obvious source of interdependency and potential systemic risk. direct credit exposures may arise from lending, loan commitments, guarantees, or derivative counterparty relationships among institutions. indirect exposures may arise through exposures to a common risk factor, such as the real estate market, that could stress the system by causing losses to many firms at the same time, through common dependence on potentially unstable sources of short - term funding, or through common participation in payment, clearing, or settlement systems. while large, correlated exposures have always been an important source of risk and an area of focus for supervisors, macroprudential supervision requires special attention to the interdependencies among systemically important firms that arise from common exposures. similarly, there must be monitoring of exposures that could grow significantly in times of system - wide financial stress, such as those arising from otc derivatives or the sponsorship of off - balance - sheet financing conduits funded by short - term liabilities that are susceptible to runs. one tool that would be useful in identifying such exposures would be the cross - firm horizontal reviews that i discussed earlier, enhanced to focus on the collective effects of market stresses. the federal reserve also would expect to carefully monitor and address, either individually or in conjunction with other supervisors and regulators, the potential for additional spillover effects. spillovers may occur not only due to exposures currently on a firm's books, but also as a result of reactions to stress elsewhere in the system, including at other systemically important firms or in key markets. for example, the failure of one firm may lead to deposit or liability runs at other firms that are seen by investors as similarly situated or that have exposures to such firms. in the recent financial crisis, exactly this sort of spillover resulted from the failure of lehman brothers, which led to heightened pressures on other investment banks. one tool that could be helpful in evaluating spillover risks would be multiple - firm or system - level stress tests focused particularly on such risks. however, this type of test would greatly exceed the scap in operational complexity ; thus, properly developing and implementing such a test would be a substantial challenge. potential role of a council the breadth and heterogeneity of the u. s. financial system have been great economic strengths of our country. however, these same characteristics mean that common exposures or practices across a wide range of financial markets and financial institutions may over time pose risks to financial stability, but may

likely to be severe if the firm is large, taking account of both its on - and off - balance sheet activities. but size is far from the only relevant consideration. the impact of a firm's financial distress depends also on the degree to which it is interconnected, either receiving funding from, or providing funding to, other potentially systemically important firms, as well as on whether it performs crucial services that cannot easily or quickly be executed by other financial institutions. in addition, the impact varies over time : the more fragile the overall financial backdrop and the condition of other financial institutions, the more likely a given firm is to be judged systemically important. if the ability of the financial system to absorb adverse shocks is low, the threshold for systemic importance will more easily be reached. judging whether a financial firm is systemically important is thus not a straightforward task, especially because a determination must be based on an assessment of whether the firm's failure would likely have systemic effects during a future stress event, the precise parameters of which cannot be fully known. for supervision of firms identified as systemically important to be effective, we will need to build on lessons learned from the current crisis and on changes we are already undertaking in light of the broader range of financial firms that have come under our supervision in the last year. in october, we issued new consolidated supervision guidance for bank holding companies that provides for supervisory objectives and actions to be calibrated more directly to the systemic significance of individual institutions and bolsters supervisory expectations with respect to the corporate governance, risk management, and internal controls of the largest, most complex organizations. 1 we are also adapting our internal organization of supervisory activities to take better advantage of the information and insight that the economic and financial analytic capacities of the federal reserve can bring to bear in financial regulation. the recently completed supervisory capital assessment process ( scap ) reflects some of these changes in the federal reserve's system for prudential supervision of the largest banking organizations. this unprecedented process specifically incorporated forwardlooking, cross - firm, and aggregate analyses of the 19 largest bank holding companies, which together control a majority of the assets and loans within the financial system. importantly, supervisors in the scap defined a uniform set of parameters to apply to each firm being evaluated, which allowed us to evaluate on a consistent basis the expected performance of the firms, drawing on individual firm information and independently estimated outcomes using supervisory models. drawing on this experience, we will conduct horizontal examinations on a periodic basis