##s from clients, adopted risk - sensitive margin practices to a greater extent, and enhanced tools to manage risk. going forward, the federal reserve plans to continue its focus on fundamental risk management related to counterparty credit risk, and i'll focus my remarks on three themes. first, banks should know their customers exceedingly well, both at onboarding and throughout the evolution of the relationship. second, banks should have tools to identify the unique risks they face as these risks materialize across products, business lines, and clients and use these risk measures to maintain appropriate margins through 1 / 5 bis - central bankers'speeches the credit cycle. third, banks should set prudent risk limits and respond to signals of risk appropriately. these risk management practices are important to help control the build - up of risk - preventing banks and the banking system from taking on outsized exposure to leveraged entities and preventing the build - up of that leverage. these credit risk management practices are important complements to prudent liquidity risk management and resilience measures, such as contingency planning, in which banks take steps to mitigate the impact of distress of a counterparty to the bank and the financial system more broadly. the federal reserve will also use its own tools to assess counterparty credit risk in the banking system. for example, alongside this year's stress test results, we will publish the aggregate results of several exploratory analyses, including analysis of the resilience of the globally systemically important banks to the simultaneous default of their five largest hedge fund counterparties. we will conduct that analysis under two different sets of financial market conditions to learn about how such exposures may vary across different types of stresses. we expect the information yielded from that analysis will deepen our supervisory understanding of counterparty credit risk at the banks. as we noted, the exploratory analysis will not affect bank capital requirements. there will be more to come on that in june, but for now let me speak about the risk management practices we plan to focus on in our ongoing supervision. 2 thorough due diligence as with many things in banking and business, strong risk management starts with knowing your customers. in traditional lending, a lender should understand the finances and exposures of the borrower to ensure it will be able to pay back the loan. a lender should also understand the borrower's managerial and financial history, profitability goals and the risk - taking to achieve them, and how

that liquidity may be less resilient than it had been previously. but this evidence is not particularly robust, and, given the limitations of the existing data, it is difficult to know the extent to which liquidity resilience may have declined. as we continue to investigate quantitative evidence of the deterioration in the resilience of liquidity in some of the financial markets, we are also trying to tease out the various drivers of liquidity conditions, such as changes in regulation, trading strategies, and market structure. regulatory changes are often cited as a contributing factor. trading financial assets is a balance - sheet - intensive activity, and the dodd - frank act, has created incentives for institutions to carefully assess the risks of such activity through stricter requirements on leverage, liquidity, and proprietary trading, raising the cost of market making and possibly affecting market liquidity. indeed, there is evidence of reductions in broker - dealer bond inventories in recent years. nonetheless, since not all broker - dealer inventories are used for market - making activities, the extent to which lower inventories are affecting liquidity is unclear. moreover, reductions in broker - dealer inventories occurred prior to the passage of the dodd - frank act, suggesting that factors other than regulation may also be contributing. in assessing the role of regulation as a possible contributor to reduced liquidity, it is important to recognize that those regulations were put in place to reduce the concentration of liquidity risk on the balance sheets of the large, highly interconnected institutions that proved to be a major amplifier of financial instability at the height of the crisis. a second possible contributor may be the growing role of electronic execution of trades across equity, treasury, and foreign exchange markets and the associated increasing role of high - frequency trading. competition from high - frequency trading in a particular market may reduce the attractiveness of that market for traditional ( manual ) traders or slower automated traders, leading to a progressive shift in the composition of market participants toward highfrequency traders ( hfts ) over time. this shift could be important to the extent that hfts may have more limited capacity to support liquidity resilience since, on average, hfts appear to trade with smaller inventories and lower capital than traditional traders. although having less inventory and capital reduces the cost of trading, it also means that markets increasingly dominated by hfts may be less able to absorb large shocks. thus, liquidity may be sufficient and relatively cheap on normal trading days