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For release on delivery
7:30 p.m. EDT
May 11, 2009

The Supervisory Capital Assessment Program

Remarks by
Ben S. Bernanke
Board of Governors of the Federal Reserve System
at the
2009 Financial Markets Conference
Federal Reserve Bank of Atlanta
Jekyll Island, Georgia

May 11, 2009

My remarks this evening will focus on the Supervisory Capital Assessment
Program, popularly known as the banking stress test. The federal bank regulatory
agencies began the assessment program in late February and concluded their review with
the release of the results just last Thursday. This initiative involved an unprecedented,
simultaneous supervisory review of the 19 largest bank holding companies in the United
States. Its objective was to ensure that these institutions have sufficient financial strength
to absorb losses and to remain strongly capitalized, even in an economic environment
more severe than currently anticipated. A well-capitalized banking system is essential for
the revival of the credit flows that will underpin a sustainable economic recovery.
Objectives of Supervisory Capital Assessment Program
As you know, the abrupt end of the credit boom in 2007 has had widespread
financial and economic ramifications, including a sharp slowdown in global economic
activity and the imposition of substantial losses on banks and other financial institutions.
Economic and financial weaknesses have fed on each other, as a declining economy has
exacerbated credit losses and the resulting pressure on banks and other financial
institutions has constrained the availability of new credit.
A number of significant steps have been taken to restore confidence in the
nation’s financial institutions, including a substantial expansion of guarantees for bank
liabilities by the Federal Deposit Insurance Corporation (FDIC), injections of capital by
the Treasury in many institutions both large and small, and Federal Reserve programs to
provide liquidity to financial institutions and support the normalization of key credit
markets. These efforts averted serious threats to global financial stability last fall and

-2have contributed to gradual improvement in key credit markets, though many markets
remain stressed.
These steps, however, did not fully address market concerns over the depletion of
bank capital caused by write-downs and increased reserving for potential losses. At the
beginning of this episode, bank losses were focused in a few asset classes, such as
subprime mortgages and certain complex credit products. Today, following the
significant weakening in the global economy that began last fall, concerns have shifted to
more-traditional credit risks, including rising delinquencies on prime as well as subprime
mortgages, unpaid credit card and auto loans, worsening conditions in commercial real
estate markets, and increased rates of corporate bankruptcy.
The loss of confidence we have seen in some banking institutions has arisen not
only because market participants expect the future loss rates on many banking assets to
be high, but because they also perceive the range of uncertainty surrounding estimated
loss rates as being unusually wide. The capital assessment program was designed to
reduce this uncertainty by conducting a stringent, forward-looking assessment of
prospective losses at major banking organizations. The objective was to identify the
extent to which each of the 19 firms is vulnerable today to a weaker-than-expected
economy in the future, and to measure how much of an additional capital buffer, if any,
each firm would need to establish now to withstand the potential losses in more-adverse
economic conditions.
To make this assessment, we began by stipulating a hypothetical, adverse
economic scenario, under which growth, unemployment, and house-price outcomes were
assumed to be more unfavorable than those implied by the consensus of private-sector

-3forecasters. Using this hypothetical adverse scenario, examiners were asked to estimate
the range of possible losses that our largest and most important banking organizations
could experience over the next two to three years, as well as the resources, such as
earnings and reserves, that those organizations would have available to offset those
losses. It is important to note that this was not a solvency test. After including capital
previously provided by the Treasury, all of these banking organizations currently have
capital well in excess of the minimum stated capital requirements of the supervisors.
Instead, the purpose of the exercise was to determine the size of the capital cushion that
each organization would need to remain well capitalized and still be able to lend--even in
an economic scenario more severe than expected.
We have now learned through this process that, if the economy were to track the
more adverse scenario, additional losses at the 19 firms during 2009 and 2010 could total
about $600 billion. After taking account of potential resources to absorb those losses,
including expected revenues, reserves, and existing capital cushions, we determined that
10 of the 19 institutions will require, collectively, common or contingent common equity
of $185 billion to ensure adequate capital cushions. Of this amount, the equivalent of
$110 billion has already been raised or is contractually committed to be in place, or to a
lesser degree reflects first-quarter pre-provision earnings above those assumed in the
initial supervisory estimates. Consequently, the remaining common equity buffer that
must be raised is $75 billion. The firms that are determined to need an additional capital
buffer will have 30 days to develop a capital plan to be approved by their supervisors and
six months to implement that plan. We have strongly encouraged institutions requiring
additional capital to obtain it through private means, including, for example, new equity

