the federal reserve – created a stress test and required the nation ’ s 19 largest bank holding companies to apply it as part of our supervisory capital assessment program ( scap ). the test involved two scenarios – one based on the consensus forecast of professional forecasters, and the other based on a severe, but plausible, economic situation – with specified macroeconomic variables such as gdp growth, employment, and house prices. each participating institution was asked to supply, in a standardized format, detailed information on portfolio risk factors and revenue drivers that supervisors could use to estimate losses and revenues over a two - year period. these data allowed supervisors to make consistent estimates across all 19 firms. the immediate motivation for the 2009 stress test was to determine how much additional capital a bank holding company would need to ensure that it would remain a viable financial intermediary even in the adverse scenario. the treasury department stood ready to provide capital to any bank that could not raise the required amount from private sources. but the federal reserve ’ s decision to disclose the results of the test on a firm - specific basis served a second purpose – to provide investors, and markets more generally, with information that would help them form their own judgments on the condition of u. s. banking institutions. this bis central bankers ’ speeches decision proved to be an important step in establishing market and public confidence that the u. s. financial system would weather the crisis. though conceived and developed in the midst of the financial crisis, scap will be remembered as a watershed for supervisory policies applicable to large institutions. congress drew on the lessons of the 2009 exercise by including a requirement for stress testing in the 2010 dodd - frank wall street reform and consumer protection act ( dodd - frank act ). but well before congress passed the dodd - frank act, the scap experience had already profoundly affected attitudes toward supervision within the federal reserve. it demonstrated in practice, not just in theory, the value of a simultaneous, forwardlooking projection of potential losses and revenue effects based on each bank ’ s own portfolio and circumstances. the forward - looking feature overcame the limitations of static capital ratios. the simultaneity, along with stress test features such as an assumed instantaneous market shock, introduced a critical macroprudential dimension that offered insights into the condition of the entire financial system, including whether banks were sufficiently resilient to continue to provide their critical intermediation functions even under such adverse conditions. regular and rigorous stress testing thus provides regulators with knowledge that can be

the recession reflects two considerations. first, as i have already suggested, a core rationale for stress testing is the macroprudential goal of ensuring that the nation ’ s financial system could continue to operate even in the face of severely adverse developments. it is precisely an outcome fairly far out on the tail at which a stress test should be directed. a more probable scenario, with a milder downturn, would not serve that purpose. second, presumably reflecting this logic, the dodd - frank act requires that we include a “ severely adverse ” scenario. accordingly, as we fully implement the dodd - frank requirement beginning next year, this level of severity will in any case be required by law. as one might expect from the severity of the adverse scenario, the losses projected by our models for the 19 firms were quite high. total losses amounted to about $ 650 billion, of which $ 535 billion was due directly to declines in balance sheet asset values. the remaining $ 115 billion was accounted for by additional items run directly through net revenue estimates, such as expenses from mortgage putbacks. the portfolio losses would be very high by historical standards. for example, the $ 340 billion in loan losses included in the total loss figure translates into a loss rate of about 7. 2 percent, which compares to about a 5. 4 percent loss rate in the peak eight quarters of losses during the financial crisis and is a higher rate than has been experienced at any point in the last century except during the great depression. similarly, pre - provision net revenue was projected to be equal to only about 2. 5 percent of average assets, an historically low rate that compares to about bis central bankers ’ speeches 3. 5 percent during the nine - quarter period from the fourth quarter of 2007 through the fourth quarter of 2009 that spanned the financial crisis. notwithstanding the stringency of the stress test, only four of the nineteen firms fell below the 5 percent tier 1 common ratio standard, or one of the other applicable ratios, even assuming that all proposed capital actions went forward during the stress period. in passing, i might observe that we would expect that firms would, in fact, pare their distributions in the face of a severely deteriorating operating environment, but the fact that some firms failed to do so in 2007 and 2008 has led our supervisors to make the conservative assumption that distributions would continue. if proposed future capital distributions are not assumed – that is, if the approach in the 2009 scap is taken – only one firm falls below the