the outcomes for the banking sector and the macroeconomic scenario. a stress testing regime that incorporated these feedbacks, including the potential for liquidity pressures, bank runs, and firesale risk, would be considerably more complex to implement, and would likely involve a greater degree of abstraction and simplification – and thus less “ precision ” – than the current supervisory capital stress tests. in that regard, the drive for precision and accuracy at the individual institution level – and the resulting complexity of the supervisory models and extensive firm - specific data inputs needed to run the models – has created other challenges. perhaps the most notable of these is that generating the supervisory projections is resource - and time - intensive, which limits the number of scenarios that can be assessed during any particular ccar cycle. some have suggested that stress testing would be more effective if many supervisory scenarios were examined, instead of just a few. any individual scenario could miss important risk exposures at individual banks or in the sector as a whole. turning that thought around, a single scenario might not uncover true capital vulnerabilities at all institutions. the bank - generated scenarios that are part of the ccar program are certainly an important channel to address concerns about idiosyncratic risk, as banks are meant to self - identify the scenarios that would be especially stressful for them. but running multiple common supervisory scenarios could provide a more robust assessment of the capital strength of the broader banking industry, at least as represented by the firms taking part in the ccar and dfast programs. how can research help address these issues and, more generally, improve the overall supervisory stress testing regime? i want to suggest two general areas of research – one tactical and the other much bigger picture and strategic. the tactical area is research that helps improve supervisory models. first, developing additional ways of projecting revenues and non - credit expenses in stressed environments is a particularly ripe area for additional work, in my view. as i noted, an important innovation in the scap was the recognition that a comprehensive stress test focused on net income needed to incorporate projections of interest and non - interest income and non - interest expense. while a number of models already existed for making such projections – for instance, those used by banks in their budgeting and planning processes – these were nearly all calibrated to produce projections assuming business as usual conditions, rather than the stressed environment assumed in the scap. the scap ppnr projections were thus based on stylized supervisory models that used available historical data on bank

another set of design choices concerns the horizon over which net income is calculated and how cumulative changes in net income over this horizon are incorporated into regulatory capital ratios. the scap assumed a two - year forward horizon, while the subsequent ccar and dfast stress tests have assumed a 9 - quarter forward horizon. 6 other supervisory stress test regimes have made different assumptions – for instance, the european stress tests use a three - year forward horizon. 7 an 2 / 8 bis central bankers'speeches alternative choice would be to project losses and income over the full lifetime of a bank ’ s loans and other assets. estimating lifetime losses on particular fixed portfolios of loans and securities was arguably the prevalent approach during the financial crisis period. 8 but in a stress testing context, the lifetime loss approach presents practical difficulties given the varying maturities of different types of assets, as well as the greater uncertainty inherent in more distant future points. at the time of the scap, we judged that a two - year horizon was long enough to capture significant losses while remaining within what could reasonably be projected conditional on the macroeconomic scenario. 9 closely related to the scenario horizon question is how cumulative losses and revenues are incorporated to calculate post - stress capital ratios. the dfast and ccar stress tests adopt a “ walk - through - time ” approach, in which net income and capital ratios are calculated on a quarterby - quarter basis throughout the stress test horizon. 10 an alternative approach would be to apply cumulative losses and revenues in a single, instantaneous shock – this was what was done in the scap. while the two approaches might be assumed to produce roughly consistent results, the walk - through - time approach may better capture true vulnerabilities, especially in cases where negative net income quarters come early in the stress test horizon but revenues accrue most strongly in subsequent quarters. the instantaneous shock approach implicitly recognizes revenues from later in the horizon as offsets to losses that occur early in the horizon and thus may overstate true capital resources. the tradeoff is that the walk - through - time approach implies a degree of precision about the quarter - by - quarter pattern of losses and revenues that might be beyond the capabilities of existing modeling technology ( this was the judgment at the time of the scap ). but the walk - through - time approach requires further assumptions, particularly regarding the evolution of the balance sheet. these assumptions range from how to capture maturing loans and securities ; what to assume about prepayments ;