, academics, and the public better evaluate both the condition of the banks and the rigor of supervisory oversight. it thus serves the dual purpose of market discipline and government agency accountability. to serve its important financial stability purpose, stress testing must never become static. as the financial system evolves, with the creation of new products and new correlations among asset price movements, the supervisory model must account for these changes. and as salient risks to the financial system arise, the scenarios must test for these new risks. apart from the inherent need for adaptation, though, there is one respect in which the federal reserve ’ s stress testing program is incomplete and other respects in which it is still in transition from a crisis and post - crisis measure to a permanent and central feature of prudential oversight. the significant way in which the stress testing program is incomplete is that it has only limited features with which to assess the condition of participating banks from a macroprudential perspective. 9 for example, it generally does not directly take account of second - round effects of see 12 usc 3907 ( a ) ( 1 ). the stress testing program does have some macroprudential elements, which have been modestly enhanced in recent years. for example, we vary the market shock over time to reduce the incentive for firms to correlate their stress on the financial system, such as the possible fire sale of assets by financial firms in need of capital or funding, which can further depress asset values of other firms below levels resulting from the initial economic or financial shock. 10 these effects are harder to model but very important for a stress test designed to achieve financial stability objectives. the federal reserve has begun a research program to try to develop, over the next few years, sound macroprudential elements to incorporate into the stress test alongside some of the countercyclical features that have already been added. the transition of stress testing from crisis program to a permanent feature of prudential oversight is unfinished in both federal reserve regulations and supervisory practice. the de facto capital requirements produced by the stress test have not been fully integrated into, and reconciled with, other applicable capital rules. thus, for example, our stress testing program assumes that a firm will continue to make its planned capital distributions during a stress period even though the regulatory capital rules now include a capital conservation buffer to limit such distributions. as to supervision - - because the failure of a firm to meet federal reserve expectations with respect to its capital risk - management and planning

processes can lead to a “ qualitative ” objection to its capital distribution plans - - firms ( and, at times, perhaps supervisors ) have placed more emphasis on these matters than on other issues raised in the supervisory process throughout the year. it is probably worth noting at this juncture that one of the features of the stress testing program that some banks have found most troubling is that it culminates in the annual asset holdings or adopt correlated hedging strategies that are treated relatively favorably under one particular market shock scenario. see, for example, fernando duarte and thomas m. eisenbach ( 2013 ), “ fire - sale spillovers and systemic risk, ” federal reserve bank of new york staff report no. 645 ( new york : federal reserve bank of new york, october ), www. newyorkfed. org / medialibrary / media / research / staff _ reports / sr645. pdf. announcements of whether the federal reserve objects to each participating bank ’ s capital plan - an event that still garners considerable investor and public attention. 11 the potential for embarrassing, public objections to their plans has been disconcerting to some banks, which pointed out that - - by design - - they were not given the supervisory model for calculating poststress minimum capital levels and that they might not be able to predict when supervisory concerns with some aspects of their capital planning processes would ripen into a public objection. it is certainly the case that this feature of our stress testing program was intended to, and has, focused the minds of banks ’ senior management on their capital positions and capital planning processes. motivating management with the stress test was appropriate in a time when capital needed to be built up and when serious shortcomings of pre - crisis risk management at many large u. s. banks needed to be remedied. to be honest, i was stunned in my first few months at the federal reserve to find out that many of these banks were unable to aggregate their total exposure to particular counterparties across the many parts of the bank in anything like a reasonable time. some firms did not have ready access to basic information about the location and value of collateral that they held. as recently as a couple of years ago, we were still seeing some significant problems with data and modelling reliability in banks ’ internal riskmanagement processes. still, the question was always how long we would need this highly focused set of annual determinations. several years ago we took