stanley fischer : supervisory stress testing of large systemic financial institutions speech by mr stanley fischer, vice chair of the board of governors of the federal reserve system, at the sveriges riksbank macroprudential conference, stockholm, sweden, 24 june 2015. * * * it ’ s a pleasure to take part in the riksbank macroprudential conference and i thank the organizers for inviting me to participate in the conference, and particularly in this panel on stress testing. stress testing has become a cornerstone of a new approach to regulation and supervision of the largest financial institutions in the united states. the federal reserve ’ s first supervisory stress test was the supervisory capital assessment program, known as the scap. conducted in 2009 during the depths of the financial crisis, the scap marked the first time the u. s. bank regulatory agencies had conducted a supervisory stress test simultaneously across the largest banking firms. the results clearly demonstrated the value of simultaneous, forward - looking supervisory assessments of capital adequacy under stressed conditions. the scap was also a key contributor to the relatively rapid restoration of the financial health of the u. s. banking system. the fed ’ s approach to stress testing of the largest and most systemic financial institutions has evolved since the scap, but several key elements persist to this day. 1 these elements include, first, supervisory stress scenarios applicable to all firms ; second, defined consequences for firms deemed to be insufficiently capitalized ; and third, public disclosure of the results. the fed has subsequently conducted five stress test exercises that built on the success of scap, while making some important improvements to the stress test processes. the first key innovation was the development of supervisory models and processes that allow the fed to evaluate independently whether banks are sufficiently resilient to continue to lend to consumers and to businesses under adverse economic and financial conditions. this innovation took place over the course of several exercises and was made possible by the extensive collection of data from the banks. these data have allowed supervisors to build models that are more sensitive to stress scenarios and better define the riskiness of the firms ’ different businesses and exposures. the second innovation since the scap was the use of the supervisory stress test as a key input into the annual supervisory evaluation of capital adequacy at the largest bank holding companies. the crisis demonstrated the importance of forward - looking supervision that accounted for the possibility of negative outcomes. by focusing on forward - looking poststress capital ratios, stress testing provides an assessment

capital standard that implies the need for reasonable comparability across banks and across boundaries to ensure the competitive balance to which i referred earlier. nonetheless, looking beyond the current proposals, i believe that over time the regulatory capital functions we have hard - wired into basel ii, along with their embedded correlation assumptions, will give way to individual bank - developed models that are verifiable by supervisors. that development will probably be a central part of the evergreen process. but the time for individual bank models is not now, and i see no reason to hold up improving the regulatory capital regime until the state of the art permits that innovation. until then, i think we have developed a workable balance between flexibility and comparability. as the old saying goes, the perfect should not be the enemy of the good. level playing fields : treating comparable banks comparably basel ii, as i noted, tries to develop a standard so that banks ’ risk exposures can be treated comparably. such a standard is central to the required level playing field. but comparability requires not that all banks be treated the same but rather that comparable banks be treated comparably, raising practical issues of definition, of unintended consequences in competitive markets, and of unavoidable differences in national regimes. general issues. as you know, basel ii proposes three options from which banks in national jurisdictions may choose - the standardized, the foundation, and the advanced internal risk - based ( a - irb ) approaches. the increasing risk sensitivity of the three options has the potential for the application of different capital charges across banks for the same exposures and implies that banks with a more or less average mix of corporate and retail exposures may have reductions in their overall minimum regulatory capital requirements as they move across the three options. any differences in regulatory capital charges have the potential to distort both national competitive positions, an issue for domestic authorities, and international competition, an issue for both national authorities and the basel committee. in considering all of these issues, one must, of course, make a distinction among minimum regulatory capital based on regulatory rules ; economic capital based on the bank ’ s own assessment of risk and capital needs ; and actual capital held, which includes buffers above both the other capital measures for reasons varying from reduced cost of funding to counterparty demands and to desired contingency flexibility. minimum regulatory capital is the lowest of the three capital “ requirements, ” and thus the degree to which it may or may