of money on the assumption that they would be able to distribute that risk easily into liquid markets. a sizable fraction of long - term assets – assets with exposure to different forms of credit risk – ended up in vehicles financed with very short - term liabilities and was placed with investors and funds that were also exposed to liquidity risk. as is often the case during periods of rapid change, more significant concentrations of risk were present than was apparent at the time. banks and investment banks sold insurance against what seemed like low probability events, but did so at what even at the time seemed like low prices. and on the assets they retained, these same institutions purchased insurance from financial guarantors and other firms that were exposed to the same risks. the crisis exposed a range of weaknesses in risk management practices within financial institutions in the united states and throughout the world. today, a group of the primary supervisors of the largest banks and investment banks in the world released a comprehensive assessment of risk management practices in these institutions. this assessment will help lay the foundation for consensus on changes to supervision going forward in the major financial centers. the report examines a range of practices that helped determine relative performance during this crisis. banks and investment banks with stronger risk management practices and cultures did substantially better. the most common failures were in how firms dealt with uncertainty about the scale of losses they would face in a less benign economic and financial environment ; the scale of the cushion they built up against that uncertainty ; how well they managed the internal tension between risk and reward ; and how quickly they moved to mitigate risk as conditions deteriorated. the typical arsenal of risk management tools relies, by necessity, on history and experience, and as a result has only limited value in assessing the scale of potential future losses. these limitations were particularly damaging in a period in which significant innovation in financial instruments and market structure was coupled with relatively stable macroeconomic and financial conditions. uncertainty about the future, and the greater complexity of leveraged structured products, created a dense fog around estimates of potential loss, making institutions and markets more vulnerable to an adverse surprise when conditions changed, and making it harder to manage the many principal agent problems inherent in the financial business. in effect, some major banks and investments banks made the choice to follow the market down as underwriting practices eroded. they took on more exposure to low probability but extremely adverse events, despite the potential consequences of getting caught when the music stopped. and even though the largest firms were able to move quickly to protect themselves as conditions

##cipate margin calls during periods of volatility. the holistic review by the financial stability board, in which we participate, could provide important insights into these issues. 12 see financial stability board ( 2020 ), holistic review of the march market turmoil ( basel, switzerland : fsb, november ), https : / / www. fsb. org / wp - content / uploads / p171120 - 2. pdf. - 10 bank capital and liquidity the resilience of the banking sector in response to the covid shock underscores the importance of guarding against erosion of the strong capital and liquidity buffers and riskmanagement, resolution, and stress - testing programs put in place pursuant to the dodd - frank act. banks entered the pandemic with strong capital and liquidity buffers, especially those banks whose size and complexity are systemically important. strong capital and liquidity buffers allowed the banking system to accommodate the unprecedented demand for short - term credit from many businesses that sought to bridge the pandemic - related shortfalls in revenues. banks ’ capital positions initially declined because of this new lending and strong provisioning for loan losses but have since risen above their pre - pandemic levels, reflecting better - than - expected loan performance and a reduction in credit provision as well as caps on dividends and restrictions on share repurchases in the past several quarters. strong capital and liquidity positions will remain important, as banks still face significant challenges — including an environment of higher - than - normal uncertainty. for instance, some sectors of commercial real estate loans and commercial and industrial loans are more vulnerable than before the crisis. similarly, net interest margins could remain in the lower part of their historical ranges for some time. although losses and delinquency rates on bank loans are currently low, performance could deteriorate as borrowers exit forbearance, with particularly hard - hit businesses and households facing arrears on rent and mortgage payments. 13 recent developments have been encouraging, but downside risks remain, which could delay recovery and lead to higher losses. according to the senior loan officer opinion survey on bank lending practices, banks expect demand to strengthen and loan performance to deteriorate for most loan categories over 2021, with the exception of c & i loans to large and middle - market firms. the survey is available on the board ’ s website at https : / / www. federalreserve. gov / data /