FSOC Identifies Risks to US Financial Stability
Commentary by Steven Lofchie
In its 2023 Annual Report, the FSOC identified potential emerging threats to U.S. financial stability and made recommendations to mitigate those threats.
The FSOC stated that "in 2023, the major drivers of economic conditions have been persistently high inflation and increasing interest rates." The FSOC stated that banks continue to face challenges as high interest rates have led "to market value losses on some bank assets [which have] contribut[ed] to rising funding costs." Further, the FSOC warned that "among some regional and community banks, funding risk and exposure to commercial real estate (CRE) continue to be vulnerabilities."
The FSOC highlighted numerous potential vulnerabilities. Among them:
- Digital Markets: The FSOC recommended Congress pass legislation to close regulatory gaps and to regulate stablecoin.
- Climate-Related Financial Risks: The FSOC said that state and federal agencies should try to develop data and that financial regulators should work to promote consistent, comparable and decision-useful disclosures that allow investors and financial institutions to better incorporate climate-related financial risks in their investment and lending decisions.
- Banking: The FSOC recommended (i) banking supervisors continue to ensure that banks maintain adequate capital and liquidity, sound interest rate risk management practices and well-developed operational resilience plans, (ii) that banking agencies closely monitor uninsured deposit levels, depositor composition and collect additional data as necessary and (iii) that banking agencies monitor banks’ reliance on uninsured deposits or other credit sensitive deposits.
- Investment Funds: The FSOC recommended that state and federal regulators should consider requirements for greater transparency and more detailed and timely regulatory reporting.
- Treasury Markets: The FSOC recommended that agencies continue to improve the resilience of the Treasury market.
- Cybersecurity: The FSOC recommended that regulators continue to work to mitigate cyber risk and to share information.
- Artificial Intelligence: The FSOC recommended (i) financial institutions monitor the rapid developments in AI to ensure that oversight structures keep up with, or stay ahead of, emerging risks to the financial system while facilitating efficiency and innovation and (ii) financial institutions, market participants and regulatory and supervisory authorities further build expertise and capacity to monitor AI.
Generally, the FSOC emphasized the need for enhanced surveillance and regulatory measures in the banking sector, on investment funds, in the insurance sector and across financial market utilities to ensure stability and resilience against potential financial disruptions.
Commentary
A substantial number of the FSOC recommendations reflect the agenda of SEC Chair Gensler (e.g., climate disclosure, Form PF amendments, mandatory clearing of US government securities). All of these rulemakings are, to put it mildly, controversial. The FSOC's endorsement of disputed actions taken by the SEC demonstrates how political concerns affect the FSOC's identification of, and recommendations on risk. Many of the risks identified are those for which the government cannot be blamed, and for which the results of government action are highly speculative or cannot really be evaluated. (See also, Secretary Yellin Touts Economy, Senator Brown Says FSOC Must Keep Us Safe from Wall Street.) The FSOC should be either remade as a bipartisan commission or disbanded. It is simply hard to see what value it provides on any individual topic beyond what the member agencies could publish in their specialty areas.
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