the extent that banks and market participants rely on such models for internal pricing, capital allocations, and other decisionmaking purposes, this is a problem for us all. the fact is that we - - both supervisors and bankers - - do not yet know the right answers with high confidence. in these circumstances, the basel ii process could lose momentum unless we can agree to go forward with something that seems reasonable and with the understanding that reasonable people may differ and that changes may be needed as we gain experience. the problem becomes even more complex when we recognize that market economies are cyclical and have crises. in a risk - sensitive system, we expect that the risk measures in the capital formula will have worse values at the trough than at the peak, so capital requirements will move somewhat as macroeconomic conditions change. this is often called the problem of procyclicality of capital requirements. if the minimum capital requirements rise as the economy weakens, it can be argued that a system of risk - sensitive capital requirements may lessen credit availability at just the wrong time. the jury is still out on just how procyclical the basel ii framework ultimately will be, or whether it may, in fact, be less procyclical than the current system in which the lack of rigor in credit evaluations itself creates a procyclical pattern of reserving and charge - offs. we have already taken some steps to address procylicality concerns since issuance of the january 2001 consultative package. for example, we've improved the proposal's treatment of expected losses - - and other measures are in train. finally there is the problem of making the pieces of the new accord fit together. the basel committee has said it wants modest capital relief incentives for large, international banks to move from the standardized to the foundation version of the irb approach and similar, perhaps larger, additional incentives to move from the foundation to the advanced version. but as i noted, these approaches and versions were designed for banks of very different levels of complexity and sophistication and for different regulatory regimes. the basic risk - weight functions are the same across the foundation and advanced versions of the irb approach. because of the conservatism built into the foundation version, capital requirements for a given bank under the advanced version, at least in this country, could be considerably less than under the foundation version. if the revised standardized approach is calibrated to yield capital similar to that of the current accord and advanced

that means that the rules will be complex in order both to be fair and to avoid unintended consequences. one of the complexities of unbundling risk - related capital charges is, in the view of many basel committee members, the need for an explicit capital charge for operational risk. devising such a charge has proved extremely difficult because of a lack of both an agreed - upon methodology and credible industry data. this has required the adoption of a strategy to permit banks to use their own internal measurement approaches - - subject to quantitative and qualitative criteria and, on a transitional basis, to a minimum or floor capital charge. sound - practice guidelines are also being developed for the pillar ii supervisory review process. the interval before final implementation in 2005 provides time for both the industry and supervisors to develop the database and to develop explicit operational risk charges better linked to the real risk at each bank. the federal reserve, and i believe the other u. s. agencies, have been, and will continue to be, committed to developing and applying a truly risk - based capital framework and supervisory process for both operational and credit risks. as with any such massive effort, timetables are required in order to motivate and to coordinate broad organizational efforts. but we have a prior commitment, one that discussions with the industry suggest that you share. that commitment is : to get it right. if we imposed a flawed structure on the industry, we would be doing a disservice to the banking industry and shirking our public responsibilities. thus, we will continue to try to get it right, even if it means more delay and modification to time schedules than either group wants. of course, we also understand that the capital framework will continue to evolve as market practices change and supervisors learn more about the strengths and weaknesses of what we develop. getting basel ii right does not mean that it can or will be perfect, even on the day the initial rule becomes final. critical to getting it right is a genuine interaction of the regulators and the banking system. we simply cannot develop basel ii correctly without your help. that does not mean dropping every feature that some entity believes is too costly or too burdensome or would put a crimp in a particular activity. but it does mean that, given our objective of creating a risk - based capital system to promote better risk management and a safer banking system, we need your operational skills and counsel. the industry's initial assistance and subsequent comments on this year's january