FRB assesses current vulnerabilities in the financial system – Finance and Banking

United States: FRB assesses current vulnerabilities in the financial system

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In its May 2021 Financial Stability Report, the Federal Reserve Board (“FRB”) examined current conditions that may reflect vulnerabilities to the stability of the financial system.

The FRB found that (i) risky asset prices and long-term Treasury yields have increased (although the latter remain low by historical standards), (ii) banks remain well capitalized, (iii) Hedge fund leverage levels are above historical averages, and (iv) domestic banks’ funding risks remain low.

According to the report:

  • stock prices have risen and valuations are generally high and supported by low interest rates;
  • valuation pressures remain high for commercial real estate;
  • corporate debt vulnerabilities remain high relative to corporate income;
  • bank capital ratios have exceeded pre-pandemic levels, but high credit risks remain;
  • indebtedness is at historically low levels among brokers and high among life insurance companies;
  • by the end of 2020, bank loans to non-bank financial institutions have returned to pre-COVID-19 pandemic levels; and
  • domestic banks continue to have high levels of liquid assets and stable funding.

The FRB also identified short-term risks to the US financial system: (i) a struggling European financial system can pass the risk to the US, and (ii) a rise in long-term interest rates can add fiscal pressure on emerging market economies.

In a related statement, FRB Governor Lael Brainard Explain that heightened vulnerabilities associated with a risk appetite and high valuation levels, combined with “very high levels” of corporate debt, could amplify the effects of a re-pricing event. Ms Brainard pointed to the Archegos event as evidence of the need for more granular and frequent disclosures from non-bank financial institutions, including hedge funds.

Primary sources

  1. FRB Report: Financial Stability Report (May 2021)
  2. FRB Statement, Lael Brainard: Financial Stability Report

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