not just by senior executives, but also by other managers or employees who have the ability, individually or collectively, to materially alter the risk profile of the institution. bonuses and other compensation arrangements should not provide incentives for employees at any level to behave in ways that imprudently increase risks to the institution, and potentially to the financial system as a whole. the federal reserve worked closely with other supervisors represented on the financial stability board to develop principles for sound compensation practices, which were released earlier this year. 5 the federal reserve expects to issue soon our own guidance on this important subject to promote compensation practices that are consistent with sound risk - management principles and safe and sound banking. finally, i would note the importance of continuing to analyze the practices of financial firms and supervisors that preceded the crisis, with the aim of fashioning additional regulatory tools that will make prudential supervision more effective and efficient. one area that warrants particular attention is the potential for supervisory agencies to enlist market discipline in pursuit of regulatory ends. for example, supervisors might require that large financial firms maintain specific forms of capital so as to increase their ability to absorb losses outside of a bankruptcy or formal resolution procedure. such capital could be in contingent form, converting to common equity only when necessary because of extraordinary losses. while the costs, benefits, and feasibility of this type of capital requires further study, policymakers should actively seek ways of motivating the private owners of banking organizations to monitor the financial positions of the issuing firms more effectively. addressing gaps and weaknesses in the regulatory framework while the actions that i have just discussed should help make banking organizations and the financial system stronger and more resilient, the crisis also has highlighted gaps and weaknesses in the underlying framework for prudential supervision of financial institutions that no regulatory agency can rectify on its own. one, which i will mention in a moment, has been addressed by the banking agencies working together. others require congressional attention. charter conversions and regulatory arbitrage the dual banking system and the existence of different federal supervisors create the opportunity for insured depository institutions to change charters or federal supervisors. while institutions may engage in charter conversions for a variety of sound business reasons, conversions that are motivated by a hope of escaping current or prospective supervisory actions by the institution's existing supervisor undermine the efficacy of the prudential supervisory framework. accordingly, the federal reserve welcomed and immediately supported an initiative led by the federal deposit insurance corporation ( fdic ) to address such regulatory arbitrage. this initiative

the financial system generally, requires a more comprehensive and integrated assessment of activities throughout the holding company. appropriate enhancements of both prudential and consolidated supervision will only increase the need for supervisors to be able to draw on a broad foundation of economic and financial knowledge and experience. that is why we are incorporating economists and other experts from non - supervisory divisions of the federal reserve more completely into the process of supervisory oversight. the insights gained from the macroeconomic analyses associated see basel committee on banking supervision ( 2008 ), principles for sound liquidity risk management and supervision ( basel, switzerland : bank for international settlements, september ). see office of the comptroller of the currency, board of governors of the federal reserve system, federal deposit insurance corporation, office of thrift supervision, and national credit union administration ( 2009 ), " agencies seek comment on proposed interagency guidance on funding and liquidity risk management, " joint press release, june 30. with the formulation of monetary policy and from the familiarity with financial markets derived from our open market operations and payments systems responsibilities can add enormous value to holding company supervision. the recently completed supervisory capital assessment program ( scap ) heralds some of the changes in the federal reserve's approach to prudential supervision of the largest banking organizations. this unprecedented process involved, at its core, forward - looking, cross - firm, and aggregate analyses of the 19 largest bank holding companies, which together control a majority of the assets and loans within the financial system. bank supervisors in the scap defined a uniform set of parameters to apply to each firm being evaluated, which allowed us to evaluate on a consistent basis the expected performance of the firms under both a baseline and more - adverse - than - expected scenario, drawing on individual firm information and independently estimated outcomes using supervisory models. drawing on this experience, we are prioritizing and expanding our program of horizontal examinations to assess key operations, risks, and risk - management activities of large institutions. for the largest and most complex firms, we are creating an enhanced quantitative surveillance program that will use supervisory information, firm - specific data analysis, and market - based indicators to identify developing strains and imbalances that may affect multiple institutions, as well as emerging risks to specific firms. periodic scenario analyses across large firms will enhance our understanding of the potential impact of adverse changes in the operating environment on individual firms and on the system as a whole. this work will be performed by a multi - disciplinary group composed of our economic and market researchers