For release on delivery
1:30 p.m. EDT
May 8, 2024
Current Assessment of Financial Stability
Remarks by
Lisa D. Cook
Member
Board of Governors of the Federal Reserve System
at
The Brookings Institution
Washington, D.C.
May 8, 2024
Thank you, David. And thank you to the Brookings Institution for hosting me
today. I am especially grateful to return to the place where, in my first job as an aspiring
economist, I was a research assistant for Alice Rivlin over three decades ago.
Today, I would like to talk about the Board's work in pursuit of financial stability,
which is critical to the well-being of households, firms, and the broader economy.1
Following the financial crisis of 2007-09, a broad set of reforms were put in place to
bolster financial stability. To ensure an ongoing focus on that area, the Board established
its Committee on Financial Stability as a venue for Governors to discuss related
developments and policy issues. I recently became the chair of this committee and will
share with you my current views on financial stability and touch on a couple of emerging
issues. Enhancing the public's understanding of our work on financial stability is
important for the transparency and accountability of our efforts. That is why we
communicate our financial stability work prominently in our Financial Stability Report,
which was most recently published last month and provides more detail on some of the
developments I will review today.2
Financial Stability at the Federal Reserve
As the U.S. and global financial system continues to grow and evolve in
complexity, the Fed's work on financial stability only becomes more important. A stable
and resilient financial system is essential for the Federal Reserve to achieve its dual
mandate of maximum-employment and price-stability. Our financial stability work also
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informs our approach and priorities to the supervision and regulation of banking
organizations, our coordination with domestic regulatory agencies, and our engagements
with international bodies such as the Financial Stability Board.
Financial Stability Framework
When people think about financial stability, they most often recall periods
affected by adverse shocks-that is, severe, unexpected events that cause widespread
disruptions to the financial markets and, in turn, the broader economy. The challenge is
that such events are hard to predict.
Therefore, the Fed's financial stability framework focuses on understanding what
makes the financial system vulnerable to a whole range of potential shocks and how those
vulnerabilities might amplify the effects of those shocks, not on predicting specific
adverse events.
Review of Vulnerabilities
Based on extensive research and experience, we routinely monitor four broad sets
of vulnerabilities to the financial system that could amplify shocks: household and
business leverage; the use of leverage by financial institutions; the degree of maturity and
liquidity transformation in the financial system, or, in plain English, "funding risk"; and
asset valuations and risk appetite.
Household and Firm Leverage
To lay out how I am currently thinking about each of these vulnerabilities, I will
start with household and firm leverage. A simple measure of whether households or
firms are borrowing too much is to compare their debt to the level of GDP, as shown in
figure 1. Based on this measure, household borrowing is lower than it has been in many
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years. Our analysis then dives deeper, including detailed assessments of mortgage
borrowing and consumer credit, and this deeper assessment supports the view of a
resilient household sector. Nonetheless, we also are attuned to possible changes in this
assessment. For example, I am watching closely the rising delinquency rates on auto
loans and credit card debt-both of which partially reflect a normalization from recent
lows-because they imply increasing household borrower stress, especially among some
lower- and moderate-income households.
From the figure, you can also see that, looking through the unusual pandemic
period, business debt relative to GDP remains above historical norms. Despite this, most
firms still have ample earnings to cover their scheduled interest and principal payments.
This solid position reflects resilient earnings and the fact that firms with access to bond
markets locked in long-term funding during the low interest rate environment of 2020
and 2021. As a result, most firms also appear, in broad terms, resilient to potential
adverse shocks.
Financial Leverage and Funding Risk
Let me turn now to the leverage and funding risk in the financial sector.
In assessing these vulnerabilities, we tend to place a lot of weight on the capital
adequacy and liquidity of the largest and most interconnected financial firms. Currently,
these firms appear well positioned to absorb a shock. For instance, figure 2 shows the
ratio of common equity tier 1 capital to risk-weighted assets-a standard regulatory
capital measure-for three groups of banks. This ratio has been increasing for all types
of banks lately and, for the largest banks, stands at multidecade highs. The largest banks
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also have strong funding profiles, owing in part to the strength of the regulatory regime
for these banks.
