scope of operations. the result has been the creation of some extremely large and diverse financial institutions with high earnings capacity. in 2003, 18 u. s. bank holding companies and six securities firms each earned more than $ 1 billion, with the five largest bank holding companies earning a combined total of nearly $ 46 billion, over 40 percent of the banking industry total. along with capital, these earnings provide a substantial cushion to absorb losses, significantly moderating the consequences of an adverse event. the wider scope of activities and greater domestic and international geographic diversification of these firms also provide a more stable revenue base. advances in risk management have also enabled firms to hedge risks more effectively and, in the aggregate, to disperse risk more efficiently across firms in the financial system. given advances in data collection and risk modeling, banks and other financial firms are able to do better risk - based pricing. firms now have the capacity to view credit and other key risks from a portfolio perspective rather than in isolation, leading to more efficient risk sharing and better capital allocation. in concert with better risk modeling, securitization and credit derivatives have facilitated the dispersion of credit risk across firms and across sectors of the financial system. these changes have led to significant risk transfers within the banking system, as well as a net transfer of credit risk from commercial banks to other financial intermediaries. as a result, we believe we are seeing a more efficient risk allocation within the financial system as a whole, since risks can be transferred to firms where they will diversify, rather than reinforce, risks arising from core businesses and to parts of the financial system that are significantly less leveraged than banks and securities firms, such as institutional investors and mutual funds. these risk management advances have been accompanied by the growth of key derivatives markets that have lowered the costs of hedging market - price - sensitive positions and activities. one important example of this is the growth of the market for long - dated swaps, which are now used by banks to hedge mortgage securities and whole loans. the notional value of long - dated interest rate derivatives ( those with maturities of more than 5 years ) has more than tripled since the end of 1998, considerably faster growth than for comparable shorter - dated instruments. the growth of these markets reflects a very substantial increase in hedging capacity, and this “ wider pipeline ” seems likely to facilitate the ease with which the market adjusts in conditions of stress. growth in these otc derivatives markets has been accompanied

the stronger payment and settlement system infrastructure make our financial system stronger today than it has been. with these favorable developments, however, come a range of challenges. i want to discuss a few of these and their implications. this is not meant to be, and is not, a comprehensive list. the first is the challenge of complexity. with financial growth and innovation, we have seen a dramatic increase in the complexity of the risk management challenge. the frontier of innovation inevitably advances somewhat ahead of the pace of improvements in the risk management and supervisory infrastructure. the models used to inform credit judgments, to measure exposure, and to price risk in the newest instruments and trading strategies are by definition less grounded in experience. the process of assigning fair or market value is much more subjective and less amenable to objective verification. consensus on the appropriate accounting treatment is less well established. as the complexity of risks has grown, so have the demands on firms to understand how exposures might evolve, especially in times of market stress. as an example, basis risk - in which hedged positions only partially offset one another - is an increasingly important concern for many firms, especially those that deal in complex products such as options. assessing and managing these more complex risks requires risk management tools with a commensurate level of sophistication. in particular, the further development of techniques for stress testing and scenario analysis and of methods for translating stress test results into concrete risk management outcomes are important areas for additional progress. the risk management challenge is complicated by the nature of the institutions at the core of the system. large, diversified financial institutions comprise many separate, highly specialized business units, each of which can have its own approach to tracking and managing risk exposures. integrating across these businesses to develop a firm - wide, portfolio risk perspective is an important challenge, one that has many guises within a large, complex firm. for example, managing the complex pattern of risk exposures that derive from membership in multiple payment and security settlement systems, each of which has loss - sharing arrangements that generate contingent exposures among and between their members, is just one small facet of the broader challenge facing such firms today. the difficulty of managing the conflicts in dealings with customers is also significantly enhanced for these large, diversified institutions, given the multiple roles that they play. more generally, it is increasingly challenging for many large, diverse financial institutions to get an accurate picture of their aggregate exposure to individual creditors when their business contacts can come through so many different