FSOC Identifies Risks to US Financial Stability
Commentary by Steven Lofchie
In its 2024 Annual Report, the FSOC identified what it believed were significant financial vulnerabilities and made recommendations to address potential threats to US financial stability.
The FSOC stated that the US economy "continued to grow at a solid pace in 2024, even as inflation has come down substantially." Despite this, the FSOC highlighted risks associated with elevated asset valuations, rising delinquency rates and challenges in sectors such as commercial real estate ("CRE") and digital assets.
The FSOC outlined key vulnerabilities and recommendations:
- Commercial Real Estate. The FSOC noted that structural changes in office use, driven by remote work, have led to rising vacancies and declining property values. The FSOC recommended that regulators ensure banks and other financial institutions have effective risk management practices, adequate allowances for loan losses and contingency plans to address interconnected risks in the CRE sector.
- Digital Assets. The FSOC reiterated concerns about stablecoins and the broader crypto-asset market, noting vulnerabilities related to market concentration and opacity. It recommended that Congress enact comprehensive federal legislation to regulate stablecoin issuers and address risks in the crypto-asset spot market.
- Climate-Related Financial Risks. The FSOC highlighted the growing financial risks from climate change, including higher insurance costs and underinsurance in high-risk areas. It recommended continued collaboration among federal and state agencies to develop frameworks for identifying and measuring these risks and to improve climate-related financial disclosures.
- Banking Sector. The FSOC emphasized the importance of maintaining sound capital and liquidity buffers and encouraged banking supervisors to focus on risks from uninsured deposits, consumer loan delinquencies and CRE exposure.
- Investment Funds. The FSOC highlighted risks related to open-end funds and collective investment funds, particularly liquidity mismatches and limited transparency. It recommended greater regulatory reporting and enhanced transparency for these funds.
- Cybersecurity. Recognizing the heightened threat from cyber incidents, the FSOC recommended continued coordination among federal and state agencies and private sector participants to assess and mitigate cyber risks.
- Artificial Intelligence. The FSOC pointed to the growing use of AI in financial services and recommended that institutions and regulators develop expertise to monitor and address systemic risks while promoting innovation and efficiency.
- Treasury Markets. The FSOC stressed the importance of ensuring the resilience of Treasury markets. It supported ongoing efforts to improve data quality and market infrastructure to prevent disruptions.
Commentary
The FSOC report seems like a good idea in theory: it is intended to reflect the collective wisdom of numerous federal financial regulators (plus a state insurance regulator), synthesizing the results of their concerns in diverse areas. In practice, the report is just a political document that reflects the message that the various regulatory agencies want to communicate. Nobody is the wiser for reading that cybersecurity or the downturn in real estate values are financial risks. Climate risk is also a constant refrain.
There might be some way to aggregate collective insights and produce a meaningful document, but this is not it. Maybe if we had an FSOC of Democratic regulators and a separate FSOC of Republican regulators, the disagreements between the two reports (and the fear of having one's statements be demonstrated wrong) would be more illuminating.