While pointing to a continued tightening in financial conditions, the Federal Reserve’s November financial stability report said that domestic banks maintained high levels of liquid assets and stable funding over the last six months.
The report, released Friday, also showed that banks’ risk-based capital ratios have remained in the middle of the range in place in 2010, with stress tests showing the system “remains resilient to a severe recession.”
However, the report states that inflation remains unacceptably high in the United States and is also elevated in many other countries, and central banks around the world (including the Fed) have responded with tightened monetary policy.
“A weaker outlook, higher interest rates, and elevated uncertainty have contributed to a substantial tightening in financial conditions,” the report states. “Economic, financial, and geopolitical risks also have risen across advanced and emerging market economies (EMEs), further contributing to asset price declines and periods of significant market volatility. These developments, and future shocks, have the potential to be amplified by vulnerabilities associated with asset valuations, borrowing by households and businesses, financial-sector leverage, and funding risks.”
The Fed’s financial stability report reviews conditions affecting the stability of the U.S. financial system. It analyzes vulnerabilities related to valuation pressures, borrowing by businesses and households, financial-sector leverage, and funding risk. It also highlights several near-term risks that, if realized, could interact with these vulnerabilities, the Fed wrote.
The latest report notes, among other things, still-elevated real estate prices; little change in vulnerabilities arising from borrowing by non-financial businesses and households over the first half of 2022; hedge fund leverage likely remaining “somewhat above” its historical average and bank lending to nonbank financial institutions reaching new highs; and, among other things, continued structural vulnerabilities in short-term funding markets, and a continued decline in the market capitalization of stablecoins (which the report notes have their own set of structural vulnerabilities, including weaknesses in regulatory oversight, opacity, and consumer protection issues).
Fed Vice Chair Lael Brainard, in a statement, said that today’s environment of “rapid synchronous global monetary policy tightening, elevated inflation, and high uncertainty associated with the pandemic and the war raises the risk that a shock could lead to the amplification of vulnerabilities, for instance due to strained liquidity in core financial markets or hidden leverage.” The volatility of the past sx months “once again demonstrates the importance of our efforts in the Financial Stability Report to identify, analyze, and closely monitor financial system vulnerabilities,” she said.
Federal Reserve Board Financial Stability Report (November 2022)