-4issues, conversions, exchange offers, or sales of businesses or other assets. To ensure
that all of these firms can build the needed capital cushions, however, the Treasury has
made a firm commitment to provide contingent common equity, in the form of mandatory
convertible preferred stock, as a bridge to obtaining private capital in the future. Banking
organizations will also have the option to exchange their existing preferred stock, issued
under Treasury’s earlier Capital Purchase Program, for the new contingent common
equity. The Treasury has indicated that it expects that any such exchange will be either
accompanied or preceded by new capital raises or the conversion of private capital
securities into common equity.
Process and Methodology
To properly understand the results of the capital assessment program, it is helpful
to understand the process that produced the results. All U.S.-owned bank holding
companies with year-end 2008 assets exceeding $100 billion were required to participate
in the program. These 19 firms collectively hold two-thirds of the assets and more than
one-half of the loans in the U.S. banking system, supporting a very significant portion of
credit intermediation in the United States. The assessment process can perhaps best be
characterized as a simultaneous examination of 19 large bank holding companies that
addressed all major categories of assets as well as revenue expectations.
The assessment was a resource-intensive undertaking, involving extraordinary
efforts by more than 150 examiners and analysts from the Federal Reserve, the Office of
the Comptroller of the Currency (OCC), and the FDIC. These staff members conducted a
detailed, firm-specific analysis over a 10-week period. Their efforts were aided by access
to data and management available only to bank supervisors. The supervisors also

-5incorporated statistical tools and quantitative models in their evaluation of each firm’s
data to facilitate comparative analysis across the 19 firms.
The analysis was a comprehensive one, which included an exhaustive review of
loan portfolios, investment securities, trading positions, and off-balance sheet
commitments. Typically, supervisory examinations focus on individual business lines or
asset classes at a single firm. In this case, we simultaneously reviewed all of the major
portfolios and business lines at each of the 19 firms, making unprecedented efforts to
achieve methodological consistency across firms, portfolios, and supervisors.
Through it all, we tried to be as transparent as possible. The assumptions,
processes, and results of the capital assessment program have been communicated in
detail, taking into account legitimate supervisory and firm confidentiality concerns. We
released a white paper on April 24 describing the process and methodology.1 On May 6,
we provided more information on the measures used to size the required capital buffer, as
well as a preview of the information that would be disclosed.2 The final release of
results, this past Thursday, May 7, included the supervisory-determined indicative loss
rates that were used in evaluating firm submissions, and, most importantly, aggregate and


See Board of Governors of the Federal Reserve System (2009), “The Supervisory Capital Assessment
Program: Design and Implementation,” white paper (Washington: Board of Governors, April 24),
See Board of Governors of the Federal Reserve System (2009), “Joint Statement by Secretary of the
Treasury Timothy F. Geithner, Chairman of the Board of Governors of the Federal Reserve System Ben S.
Bernanke, Chairman of the Federal Deposit Insurance Corporation Sheila Bair, and Comptroller of the
Currency John C. Dugan: The Treasury Capital Assistance Program and the Supervisory Capital
Assessment Program,” joint press release, May 6,