Despite the overall resilience of the banking sector, some regional banks
experienced large deposit outflows amid the failures of three banks last spring.
Conditions have improved considerably since then: Bank profitability remains solid, and
deposit flows have stabilized. In addition, as shown in figure 3, most institutions have
lowered their reliance on uninsured deposits since the beginning of 2023. We remain
attuned to vulnerabilities in this sector. Supervisors are working closely with the set of
banks that have experienced outsized fair-value losses from higher interest rates and with
banks that have high concentrations of commercial real estate loans.
We have varying levels of visibility into the leverage and funding vulnerabilities
of other financial intermediaries. While there are some areas of apparent vulnerability,
there is also evidence of resilience. Hedge fund leverage is hard to measure, but
available data suggest that these funds' leverage is near the high end of its range. Large
insurers are well capitalized, but they have been increasing their use of liabilities subject
to rollover risk at the same time as they have raised the portion of their assets invested in
riskier corporate debt instruments. Money funds have inherent funding vulnerabilities
that regulators have been taking steps to address. Reforms adopted by the SEC and
coming into force this year will improve funds' liquidity positions and address the
structural first-mover advantages among money fund investors that contributed to some
of the runs we have seen in this sector over the years.
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Asset Valuations
Let me turn now to asset valuations. I think it is helpful to consider this potential
vulnerability in the context of how a sharp change in valuations could interact with the
vulnerabilities I have already discussed. I will start with the classic concern for all of us
who lived through the Great Recession: A large decline in asset prices against the
backdrop of a weak economy. For example, house prices are high relative to historical
benchmarks, likely owing partly to a limited supply of homes for sale. What might the
implications be if house prices were to weaken at some future date?
The house-price growth we have seen over the past few years has not been
accompanied by increased lending or weaker credit standards, as was the case in the early
2000s. The household sector also is much more resilient than in 2006. One way to see
this is to run the distribution of risk characteristics we see in the household sector through
a constant set of income and house-price shocks.3 The stronger underwriting standards
that have prevailed since the post-crisis reforms went into place and stronger household
balance sheets mean that post-stress delinquency rates should be lower the next time we
experience a housing shock. Finally, the financial system is in substantially stronger
shape to resist any losses that do occur: The largest banks are subject to stress tests that
require them to be able to continue to function through a severe recession, and important
structural improvements have been implemented among nonbank entities.
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Commercial Real Estate
Now I will turn to commercial real estate, or "CRE," where the shocks created by
the COVID-19 pandemic continue to reverberate.
CRE is a broad asset class, encompassing multifamily housing, hospitality, retail,
warehouses, office buildings, and many other business properties. Accounting for this
heterogeneity is important in assessing the risks associated with CRE. Properties have
been differentially impacted by changes in the way many people live, shop, and work.
For instance, occupancy rates of suburban medical offices are very different from those
of downtown corporate headquarters. Looking at broader trends, values of office
buildings have been most affected by lifestyle changes, and values of multifamily
properties have also dropped over the past year. These trends present challenges for
property owners and lenders, who will need to manage those risks and make appropriate
adjustments as the outstanding loans come due.
As of the fourth quarter of last year, banks accounted for a bit more than half of
the $6 trillion in outstanding debt backed by CRE. Figure 4 shows that much of that
exposure is in smaller regional and community banks. On average, CRE loans make up
only about 5 percent of total assets at large banks but around 30 percent of assets at
smaller banks. Those high concentrations have caused us to step up our supervisory
work with community and regional banks that have significant CRE concentrations and
to augment our regulatory data for this sector. For instance, data available from SEC
Form 10-Q filings suggest that office exposures account for a small share of most
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regional banks' CRE loans.4 All told, I view CRE risks currently as sizable but
manageable, and I will be paying close attention to the sector in the short and medium
run.
Private Credit
Risks related to CRE are well known to investors and supervisors alike. Another
big part of our job is to look for emerging vulnerabilities, and one that has garnered my
attention is private debt. Private credit generally refers to direct loans made to
businesses, mostly middle-market firms, by nonbank entities such as private debt funds
and business development companies. In the U.S., private credit funds' assets under
management have grown rapidly in recent years. They were estimated to stand at $1.1
trillion as of September 2023, comparable in size to both the high-yield bond and
institutional leveraged-loan markets.
