of our regulatory and supervisory performance and have been actively implementing improvements. on the regulatory side, we have played a key role in international efforts to ensure that systemically critical financial institutions hold more and higher - quality capital, have enough liquidity to survive highly stressed conditions, and meet demanding standards for companywide risk management. we have also been taking the lead in addressing flawed compensation practices by issuing proposed guidance to help ensure that compensation structures at banking organizations provide appropriate incentives without encouraging excessive risk - taking. 6 less formally, but equally important, since 2005 the federal reserve has been leading cooperative efforts by market participants and regulators to strengthen the infrastructure of a number of key markets, including the market for securities repurchase agreements and the markets for credit derivatives and other over - the - counter derivative instruments. to improve both our consolidated supervision and our ability to identify potential risks to the financial system, we have made substantial changes to our supervisory framework. so that we can better understand linkages among firms and markets that have the potential to undermine the stability of the financial system, we have adopted a more explicitly multidisciplinary approach, making use of the federal reserve ’ s broad expertise in economics, financial markets, payment systems, and bank supervision to which i alluded earlier. we are also augmenting our traditional supervisory approach that focuses on firm - byfirm examinations with greater use of horizontal reviews that look across a group of firms to identify common sources of risks and best practices for managing those risks. to supplement information from examiners in the field, we are developing an off - site, enhanced quantitative surveillance program for large bank holding companies that will use data analysis and formal modeling to help identify vulnerabilities at both the firm level and for the financial sector as a whole. this analysis will be supported by the collection of more timely, detailed, and consistent data from regulated firms. many of these changes draw on the successful experience of the supervisory capital assessment program ( scap ), also known as the banking stress test, which the federal reserve led last year. as in the scap, representatives of primary and functional supervisors will be fully integrated in the process, participating in the planning and execution of horizontal exams and consolidated supervisory activities. improvements in the supervisory framework will lead to better outcomes only if day - to - day supervision is well executed, with risks identified early and promptly remediated. our internal reviews have identified a number of directions for improvement. in the future, to facilitate swifter, more - effective

donald l kohn : financial markets and central banking speech by mr donald l kohn, vice chairman of the board of governors of the us federal reserve system, at the c peter mccolough series on international economics, council on foreign relations, new york, 28 november 2007. * * * i thought it might be useful to start this session with a few thoughts on some of the issues facing central banks as they deal with the consequences of the recent turbulence in financial markets. 1 this list is not comprehensive : i have concentrated on the issues associated with our roles as monetary policy makers and providers of liquidity – and even in that category i cannot address all the issues in the short time allotted. like every other period of financial turbulence, this one has been marked by considerable uncertainty. central banks, other authorities, and private - market participants must make decisions based on analyses made with incomplete information and understanding. the repricing of assets is centered on relatively new instruments with limited histories – especially under conditions of stress ; many of them are complex and have reacted to changing circumstances in unanticipated ways ; and those newer instruments have been held by a variety of investors and intermediaries and traded in increasingly integrated global markets, thereby complicating the difficulty of seeing where risk is coming to rest. operating under this degree of uncertainty has many consequences. one is that the rules and criteria for taking particular actions seem a lot clearer in textbooks or to many commentators than they are to decisionmakers. for example, the extent to which institutions are facing liquidity constraints as opposed to capital constraints, or the moral hazard consequences of policy actions, are inherently ambiguous in real time. another consequence of operating under a high degree of uncertainty is that, more than usually, the potential actions the federal reserve discusses have the character of " buying insurance " or managing risk – that is, weighing the possibility of especially adverse outcomes. the nature of financial market upsets is that they substantially increase the risk of such especially adverse outcomes while possibly having limited effects on the most likely path for the economy. moral hazard central banks seek to promote financial stability while avoiding the creation of moral hazard. people should bear the consequences of their decisions about lending, borrowing, and managing their portfolios, both when those decisions turn out to be wise and when they turn out to be ill advised. at the same time, however, in my view, when the decisions do go poorly, innocent bystanders should not have to bear the cost. in