-6firm-specific estimates for losses, loss rates, resources to absorb losses, and the resulting
capital buffer needs.3
Finally, as I have noted, the assessment was forward-looking. To project losses
and offsetting resources two to three years in the future under the adverse scenario, we
analyzed the historical relationships of losses and earnings to macroeconomic conditions
and other determinants, and we dug deeply into cross-firm differences in portfolio
compositions and vulnerabilities.
The process began in earnest in early March when each firm submitted its
estimate of losses and earnings over a two-year scenario, under two alternative assumed
paths for the U.S. economy. The baseline scenario reflected the consensus expectation
for the economy among professional forecasters as of February 2009, and the more
adverse scenario incorporated the possibility that the recession could be more severe than
the consensus expectation and that house prices could fall even more sharply.
Although we began the process by asking the firms to submit their own estimates
of expected losses and revenues, we by no means accepted these submissions uncritically.
Senior supervisors and on-site examiners evaluated the firms’ estimates to identify
methodological weaknesses, missing information, over-optimistic assumptions, and other
problems. Examiners had detailed conversations with bank managers, which led to
numerous corrections to and modifications of the firms’ submissions, including
sensitivity analyses based on alternative assumptions.
As a second step, supervisors made judgmental adjustments to the firms’ loss and
revenue estimates. This process used both firm-specific and comparative analyses. For

See Board of Governors of the Federal Reserve System (2009), The Supervisory Capital Assessment
Program: Overview of Results (Washington: Board of Governors, May 7),

-7example, supervisors sometimes disagreed with the technical assumptions underlying a
firm’s loss forecast. In these cases, they adjusted the loss rates based on sensitivity
analyses performed by the firm, results from other firms, and the supervisors’ own expert
Third, the supervisors’ judgmental assessments were supplemented by objective,
model-based estimates for losses and revenues that could be applied on a consistent basis
across firms. For example, we used statistical models to estimate residential mortgage
losses at firms based on loan data submitted by the firms as part of the exercise. Each
participating institution was asked to supply detailed information, in a standardized
format, about the composition of its residential real estate portfolios, including
breakdowns by type of product, loan-to-value ratio, FICO score, year of origination, and
so on. These data allowed supervisors to consistently estimate potential future losses
across firms using a variety of independently constructed models. Some of these models
were already in use to monitor risk as part of the ongoing supervisory oversight process,
while others were developed or refined specifically for the capital assessment exercise.
Similarly, to assess firms’ revenue projections for 2009 and 2010, the agencies
examined the components of expected revenue in detail, compared the projections to
historical results, and cross-checked the underlying assumptions with projections of
portfolio growth, funding costs, and the like. The agencies also used more-formal
statistical analyses to develop firm-by-firm forecasts that would reflect the historical
relationship between revenues and macroeconomic conditions, thereby enabling them to
assess which components were less likely to be sustainable in a weaker economy.
Information from all of these sources was incorporated into the final revenue projections.

-8Finally, the supervisors systematically incorporated all of these inputs into loss, revenue,
and reserve estimates for each institution.
Determining the Size of the Capital Buffer
A key question in this assessment was the appropriate size of the capital buffers
that these firms would be required to hold, as well as the quality of those buffers. Recall
that our analysis of the firms’ financial conditions focused not on current capital levels
alone but also on how capital levels might evolve over a two-year horizon, assuming a
more adverse economic environment than currently anticipated. In other words, the
assessment was not a forecast of expected outcomes but rather a “what-if” exercise,
intended to help supervisors gauge the capital buffers needed to keep banks well
capitalized and able to lend across a range of economic scenarios.
In judging the needed buffer, we understood that no single measure of capital
adequacy is universally accepted or would guarantee a return of market confidence.
Fortunately, our existing capital framework is well understood and addresses the key
concerns that have been voiced by the market. Under our existing standards, banks are
considered “well capitalized” with Tier 1 capital at 6 percent of risk-weighted assets.
Using that benchmark in the context of bank holding companies, we sized the capital
buffer so that each of the 19 companies would be expected to meet that threshold at yearend 2010 if the losses and revenues implied by the adverse case were realized.
In addition, common equity ratios in various guises are viewed by stockholders,
bondholders, and counterparties as key measures of solvency, because common equity
provides superior loss absorption and greater financial flexibility than other forms of
capital. Because of these attributes of common equity, our bank holding company capital

