Fed Governor Touts Benefits of Scenario Analysis to Strengthen Financial Stability
Federal Reserve Governor Lisa D. Cook outlined how the Fed is refining its approach to financial stability by expanding scenario analysis, addressing data gaps, and tracking linkages across markets and institutions.
In an address at the Yale Program on Financial Stability, Ms. Cook emphasized the necessity of scenario analysis to assess how markets would react to unprecedented, systemic shocks. She said that while traditional supervisory stress tests focus on direct, first-round capital losses at individual banks, scenario analysis explores hypothetical tail risks—such as the potential economic fallout if artificial intelligence disappoints. She cautioned that this broader analysis is crucial for uncovering unpredictable second-round amplification effects, such as rapid deleveraging and asset fire sales, while acknowledging the inherent uncertainty of such exercises and the limitations posed by incomplete data and imperfect models.
Ms. Cook warned that policy interventions can have "unintended consequences." She said that constraining activity in one corner of the market could fuel unwanted, opaque growth in another. She also underscored the vital role of global systemically important banks in buffering systemic stress, and said policymakers must balance embracing transformative innovations, like digital assets and AI, with monitoring their potential to introduce new risks. She emphasized that policymaking during periods of stress is especially challenging due to limited time and information, and highlighted the importance of preparation, clear communication, and central bank credibility in stabilizing markets and minimizing the scale of intervention.
Ms. Cook highlighted the role of the Fed’s Financial Stability Report in tracking core risks, including asset valuations and leverage. She noted that bank lending commitments to nonbank financial institutions have grown rapidly, expanding at roughly three times the pace of traditional commercial lending. She said consistently tracking these shifting sector linkages gives policymakers the information needed to understand how stress might transmit across the financial system. She added that the report is designed to promote transparency and inform policymaker judgment rather than present a single unified view, and that its ongoing updates help capture the evolving structure of the financial system.