History teaches us that rapidly growing lending often involves weak underwriting
or excessive risk appetite. The growth in private credit is likely attributable to a
confluence of factors. After the financial crisis of 2007-09, private equity investments
and leveraged buyouts grew quickly, and demand for credit from middle-market and
private equity-sponsored firms grew along with them. Some borrowers appear to prefer
private credit deals to bank lending because of easier deal execution and greater
contractual flexibility, particularly during the ups and downs of the economic cycle. In
addition, the growth of private credit coincided with a period in which stronger bank
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regulation and supervision were put in place, suggesting that those actions to make banks
safer played a role.
Overall, I think that the growth of private credit likely has not materially
adversely affected the financial system's resilience. Private credit funds appear well
positioned to hold the riskiest parts of corporate lending. These intermediaries generally
use little leverage and are organized as closed-end funds, which means that investors
cannot withdraw the funding supporting the investments. Nonetheless, private credit
funds also have growing interconnections with traditional financial intermediaries,
including banks. Banks are increasingly originating their own private credit deals-such
as through business development companies that are operated or minority-owned by the
banks themselves. As a result, I will be monitoring the contribution of private credit to
the overall leverage of the business sector and the evolving interconnectedness between
private credit and the rest of the financial system.
Cyber Risks and Financial Stability
I will conclude with a few thoughts on cyber risk. I should emphasize at the
outset that the Federal Reserve's role in managing cyber vulnerabilities is focused
primarily on ensuring the institutions we supervise effectively manage the cyber risks
they face, including from key technology service providers to those institutions, and
safeguarding the resilience of the services provided by the Federal Reserve and the
financial system more broadly in the event of a successful attack. We also work with our
partners across the government, including the U.S. Department of the Treasury, and with
the private sector to understand and address cyber risks.
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Over the past few years, we have seen an accelerating tempo of cyberattacks from
a mix of groups associated with criminal enterprises and hostile governments. While the
news sometimes seems dominated by ransomware attacks, we also continue to observe
other types of attacks, such as those that seek to uncover information from governments
and firms or to carry out or plant the seeds for destructive attacks on information systems
that could severely disrupt operations.
In response to these risks, we are examining cyber incidents carefully to make
sure we have a fuller understanding of how attacks can affect the financial system,
including through banks, nonbank financial firms, digital service providers, and critical
infrastructure. In this work, we focus heavily on the operational resilience of the
institutions we supervise, the service providers used by such institutions, and the financial
services provided by the Federal Reserve. We have also begun to incorporate analysis of
timely data on firm-level cyber vulnerabilities and interconnections across firms and with
service providers to monitor cyber vulnerabilities at the system level.
As we contemplate future incidents, my view is that financial resilience can also
play a crucial role in mitigating the adverse effects of cyberattacks. Cyberattacks erode
the confidence that investors and institutions have in each other and in the financial
sector. While strong capital and liquidity positions will not, by themselves, prevent an
intrusion, they leave the affected institution in a better position to rejoin the system once
the attack is resolved and, most importantly, promote confidence among its
counterparties. Moreover, the effects of chaotic markets may impact other institutions
that suddenly face losses whose magnitudes might be hard to judge. Well capitalized,
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highly liquid, and well managed institutions will be best positioned to manage such
difficult circumstances.
Conclusion
Let me conclude by summarizing how we approach the set of issues I have
discussed-including systemwide monitoring, CRE and private credit developments, and
cyber risks-in our financial stability work. We cannot know the next shock that will test
the resilience of the financial system. That is why we focus on the resilience of the
financial sector in our regulatory and supervisory work concerning banking organizations
and in our engagement with other regulators. We also continuously monitor the financial
system and regularly report our assessments in the Financial Stability Report. Such
public communication contributes to the transparency and accountability of our efforts. I
hope it also stimulates a public discussion of vulnerabilities to financial stability, as my
colleagues and I value the range of views on these issues held across researchers,
financial market participants, and the broader public. For this reason, I look forward to
our discussion.
