i will follow my discussion of the vulnerabilities created by shadow banking with some suggestions for near - and medium - term reforms. fragility of the shadow banking system it is not my purpose here today to discuss the history and complex nature of the shadow banking system. there is a rich and growing academic literature devoted to this task. however, i do want to identify some features of shadow banking that are reasonably well - established and particularly salient for reform efforts. first, and in many respects foremost, it bears noting that the use of the term “ shadow banking ” refers not simply to the functions of credit intermediation and maturity transformation. shadow banking also refers to the creation of assets that are thought to be safe, short - term, and liquid, and as such, “ cash equivalents ” similar to insured deposits in the commercial banking system. of course, as many financial market actors learned to their dismay, in periods of stress these assets are not the same as insured deposits. bis central bankers ’ speeches the years preceding the financial crisis saw a surge in the volume of dollar - denominated, seemingly safe, seemingly liquid financial instruments. the causal interplay of factors leading to this surge is still actively debated. but it seems reasonably clear that both a rise in the demand by investors for safe, liquid assets as tools for precautionary or transactional liquidity and a rise in demand for short - term financing by certain borrowers – notably financial intermediaries looking to fund longer - term assets – played important, probably reciprocally reinforcing roles. examples of investor demand for safe, liquid assets are not hard to identify. one source has been foreign official investors, mostly emerging market countries, which invested about $ 1. 6 trillion in the united states in the four years preceding the crisis, largely in u. s. treasury and agency securities. much of this activity arose from the investment of foreign exchange reserves by countries running large current account surpluses. some of these reserves were undoubtedly built up as a precautionary measure in light of the financial problems in emerging markets during the late 1990s, while others are attendant to policies of managed exchange rates. this official sector demand for safe assets was largely if not entirely focused on u. s. government securities, rather than cash equivalents. but this source of demand absorbed roughly 80 percent of the increase in u. s. treasury and agency securities over the four - year period, potentially crowding out other investors and

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 - 3years. 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 inter