OFR_2016_Financial-Stability-Report

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The analysis pointed to seven key threats, which fit into four themes: n n n n The potential for disruptions in the global economy to affect U.S. financial stability. We focus on potential spillovers from Europe. Risk-taking amid low long-term interest rates. We focus on risks in U.S. nonfinancial corporate credit. Risks facing U.S. financial institutions. We focus on cybersecurity incidents affecting financial firms, central counterparties as contagion channels, pressure on U.S. life insurance companies, and systemic footprints of the largest U.S. banks. Challenges to improving data. We focus on deficiencies in data and data management. The four themes are not mutually exclusive. Low long-term interest rates are a key factor in the growth of nonfinancial corporate credit, but they also underlie the earnings and funding challenges faced by banks, insurance companies, and others. Data challenges affect our analysis of many of these issues. Figure 1 on page 2 maps these seven key threats to the risk categories in the OFR’s Financial Stability Monitor, described in Chapter 1. The systemwide view in Chapter 1 provides the context for the deeper discussion of specific threats in this chapter. Some risks discussed in Chapter 1 are not in this chapter. These include the fragility of market liquidity, run risk in money market funds and other short-term funding markets, and credit risks in emerging markets. These vulnerabilities have been discussed in prior OFR annual reports and are topics of ongoing OFR research. They remain potential sources of risk to the U.S. financial system. The rest of this chapter examines the seven key threats in more depth. We also draw conclusions about how to mitigate these risks. In these conclusions, we concentrate on ways to increase visibility into still-opaque parts of the financial system for supervisors, policymakers, and the public. 22 2016 | OFR Financial Stability Report
2.1 Potential Spillovers from Europe Disruptions in the global economy could pose risks to U.S. financial stability. In particular, the political and economic environment in Europe is likely to be uncertain for some time in the wake of the United Kingdom’s (U.K.) vote to leave the European Union (EU). This uncertainty magnifies vulnerabilities already seen in Europe’s financial system. Economic weakness in Europe could spill over to the U.S. economy and cause investors to take excessive interest rate risks, credit risks, and liquidity risks. Risks to some large European banks appear to be rising, and these banks are substantially interconnected. The potential failure or material distress of a large European bank could have spillover effects in the United States. U.S. financial stability and economic growth could be affected more if European cohesion is threatened in other ways. Disruptions would most affect those U.S. financial institutions with large direct financial exposures. These exposures could be vulnerable to losses from lower asset prices and increased defaults on debt. Many European financial institutions also operate in the United States. Under stress, they may reduce U.S. operations. Reduced operations could have short-run effects on the U.S. financial services industry and economy, such as through reduced credit. A shock in Europe could also affect the U.S. financial system through several indirect channels. One is through trade. A European recession that included a material depreciation of the euro would reduce demand for U.S. exports, potentially slowing growth and leading to lower valuations for equities and corporate bonds. Another is through confidence. A loss of investor confidence from a shock in Europe could trigger a decline in prices of U.S. equities and other risky assets. Such confidence shocks can be self-fulfilling. Indirect linkages can be invisible until revealed by stress. The consequences of low long-term interest rates represent another potential channel. U.S. rates are low partly due to spillover from falling and increasingly negative rates in Europe, as noted in Chapter 1. The U.K. vote pushed European rates even lower and will likely prolong negative interest rate policies in the eurozone and elsewhere. U.S. long-term interest rates reached historical lows in the week after the vote. Lower short-term interest rates may stimulate economic activity, but lower long-term rates may also reduce profits for U.S. banks and life insurance companies and hurt their ability to generate capital internally. The eurozone’s sovereign debt crisis in 2010-12 did not destabilize the U.S. economy or financial system. However, those stresses did not pose the existential threat to European cohesion that the exit of an EU member The potential failure or material distress of a large European bank could have spillover effects in the United States. A shock in Europe could also affect the U.S. financial system through several indirect channels. Key Threats to Financial Stability 23
Page 1: OFFICE OF FINANCIAL RESEARCH 2016 F
Page 5: Contents Executive Summary ........
Page 8 and 9: Chapter 2 provides deeper analysis
Page 10 and 11: of sharp decreases in U.S. equity a
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 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
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Page 52 and 53: Figure 46. U.S. Financial Regulator
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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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Page 72 and 73: Drivers of Insurers’ Systemic Ris
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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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