of senior supervisors from each basel member country, which has already begun to meet. it is the aig's task to work out common standards and procedures and act as a forum in which conflicts can be addressed. no doubt some differences in application would be unavoidable across banking systems with different institutional and supervisory structures, but all of the supervisors, and certainly the federal reserve, would remain alert to this issue and work to minimize it. i also emphasize that, as is the case today, u. s. bank subsidiaries of foreign banks would be operating under u. s. rules, just as foreign bank subsidiaries of u. s. banks would be operating under host - country rules. another issue relates to the concern among u. s. basel ii banks of the potential competitive edge that might be given to any bank that would have its capital requirements lowered by more than that of another basel ii bank. the essence of basel ii is that it is designed to link the capital requirement to the risk of the exposures of each individual bank. a bank that holds mainly lower - risk assets, such as high - quality residential mortgages, would have no advantage over a rival that held mainly lowerquality, and therefore riskier, commercial loans just because the former had lower required capital charges. the capital requirements should be a function of risk taken, and, under basel ii, if the two banks had very similar loans, they both should have a very similar required capital charge. for this reason, competitive equity among basel ii banks in this country should not be a genuine issue because capital should reflect risk taken. under the current capital regime, banks with different risk profiles have the same capital requirements, creating now a competitive inequity for the banks that have chosen lower risk profiles. the most frequently voiced concern about possible competitive imbalance reflects the " bifurcated " rules implicit in the u. s. supervisors'proposed scope of application : that is, requiring basel ii through

these and other large banks to push their management frontier forward. basel ii the proposed substitute for the current capital accord, basel ii, is more complex than its predecessor for very good reasons. first, the assessment of risk in an environment of a growing number of instruments and strategies with subtle differences in risk - reward characteristics is inevitably complicated. second, the basel ii reform has several objectives : u. s. supervisors are trying to improve risk measurement and management both domestically and internationally ; to link to the extent that we can the amount of required capital to the amount of risk taken ; to further focus the supervisor - bank dialogue on the measurement and management of risk and the risk - capital nexus ; and to make all of this transparent to the counterparties that ultimately fund - and hence share - these risk positions. to achieve all these objectives, the framework for basel ii contains three elements, called pillars 1, 2, and 3. the most important pillar, pillar 1, consists of minimum capital requirements - that is, the rules by which a bank calculates its capital ratio and by which its supervisor assesses whether it is in compliance with the minimum capital threshold. as under basel i, a bank's risk - based capital ratio under basel ii would have a numerator representing the capital available to the bank and a denominator that would be a measure of the risks faced by the bank, referred to as " risk - weighted assets ". the definition of regulatory capital in the form of equity, reserves, and subordinated debt and the minimum required ratio, eight percent, are not changing. what would be different is the definition of risk - weighted assets, that is, the methods used to measure the " riskiness " of the loans and investments held by the bank. it is this modified definition of risk - weighted assets, its greater risksensitivity, that is the hallmark of basel ii. the modified definition of risk - weighted assets would also include an explicit, rather than implicit, treatment of " operational risk. " pillar 2 addresses supervisory oversight ; it encompasses the concept that well - managed banks should seek to go beyond simple compliance with minimum capital requirements and perform for themselves a comprehensive assessment of whether they have sufficient capital to support their risks. in addition, on the basis of their knowledge of industry practices at a range of institutions, supervisors should provide constructive feedback to bank management on these internal assessments. finally, pillar 3 seeks to complement these activities with stronger market discipline by requiring banks publicly to disclose key measures