It’s not clear at this point how the SEC’s regime will work in practice, but it seems to offer the prospect of some evolution in the regulatory framework for investment banks in the direction of convergence with those that apply to bank holding companies. That is, the proposed new CSE regime will add a consolidated approach to risk based capital and an intensified focus on the risk management regime to the traditional SEC focus on enforcement of laws directed at investor protection and market integrity. A second point is that it is important that those who run financial institutions calibrate the strength of the internal risk management architecture to the more complicated nature of the risks they confront. Even with the major improvements in capital, earnings capacity, and in the sophistication of the risk management framework, there remain many aspects of the changing financial environment which pose ongoing challenges for management. The degree of concentration at the core of the financial system means that financial institutions have to think more carefully about the implications of the failure of a major counterparty or clearing organization. The increase in the combined weight of the highly leveraged financial institutions as a group highlights the importance of both strong counterparty risk management disciplines in managing  4  BIS Review 55/2004  direct credit exposure, and understanding the impact a disorderly exit would have on other positions held by the firm.
Our approach at the Fed seeks to achieve this outcome for the major institutions for which we are the consolidated supervisor. But the basic argument for applying exacting standards for risk based capital, for liquidity management, and for operational resilience applies to a broader range of supervised and regulated financial institutions whose operations pose significant systemic implications for the financial system. This is particularly compelling in the case of the major GSEs, where the regulatory framework, capital regime and sophistication of the internal risk management framework need to be upgraded to a standard more commensurate with their risk profile and the risks they present to the system. It is as compelling in the case of the institutions - a number of them specialized financial utilities - that make up the core of the payments infrastructure. Here, because of their overall importance to the functioning of our financial system, we are working to encourage improvement in operational resilience, to ensure they meet the recently updated international standards for risk management and internal financial resources, and to strengthen the oversight framework. It is important to note that the SEC has itself outlined a framework that would provide a form of consolidated supervision of the major investment banks with a risk-based capital framework based on Basel II.