Again, thank you to the Hutchins Center and the Brookings Institution for hosting
me today.
Figure 1
Business and Household Debt-to-GDP
Ratio Ratio
1.1 1.0
Quarterly
1.0
0.9
0.9
0.8
0.8
0.7 0.7
Q4
0.6
Nonfinancial business 0.6
(right scale)
0.5
Household (left scale)
0.5
0.4
0.3 0.4
1983 1987 1991 1995 1999 2003 2007 2011 2015 2019 2023
Note: The shaded bars indicate periods of business recession as defined by the National Bureau of Economic Research: January
1980-July 1980, July 1981-November 1982, July 1990-March 1991, March 2001-November 2001, December 2007-June 2009, and
February 2020-April 2020. GDP is gross domestic product.
Source: Federal Reserve Board staff calculations based on Bureau of Economic Analysis, national income and product accounts,
and Federal Reserve Board, Statistical Release Z.1, 'Financial Accounts of the United States.'
Figure 2
Banks' CET1 Risk-based Capital Ratio
Ratio
16
Q4
14
Quarterly
12
10
8
6
U.S. G-SIBs
Large non-G-SIBs
4
Other BHCs
2
0
2002 2005 2008 2011 2014 2017 2020 2023
Note: The data are seasonally adjusted by Federal Reserve Board staff. The sample consists of domestic bank holding companies
(BHCs) and intermediate holding companies (IHCs) with a substantial U.S. commercial banking presence. U.S. G-SIBs are U.S.
global systemically important banks. Large non-G-SIBs are BHCs and IHCs with greater than $100 billion in total assets that are not
G-SIBs. CET1 stands for common equity Tier 1 capital, which is the numerator of the CET1 ratio. Before 2014:Q1
(advanced-approaches BHCs) or before 2015:Q1 (non-advanced-approaches BHCs), the numerator of the CET1 ratio is
approximated by Tier 1 common capital. The denominator is risk-weighted assets. The shaded bars indicate periods of business
recession as defined by the National Bureau of Economic Research: March 2001-November 2001, December 2007-June 2009, and
February 2020-April 2020.
Source: Federal Reserve Board, Form FR Y-9C, Consolidated Financial Statements for Holding Companies.
Figure 3
Uninsured Deposits
Percent of assets
40
Quarterly
30
Q4
20
10
U.S. G-SIBs
Large non-GSIBs
Regional
0
2016 2017 2018 2019 2020 2021 2022 2023
Note: Uninsured deposits are reported by banks with total assets above $1 billion. For smaller banks, uninsured deposits are
estimated based on the amount in large deposit accounts, excluding the first $250,000 in each of those accounts. U.S. G-SIBs are
U.S. global systemically important banks. Large non-G-SIBs are bank holding companies and intermediate holding companies with
greater than $100 billion in total assets that are not G-SIBs. Regional are banks with between $10 billion and $100 billion in total
assets.
Source: Federal Reserve Board staff calculations based on Federal Reserve Board, Form FR Y-9C, Consolidated Financial
Statements for Holding Companies and Federal Financial Institutions Examination Council, Call Report Form FFIEC 031,
Consolidated Reports of Condition and Income (Call Report).
Figure 4
Commercial Real Estate Loans as Share of Total Assets
Percent of assets
40
Large banks
Apr.
35
Small banks
15
30
25
20
15
10
5
0
2006 2009 2012 2015 2018 2021 2024
Note: Share is defined as "Real Estate Loans: Commercial Real Estate Loans" divided by "Total Assets" for large and small
domestically chartered commercial banks. Large domestically chartered commercial banks are defined as the top 25 domestically
chartered commercial banks, ranked by domestic assets as of the previous commercial bank Call Report to which the H.8 release
data have been benchmarked. Small domestically chartered commercial banks are defined as all domestically chartered commercial
banks not included in the top 25. The shaded bars indicate periods of business recession as defined by the National Bureau of
Economic Research: December 2007-June 2009 and February 2020-April 2020.
Source: Federal Reserve Board, Statistical Release H.8, 'Assets and Liabilities of Commercial Banks in the United States.',
accessed via Federal Reserve Economic Data.