Fourteen financial vulnerabilities for U.S. financial stability – similar to those noted a year ago, with some having evolved “in consequential ways” – and recommendations for addressing each are detailed in the 2024 annual report of the Financial Stability Oversight Council (FSOC), released Friday.
The FSOC, chaired by the Treasury Secretary and including (among others) representatives from financial regulators across the federal government, is the body established under the 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank) to monitor risks to U.S. financial stability, promote market discipline, and respond to emerging threats to the U.S. financial system.
The 14 vulnerabilities identified by the report relate to commercial real estate; residential real estate; corporate credit; short-term funding markets; digital assets; climate-related financial risks; depository institutions; investment funds; central counterparties; insurance sector; Treasury markets; cybersecurity; use of artificial intelligence (AI) in financial services; and third-party service providers.
Here are a few highlights:
- Depository institutions: While risks to financial institutions persist, depository institutions did not experience the acute turmoil in 2024 that they did in the spring of 2023. The U.S. banking and credit union systems as a whole remained resilient, supported by sound levels of regulatory capital, adequate liquidity buffers, and healthy profitability. However, areas of potential vulnerability warrant continued monitoring. Funding costs remain high relative to the previous decade, compressing institutions’ net interest margins (NIMs). As in 2023, CRE exposure remains in focus, particularly in the office and multifamily segments of the market. Further, the performance of certain consumer loans has continued to worsen at banks as well as credit unions, surpassing pre-pandemic benchmarks.
- Third-party service providers: Risk centered in third-party service providers continues to be a potential threat to financial stability. These providers often play a critical role in financial institutions’ delivery of products and services. State and federal banking regulators have observed an increase in the frequency and complexity of arrangements between banks and non-bank entities such as financial technology companies (fintechs). [The report recommends, among other things, that Congress pass legislation that ensures that the Federal Housing Finance Agency (FHFA), National Credit Union Administration (NCUA), and other relevant agencies have adequate examination and enforcement powers to oversee third-party service providers that interact with their regulated entities.]
- Commercial real estate (CRE): The report points to a growing rise in vacancies, slower rent growth, and increased borrowing costs – pressures that have led to increased delinquencies, loan losses, and provision expenses for banks. It also noted the first loss (in May) experienced by a private label commercial mortgage-backed securities (CMBS) tranche originally rated AAA since the global financial crisis.
- Residential real estate: Nonbank mortgage companies (NMCs) present a transmission mechanism through which a shock might be spread and amplified to the financial sector. As mortgage servicers, NMCs conduct a wide range of loan administration duties for borrowers, guarantors, insurers, and investors. NMCs owned the servicing rights on 54% of all mortgage balances in 2022 and serviced mortgages collateralizing over 60% of all agency-backed securities and over 80% of securities in Government National Mortgage Association (Ginnie Mae) programs in 2023.
- Corporate credit: The private credit market has become an increasingly important source of funding for small and mid-size firms and only limited information on these firms’ nonbank borrowing is available to regulators or the public. In addition, the opaque nature of private credit lenders makes it difficult for regulators to assess risk management practices and the buildup of risks in the sector.
- Digital assets: As of July 2024, the total global market value of crypto-assets was just under $2 trillion, while the S&P 500’s market cap was $48 trillion. However, the listing of new crypto-asset exchange traded products (ETPs) has made crypto-assets more available to investors. The total market value for spot crypto-asset ETPs has reached close to $80 billion since the SEC approved the listing and trading of several crypto-asset ETPs in January. Noting the connection to the broader financial system through stablecoins, the report notes that a single firm holds around 70% of the stablecoin sector’s total market value. If it continues to grow, its failure could disrupt the crypto-asset market and create knock-on effects for the traditional financial system. Also, stablecoin issuers operate outside of, or in noncompliance with, a comprehensive federal prudential framework.
- Climate-related financial risks: In response to rising insured losses, some insurers are requesting significant rate increases, increasing policy exclusions, avoiding renewals in unprofitable markets, and implementing higher deductibles in areas with significant exposure to climate-related impacts and events. On average nationwide, homeowners saw double-digit percentage rate increases in 2023, with several states seeing effective rate increases over 20%, though many non-climate-related factors also contributed. [The Council recommends that state and federal agencies continue to coordinate on developing a framework to identify and measure climate-related financial risk, including by iteratively identifying a preliminary set of risk indicators.]
Financial Stability Oversight Council Releases 2024 Annual Report
Leave a Reply