. this is an important innovation, as banks were slow to reduce dividends during the financial crisis, even as losses mounted and share prices fell. 1 i want to examine supervisory stress testing through the lens of a paper i wrote in 2009 with former colleague til schuermann and current colleague kevin stiroh, now head of the new york fed ’ s supervision group. 2 that paper looked at the very first set of stress tests conducted by the federal reserve and other federal banking supervisors. the supervisory capital assessment program, or scap, was a watershed moment in the financial crisis. the program covered the 19 largest domestic bank holding companies — firms with assets of at least $ 100 billion — accounting for two - thirds of the assets and one - half of the loans in the u. s. banking system at that time. collectively, these firms spanned nearly every business area in the u. s. banking industry — including commercial and consumer lending, real estate lending, trading, derivatives, custody services and investment banking. the key point in our paper was that the scap was a program that used microprudential supervisory tools to achieve macroprudential objectives. i am sure that everyone here is familiar with these two terms, but let me provide a quick overview. microprudential objectives focus on the health, performance, safety and soundness of individual firms. this was the perspective that 1 / 6 bis central bankers'speeches dominated supervision prior to the financial crisis. in contrast, macroprudential objectives focus on the stability and performance of the entire banking and financial system, emphasizing links among firms, how their activities can interact and the impact of the financial sector on the broader economy. this perspective has become more prominent since the global financial crisis. macroprudential objectives can themselves be divided into two distinct groups. the first is what might be called structural objectives, which focus on the impact large, systemically important institutions have on the rest of the system when they fail or become distressed. structural macroprudential objectives motivate regulatory tools such as additional capital requirements for systemically important banks ( “ sifi surcharges ” ), which aim to reduce the probability that a large institution fails, and resolution and recovery planning, which seeks to limit the damage in the event of failure. the second set of macroprudential objectives are cyclical objectives, focusing on the build - up of risks during credit and asset price booms and the consequent pull - back in financial

raise the ioer rate – pushing up the federal funds rate and other short term rates – to tighten broader financial conditions and reduce demand. 2 if the demand for credit were insufficient to push the economy to full employment, then the federal reserve would reduce the ioer rate – pushing down the fed funds rate and other short term rates – to ease financial conditions and support demand, recognizing that the ioer rate cannot fall below zero. while the mechanism is different, the basic approach is very similar to the way the federal reserve has behaved historically. although our ability to pay interest on excess reserves is sufficient to retain control of monetary policy, it is not bad policy to have both a “ belt and suspenders ” in place. as a result, we have developed means of draining reserves to provide reassurance that we will not – under any circumstance – lose control of monetary policy. these include reverse repo transactions with dealers and other counterparties, auctions of term deposits for banks, or securities sales from the fed ’ s portfolio. a related concern is whether the federal reserve will be able to act sufficiently fast once it determines that it is time to raise the ioer. this concern reflects the view that the excess reserves sitting on banks ’ balance sheets are essentially “ dry tinder ” that could quickly fuel excessive credit creation and put the fed behind the curve in tightening monetary policy. in terms of imagery, this concern seems compelling – the banks sitting on piles of money that could be used to extend credit on a moment ’ s notice. however, this reasoning ignores a very important point. banks have always had the ability to expand credit whenever they like. they didn ’ t need a pile of “ dry tinder ” in the form of excess reserves to do so. that is because the federal reserve ’ s standard operating procedure for several decades has been a commitment to supply sufficient reserves to keep the fed funds rate at its target. if banks wanted to expand credit that would drive up the demand for reserves, the fed would automatically meet that demand by supplying additional reserves as needed to maintain the fed funds rate at its target rate. in terms of the ability to expand credit rapidly, it makes no difference whether the banks have lots of excess reserves on their own balance sheets or can source whatever reserves they need from the fed funds market at the fed funds rate. 3 the ioer rate and the federal funds rate are likely to track each other closely in most circumstances. banks do not have any incentive to lend reserves in the fed