OFR_2016_Financial-Stability-Report

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of sharp decreases in U.S. equity and commercial real estate prices, which can coincide with rising U.S. corporate defaults. These risks were included in the Federal Reserve’s latest annual large-bank stress test, which is used to determine capital distributions. But broader testing is needed. Depending on the type of firm, stress tests may be the basis for increased capital or other loss-absorbing capacity, improved liquidity reserves and management, and improved risk management. The Securities and Exchange Commission is currently considering how to implement stress testing requirements for large investment advisers and funds. 3. Risks Facing U.S. Financial Institutions We group key financial stability risks related to cybersecurity into three categories: the lack of substitutability for the services that many financial companies provide; the potential loss of confidence in a financial company by customers; and the threat to data integrity. Regulators now require banks to hold more capital and subject them to heightened oversight through regular stress testing requirements, liquidity requirements, and resolution plans. But risks remain in U.S. financial institutions. Chief among those risks are operational risks and cyber threats. In addition, companies remain highly interconnected and key activities are concentrated among a small number of large players. Malicious cyber activity aimed at financial firms has become more common and more sophisticated (see Section 2.3). Financial firms are vulnerable. They rely heavily on information technology. Their activities are closely linked to each other and to other parts of the economy. We group key financial stability risks related to cybersecurity into three categories: the lack of substitutability for the services that many financial companies provide; the potential loss of confidence in a financial company by customers; and the threat to data integrity. Financial firms and regulators recognize these risks and are working to prepare for potential incidents. Regulators have also taken steps to build resilience through information sharing and collaboration, and by issuing guidance and rules. Regulators could build on that progress by focusing on links among financial institutions. They should take into account how regulatory boundaries may affect their view of parts of financial networks, especially third-party vendors, overseas counterparties, or service providers. Financial regulators and the industry also need to continue to work together to enhance security, improve network resilience, and increase the capacity to recover. The growing role of central counterparties (CCPs) in financial markets improves market efficiency, transparency, and financial stability. It may also concentrate risks (see Section 2.4). To address these risks, supervisors have introduced international risk management standards for CCPs and other financial market infrastructures. New disclosures that began in 2016 improve transparency. Market-wide stress tests in Europe and the United States also offer new insights on the sufficiency of financial resources. Increased 4 2016 | OFR Financial Stability Report
standardization of the data disclosures and continued, system-wide, stress tests will help monitor system resilience. Life insurers, having taken on more duration and volatility risk, are increasingly vulnerable to market declines (see Section 2.5). Low long-term interest rates strain their earnings. A large common shock to all life insurers or the failure of a large and interconnected insurer could adversely affect U.S. financial stability. Key policy gaps also remain. These gaps include the need for more robust stress testing, liquidity standards, and the evaluation of options for strengthening the resolution framework. The largest and most interconnected U.S. banks have become more resilient since the financial crisis. Reforms have required new capital and liquidity standards and promoted rigorous stress testing. These efforts have reduced the probability and immediacy of a large bank failure. Still, the largest U.S. banks remain a potential source of risk due to their size, complexity, and interconnectedness. The largest banks also remain concentrated and the potential impact of a large-bank failure remains substantial (see Section 2.6). We note that supervisory monitoring and stress testing need to take into account changing business models. Also, supervisors have not approved most of the living wills that global systemically important banks have produced to describe how they would manage their own potential failure. Whether a large bank could go through bankruptcy without extraordinary government support remains unclear. 4. Challenges to Improving Data The largest and most interconnected U.S. banks have become more resilient since the financial crisis. Whether a large bank could go through bankruptcy without extraordinary government support remains unclear. Risk managers and regulators today have better data than ever before, thanks to a number of new data collections and data standards initiatives. Still, weaknesses in data scope, quality, and accessibility continue to prevent a full assessment of risks in key markets (see Section 2.7). Data management systems are hard pressed to keep pace with financial and technical innovation. The OFR has a core mandate to improve financial data. We have a particular interest in shadow banking activities, in which credit is extended by nonbank companies or funded by liabilities that are susceptible to runs because they are payable on demand and lack any government backstop. We conclude that regulators should continue to work together to address remaining challenges. For example, the OFR has argued that regulatory mandates are needed to support industry adoption of standards such as the Legal Entity Identifier (LEI). The LEI is a unique, 20-digit code assigned to legal entities that take part in financial market transactions. Executive Summary 5
Page 1: OFFICE OF FINANCIAL RESEARCH 2016 F
Page 5: Contents Executive Summary ........
Page 8 and 9: Chapter 2 provides deeper analysis
Page 13 and 14: 1 Financial Stability Assessment Ov
Page 15 and 16: Figure 3. Real GDP Growth (year-ove
Page 17 and 18: Figure 8. Ten-Year U.S. Treasury Yi
Page 19 and 20: Monitoring Shadow Banking Risks The
Page 21 and 22: An earlier OFR paper proposed an ac
Page 23 and 24: Figure 17. Size, Liquidity, and Con
Page 25: Figure 19. Top Systemic Risk Scores
Page 28 and 29: The analysis pointed to seven key t
Page 30 and 31: could. In early 2016, investor conc
Page 32 and 33: earnings or share issuance. But red
Page 34 and 35: Fund Monitor, the OFR assessed expo
Page 36 and 37: 2.2 Risks in U.S. Nonfinancial Corp
Page 38 and 39: Figure 31. U.S. Nonfinancial Corpor
Page 40 and 41: Figure 36. U.S. Corporate Bond Defa
Page 42 and 43: Commercial Real Estate Prices Have
Page 44 and 45: 2.3 Cybersecurity Incidents Affecti
Page 46 and 47: Hackers Breach Bangladesh’s Centr
Page 48 and 49: Figure 42. Banks that Include an Op
Page 50 and 51: The industry is working with the pu
Page 52 and 53: Figure 46. U.S. Financial Regulator
Page 54 and 55: 48 2016 | OFR Financial Stability R
Page 56 and 57: eleased the results of an unprecede
Page 58 and 59: Figure 49. CCP Default Waterfall ($
Page 60 and 61:
Figure 50: CCP Ratios and Amounts f
Page 62 and 63:
cause more-prudent CCPs to appear m
Page 64 and 65:
2.5 Pressure on U.S. Life Insurance
Page 66 and 67:
The experience of Japan’s life in
Page 68 and 69:
2015). These benefits are effective
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Figure 55. Life Insurance Securitie
Page 72 and 73:
Drivers of Insurers’ Systemic Ris
Page 74 and 75:
2.6 Systemic Footprints of Largest
Page 76 and 77:
Interest Rates and Derivatives Expo
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Figure 63. Components of U.S. G-SIB
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Figure 66. Five-Year Changes to G-S
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2.7 Deficiencies in Data and Data M
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Figure 68. Examples of Key Post-Cri
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Broader Adoption of Data Standards
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Better Regulatory Sharing Needed Th
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The U.S. Census Bureau surveys publ
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The group will also consider how th
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and contracts would be crucial. The
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Figure 72. Scaling of Data Validati
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Glossary 10-Year, 10-Year Forward R
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Conditional Value-at-Risk (CoVaR) C
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Fire Sale Form N-MFP Form PF Fundin
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Liquidity Risk Liquidity Transforma
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Pension Funded Ratio Pension Risk T
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Stress Test Supplemental Leverage R
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Bibliography Adrian, Tobias, and Ma
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Board of Governors of the Federal R
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www.richmondfed.org/~/media/richmon
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Her Majesty’s Government and Mars
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Paul, Ruma. “Bangladesh hopes to
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Zetter, Kim. “That Insane, 18M Ba
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