Finally, stress tests must be modified so as to avoid incentivizing firms to correlate their asset holdings or adopt correlated hedging strategies. This potential problem can be illustrated by reference to the market shocks we have applied to the trading books of the six largest financial firms in the last two stress tests.
Second, we need to re-examine all aspects of the current regulatory framework to ensure it does not contribute to the intrinsic cyclicality of banking. A number of potential sources of pro-cyclicality need to be investigated, including fair value accounting and leverage, capital requirements and provisioning regimes.