-9rules require that voting common stockholders’ equity make up the dominant portion of
Tier 1 capital elements. In the context of the assessment program, we have structured the
required capital buffer to ensure that, under the adverse scenario, each of the 19 firms
would have a minimum 4 percent Tier 1 Common ratio at year-end 2010. (Tier 1
Common is simply common equity subject to the same deductions from capital as are
required when determining Tier 1 capital--for example, deducting goodwill.)
Importantly, the “6-4” metric used to size the appropriate capital buffer does not
represent a new capital standard and is not expected necessarily to be maintained on an
ongoing basis. Going forward, with the required initial buffer in place, supervisors will
work with banks and bank holding companies to ensure that capital levels are appropriate
for the level of risk in banks’ portfolios and in the economic environment.
Evaluating the Results
Projecting credit losses in an uncertain economic environment is difficult, to say
the least, but the intensive, painstaking nature of this process gives us confidence in our
results. In particular, we believe that our estimates of needed capital buffers are
appropriately conservative. Notably, a comparison to historical loss rates shows that the
loss estimates we obtained significantly exceed those experienced in past recessions. The
estimated two-year cumulative losses on total loans under the more adverse scenario
averaged 9.1 percent across the 19 participating bank holding companies. This two-year
rate is higher than any two-year period dating back to 1920, including the historical peak
loss years of the 1930s. In particular, estimated loss rates for mortgage and consumer
credit are high, reflecting the combination of high unemployment and steep declines in
house prices that were specified in the more adverse scenario.

- 10 Still, it is useful to know whether our estimates are consistent with what has been
found by others. Two studies released within the last few weeks essentially bracketed the
supervisory estimate. The International Monetary Fund estimated lifetime losses that
would imply a loan loss rate for U.S. banking firms of about 8 percent in a stressed
scenario.4 One of the major rating agencies estimated an annual loan loss rate of about 43/4 percent in a stress scenario for the next two years.5 More broadly, our informal
survey of the results of a considerable number of private-sector studies and analyst
reports published over the past several months generally placed our projected loss rates
for key portfolios near the midpoints of the ranges of these independent estimates.
When making comparisons, it should be kept in mind that studies differed in the
ways that losses were estimated and reported. Four particular sources of differences are
First, studies differed in the time frames over which losses were calculated. Some
outside reports included cumulative losses from the beginning of the financial crisis in
mid-2007, and others included projections of losses over the lifetimes of currently held
loans and securities. Our estimates are for potential losses in 2009 and 2010 and,
indirectly, for 2011, through the estimate of the end-2010 loan loss reserve. Our
estimates do not include the sizable losses that have already been recognized by the 19
banks--about $325 billion of loans and securities in the last six months of 2007 and in
2008--because they are already reflected in the firms’ balance sheets. Moreover, while
we exclude losses beyond 2011, this limit would only be material for sizing the capital


International Monetary Fund (2009), Global Financial Stability Report: Responding to the Financial
Crisis and Measuring Systemic Risks (Washington: IMF, April),
Standard and Poor (2009), “What Stress Tests Reveal about U.S. Banks Capital Needs,” May 1.

- 11 buffer if those losses were expected to substantially exceed pre-provision earnings after
2011, an outcome that we do not expect.
Second, a few private-sector estimates implicitly or explicitly assumed mark-tomarket or liquidation prices for loans, which effectively incorporate a substantial liquidity
discount in today’s market. However, because banks are portfolio lenders with core
deposit funding and the ability to hold loans to maturity, our estimated valuations are
based on projected cash flow credit losses related to a borrower’s failure to meet its
obligation, not a liquidation value.
Third, some private-sector studies may not have taken into account the
markdowns in asset valuations that occurred in the context of acquisitions of other firms.
In particular, in the course of acquisitions by the 19 bank holding companies in 2008, the
value of troubled loans was written down by almost $65 billion.6 These potential losses
should only be realized once and thus are excluded from our estimates of prospective
losses for 2009 and 2010. Of course, we took full account of these writedowns in our
sizing of required capital buffers.
Fourth, in contrast to some outside estimates, estimated losses for the capital
assessment program are for the 19 firms, not the entire banking system. Moreover,
numerous adjustments were necessary to reflect particular facts and circumstances at
these firms. That level of analysis simply has not been done--nor could it be done--by
outside observers without the level of access available to supervisors.
Despite the care and rigor of this process, I would be the first to acknowledge that
any loss forecast is inherently uncertain. The assessment program did not address some


Purchase accounting adjustments were recognized for Capital One Financial Corporation, JPMorgan
Chase & Co., PNC Financial Services Group, Inc., and Wells Fargo & Company.

