start by explaining why banks have capital. banks play a critical role in the economy by connecting those seeking to borrow with those seeking to save. 2 a bank lends to its customers, including individuals and businesses, based on its assessment of the customer ’ s creditworthiness. a bank ’ s depositors benefit from having bank accounts that allow them to easily make payments to others and to maintain a balance of money in a safe and liquid form. a healthy banking sector is central to a healthy economy. the nature of banking, however, along with the interconnectedness of the financial system, can pose vulnerabilities. even if a bank is fundamentally sound, it can suddenly be threatened with failure if its customers lose confidence and withdraw deposits. 3 this inherent vulnerability can pose risks to the entire economy. in the 19th and early 20th centuries, before the creation of the federal reserve and the federal deposit insurance corporation ( fdic ), banking panics were frequent and costly to the economy. 4 based on this experience — and similar experiences around the globe — many countries employ deposit insurance and other forms of a safety net to kashyap, rajan and stein ( 2002 ) describe the dual role that banks play in the economy, providing liquidity to both households and businesses. fama ( 1985 ) notes that banks are special on both the asset and liability side of the bank ’ s balance sheet. see the bank run literature developed by diamond and dybvig ( 1983 ) and others. jalil ( 2015 ) concludes that “ major banking panics either caused or amplified nearly half of all business cycle downturns between 1825 and 1914. ” bernanke ( 1983 ) shows that bank failures did economic harm during the great depression. - 3protect depositors and banks. 5 but offering this protection, shielding depositors and banks from risk, can have the perverse effect of encouraging risk - taking, creating what is called “ moral hazard. ” supervision and regulation — including capital regulation — provides a critical counterbalance, to ensure that banks, not the taxpayers, internalize the costs to society of that risk - taking. the impact of inadequate supervision and regulation was starkly revealed in the global financial crisis, as banks and their functional substitutes in the nonbank sector borrowed too much to fund their operations. 6 while nearly all were “ adequately capitalized ” in theory, many were undercapitalized in practice, since their capital levels did not reflect future losses that would

new set of hypothetical financial and economic conditions and updates to the banks risk profile. lastly, the stress test can potentially counteract actions by a bank to “ optimize ” against the capital regime — for instance, lowering its risk - weighted assets without reducing its risk. 21 in this way, the stress test — along with strong supervision — can serve as a check on excessive bank risk - taking. as i ’ ll return to in a moment, we are focused on ensuring the stress test results feed directly into the capital buffer for large firms. the stress capital buffer is floored at 2. 5 percent, which aligns with the capital conservation buffer applicable to smaller firms. greenwood et al ( 2017 ). - 12 that stress testing remains forward - looking and effective at requiring banks to have capital to cushion losses from emerging risks. a final prudential requirement — a long - term debt requirement — complements the regulatory capital regime. unlike regulatory capital — which helps a firm absorb losses as it continues operations through times of stress — long - term debt becomes especially relevant once a firm has already entered bankruptcy or resolution. at the point of resolution, equity can be written off and certain long - term debt claims can be written down to absorb losses. the remaining debt claims can be effectively converted to equity to provide flexibility to the bankruptcy court or resolution authority in managing the firm ’ s path through resolution. in particular, this equity can be used to help the firm continue critical operations as its operations are restructured, wound down, or sold, in order to minimize disruptions to the larger financial system. long - term debt requirements were initially applied to global systemically important banks ( gsibs ). the board and the fdic are currently considering whether the costs of a resolution of a large, non - gsib may also justify the imposition of long - term debt requirements on such firms as well. 22 role of stress testing in the forward - looking regime as i ’ ve said before, it is critical that our capital regime is forward - looking. and while the stress test is the most risk - sensitive and dynamic component of our regulatory capital framework, history has taught us not to become complacent or to shed our humility. in an environment of ever - changing risks, stress tests can quickly lose their relevance if their assumptions and scenarios remain static. let ’ s not forget that for some https : / / www. federalreserve. gov / newsevents / pressrelease