Comptroller Hsu Warns of "Blind Spots" in Financial Stability Efforts
Commentary by Steven Lofchie
Acting Comptroller of the Currency Michael J. Hsu urged financial regulators to strike a careful balance in managing systemic risks, warning against both overreach and excessive caution.
In remarks delivered at the CFA Institute Systemic Risk Council, Mr. Hsu described the dual challenges facing financial regulators: acting decisively on known risks, while remaining vigilant to emerging, less visible threats. He warned that a fixation on certain risks can crowd out awareness of others. He argued that this was exemplified in the 2008 financial crisis, where regulators were focused on threats to the financial system posed by hedge funds and equity tranches and missed the risks posed by banks, money funds, insurance companies and AAA-rated securities.
Mr. Hsu offered a framework for addressing systemic risk, distinguishing between "known knowns," "known unknowns" and "unknown unknowns." He highlighted the persistent challenges of interest rate and liquidity risks under "known knowns," noted cyber risks and concentrated financial trades as significant "known unknowns" and pointed to the potential vulnerabilities from, for instance, undersea cables and quantum computing which would be categorized as "unknown unknowns."
Mr. Hsu underscored the need for an adaptable approach. He said: "By design, good risk identification processes should result in overinclusive lists. Done right, that should then give rise to the challenge of figuring out what to prioritize and focus on."
Commentary
In theory, it sounds like a good thing for regulators to say that the list of risks that they worry about should be overinclusive and must account for the "unknown unknowns." The downside of this good thing is that it can become a justification for the government to exercise authority without any real basis, on the claim that it is protecting the system from risks that cannot be readily identified or quantified.