- 12 risks that institutions still need to consider in their own internal stress tests, such as
operational, liquidity, and reputational risks. For all 19 firms, and particularly those with
trading and investment banking businesses, those risks are important and will need to be
monitored by both the firms and the supervisors. Ideally, the stress tests used in the
assessment program should be part of a broader palette of internal stress tests conducted
by firms; indeed, we do not intend that the capital assessments should be taken as all that
those firms need to do.
A principal goal of the capital assessment process is to help increase confidence
in the banking system. In particular, if it helps reduce uncertainty among investors
regarding future losses and capital needs, and thereby improves the banking system’s
access to private capital, one of the key objectives of the program will have been
achieved. It will be some time before we can evaluate the success of the program on this
criterion. However, the initial indications are encouraging. Each of the 10 banks
requiring an additional capital buffer has pledged to have the necessary buffer in place by
the November 9 deadline. Many of the banks are well ahead in finding private-sector
options for increasing their common equity, and several have announced plans for new
equity issues. In another positive sign, several have announced plans to issue long-term
debt not guaranteed by the FDIC.
Lessons from the Assessment Program for the Supervisory Process
We’ve learned important lessons in the capital assessment process that will
inform our supervisory efforts in the future. Notably, the process of comprehensively
evaluating 19 major firms represented an important step forward in consolidated

- 13 supervision, as it gave us insights into the challenges posed in understanding risks and
exposures across complex organizations.
The cross-firm aspects of the assessment program were also instructive from a
supervisory point of view. As I have mentioned, unlike traditional examinations focused
on individual banks, the assessment process specifically incorporated cross-firm and
aggregate analyses of a set of firms that constitute a majority of the banking system. This
approach allowed a broader analysis of risks than is possible within the traditional
supervisory focus on individual institutions. Supervisors evaluated loss rates for similar
portfolios using consistent data and metrics, allowing them to identify outliers and more
effectively evaluate the quality of individual firm estimates. The process was an iterative
one, with both the firms and supervisors conducting sensitivity analyses around key
The federal bank regulators--the Federal Reserve, OCC, and FDIC--cooperated
extensively throughout this process, from the design to the implementation. In addition,
within each agency, many resources across a range of skills were brought to bear. For
example, quantitative experts supported examiners by incorporating statistical tools to
facilitate benchmarking across institutions and to develop consistent loss estimates.
We learned from this effort that it is not a simple matter to simultaneously
evaluate the consolidated risks for two-thirds of the assets in the U.S. banking system,
using a common forward-looking framework and common metrics. But it was an
enlightening exercise that will improve the toolkit we use to help ensure the safety and
soundness not just of individual firms, but of the financial system more broadly.

- 14 Conclusion
In summary, the Supervisory Capital Assessment Program is an important
element of broader and ongoing efforts by the Federal Reserve, other federal bank
regulators, and the Treasury to ensure that our banking system has sufficient resources to
navigate a challenging economic downturn. A collateral benefit is that many lessons of
the exercise can be used to improve our supervisory processes. In particular, the
supervisory capital assessment has demonstrated the benefits of using cross-firm, crossportfolio information and the simultaneous review of a number of major firms to develop
a more complete and fine-grained view of the health of the banking system.
Whether the objectives of the assessment program were achieved will only be
known over time. We hope that in two or three years we will be able to reflect on the
banking system’s return to health with a sharply diminished reliance on government
capital. More immediately, we hope and expect that the public and investors will take
considerable comfort from the fact that our largest financial institutions have been
evaluated in a comprehensive and rigorous fashion; and that they will, as a consequence,
be required to have a capital buffer adequate to weather future losses and to supply
needed credit to our economy--even if the economic downturn is more severe than is
currently anticipated.