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In MicrosoftÂ® WindowsÂ® 2000 and Windows Server 2003 Active Directory domains, you could apply only one password and account lockout policy, which is specified in the domain's Default Domain Policy, to all users in the domain. As a result, if you wanted different password and account lockout settings for different sets of users, you had to either create a password filter or deploy multiple domains. Both options were costly for different reasons.
In Windows Server 2008, you can use fine-grained password policies to specify multiple password policies and apply different password restrictions and account lockout policies to different sets of users within a single domain. For example, to increase the security of privileged accounts, you can apply stricter settings to the privileged accounts and then apply less strict settings to the accounts of other users. Or in some cases, you may want to apply a special password policy for accounts whose passwords are synchronized with other data sources.
Functional levels determine the available Active Directory Domain Services (AD DS) domain or forest capabilities. They also determine which Windows Server operating systems you can run on domain controllers in the domain or forest. However, functional levels do not affect which operating systems you can run on workstations and member servers that are joined to the domain or forest.