affect multiple institutions, as well as specific firms. as in the stress tests, our staff members will conduct forward - looking scenario analyses to gauge the potential effects of adverse changes in the operating environment on individual firms and on the system as a whole. this work will allow us to more effectively connect the firm - specific information and insights gained from traditional examinations and other supervisory activities with analysis of system wide developments and emerging stresses. enhanced data collection is a key component of our supervisory restructuring, particularly for our increased emphasis on systemic surveillance. we have initiated new efforts to better measure large institutions ’ counterparty credit risk and interconnectedness, sensitivity to market risk, and funding and liquidity exposures. these efforts will help us focus not only on risks to individual firms, but also on concentrations of risk that may arise through common exposures or sensitivity to common shocks. for example, we are now collecting additional data in a manner that will allow for the more timely and consistent measurement of individual bank and systemic exposures to syndicated corporate loans. in addition, supervisors are mining detailed data from banks ’ risk - management systems and aggregating, where possible, the largest exposures to other banks, nonbank financial institutions, and corporate borrowers. that effort can reveal banks ’ common exposures to individual borrowers and help assess the effect of a failure of a large financial institution on individual banks or the system more broadly. last year ’ s stress assessment was a one - time event in the sense that circumstances may not again call for a simultaneous evaluation of institutions holding two - thirds of the banking system ’ s assets. but we are incorporating elements of the assessment into our ongoing supervision of capital adequacy. we are developing and refining the tools necessary to better gauge appropriate capital buffers for our largest firms. as a follow - on effort to last year ’ s stress assessment, we are now conducting a horizontal examination to evaluate whether these banks can effectively estimate their capital needs and identify resources to meet those needs. bankers need to conduct their own stress tests as well. two years ago at this conference, before the scap had been conceived, i discussed, among other topics, the emphasis placed on stress testing by the international senior supervisors group. 4 i noted then that stress tests are a good way to augment models and other standard quantitative techniques for risk management. and they force bankers to think through the implications of scenarios that may seem relatively unlikely but could pose serious risks if those scenarios materialized. stress tests must be an integral

agenda, which includes both changes by financial regulatory agencies acting under their existing authority and new legislation. the first important item on the reform agenda is to extend the perimeter of regulation so that any firm whose failure could have serious systemic consequences will be subject to consolidated supervision, including minimum capital and liquidity requirements. as last year's events showed, systemic problems can arise from the activities of non - banking firms but, under present law, these requirements apply only to firms owning a commercial bank. indeed, there is an incentive to shift riskier activities into unregulated firms. a second item is to strengthen the prudential rules applicable to supervised institutions. this component of a reform program has manifold elements. there is little doubt that capital levels prior to the crisis were insufficient to serve as an adequate buffer against loss and constraint on leverage, particularly in some of the largest financial institutions. working with our counterparts in the basel committee on banking supervision, u. s. supervisory agencies have already increased capital requirements for trading activities and securitization exposures, two of the areas in which losses were especially high. we are moving toward agreement on modifying existing rules to improve the quality of capital used to satisfy minimum capital rules, with a particular emphasis on the importance of common equity. liquidity issues have rightly garnered considerable attention in the aftermath of the crisis. it has always been recognized that a solvent financial institution can be brought down by liquidity problems. that, of course, is one traditional justification for reserve requirements. but the tightly wound, often complex channels of financing characteristic of the shadow banking system, including the wholesale funding practices of many regulated institutions, simply outraced conventional liquidity risk management assumptions. the bank regulatory agencies are implementing strengthened guidance on liquidity risk management and weighing proposals for quantitatively based requirements. a third part of the reform agenda is to use market discipline more effectively as a regulatory and supervisory tool. too - big - to - fail perceptions weaken normal market disciplinary forces by producing a distorted set of incentives in which counterparties of a large institution may not price into their extensions of credit the full risks assumed by the institution. the management and shareholders of the too - big - to - fail institution may regard themselves as holding a put option and may, accordingly, be motivated to take greater risks with the cheaper funds now available to them. the assumption, of course, is that the government will bail out a large firm encountering severe distress, to preclude potential contagion from the