The problem was that on a mark-to-market basis, some of these banks were viewed as potentially insolvent. But the mark-to-market price declines overstated the problem because a significant portion of the decline in prices did not reflect expected losses but instead was due to a huge increase in the illiquidity premium. This was due to the fact that risky assets could no longer be financed easily on a leveraged basis. As long as banks could hold onto the assets, losses would shrink once the illiquidity premium narrowed back to a more typical level. To sum up, I believe that the SCAP was an important turning point in the financial crisis. Confidence improved as banks raised capital mainly in the private markets. So what were the lessons from the CCAR? 4  BIS central bankers’ speeches  I think here the lessons were mostly for the banks. There were negative consequences for banks that had inadequate capital planning capabilities or asked to make distributions that were too large relative to expected capital resources. From the CCAR, we concluded that all banks could and should be required to improve their capital planning processes, even those that received a decision of “no objection” to their proposed distributions. A detailed letter went to each firm outlining areas for improvement and we will be tracking the banks progress. CCAR is not a one-off event. It will be an ongoing process. It is designed to push banks to continue to upgrade their risk management and capital assessment processes.
By moving the banking industry collectively back to Figure 1 from Figure 2, the “bad state of the world” becomes less likely. In the SCAP, we had to make a number of important decisions. These included:   The appropriate capital target. We focused on the Tier I common ratio because we believed that this was the most credible form of capital. This put much greater emphasis on common equity than previously.   The severity of the stress test. We assumed a stress scenario with an unemployment rate 1.5 percentage points higher than the baseline scenario, and further home price declines of about 29 percent compared with 18 percent in the base case. We were aiming for a stress test scenario that had about a 5 percent to 10 percent probability of being realized.   The capital target at the end of 2010 and the stress test severity were both important in terms of the credibility of the SCAP. Going in, we were worried that with our capital goal, the BHCs’ needs might turn out to be higher than the available  BIS central bankers’ speeches  3  resources from the private sector and the U.S. Treasury. We decided not to compromise the credibility of the stress test to save on needed capital resources.