The Federal Reserve released its twice–yearly report Monday on financial hazards in its 2023 financial stability report. The report comes after a busy week for the Fed, following the second largest bank failure in U.S. history with First Republic, now three of the top four largest failures over just the past two months. The Fed said recent turmoil in the banking industry has stabilized but could weigh on credit conditions going forward. The Fed said it is prepared to address any bank liquidity pressures that may arise, committed to ensuring deposits remain safe and banks can continue to provide access to credit.
May 2023 Financial Stability Report Highlights
- Recent turmoil in banking industry has stabilized, but could weigh on credit conditions going forward – financial stability report
- Persistent inflation and monetary tightening, alongside banking sector stress, are top-cited potential risks by survey respondents
- Nearly half of respondents to fed survey on near-term risks cited US debt limit, which was not singled out as a risk in prior report
- The banking sector overall remained resilient with substantial loss-absorbing capacity
- Large banks subject to liquidity coverage ratio had sufficient levels of high-quality liquid assets to withstand expected short-term cash outflows
- Policy interventions by bank regulators limit the potential for further stress, domestic banks have ample liquidity overall
- Funding strains were notable for some banks, but overall funding risks across the banking system were low
- It is prepared to address any bank liquidity pressures that may arise, committed to ensuring deposits remain safe and banks can continue to provide access to credit
- Silicon valley bank and signature bank were outliers in terms of their heavy reliance on uninsured deposits; most banks had a much more balanced mix of liabilities
- Runs on silicon valley bank and signature bank were of unprecedented speed
- Prime money market funds and other cash-investment vehicles remain vulnerable to runs and contribute to the fragility of short-term funding markets
- Amount of high-quality liquid assets decreased for banks but remained high compared with pre-pandemic levels
- Commercial real estate prices have declined since November but valuations remain high
Overview
This report reviews conditions affecting the stability of the U.S. financial system by analyzing vulnerabilities related to valuation pressures, borrowing by businesses and households, financial leverage, and funding risk. It also highlights several near-term risks that, if realized, could interact with these vulnerabilities.
Since the November 2022 Financial Stability Report was released, Silicon Valley Bank (SVB) Signature Bank, and First Republic Bank failed following substantial deposit outflows prompted by concerns over poor management of interest rate risk and liquidity risk. In March, to prevent broader spillovers in the banking system, the Federal Reserve, together with the Federal Deposit Insurance Corporation (FDIC) and the Department of the Treasury, took decisive actions to protect bank depositors and support the continued flow of credit to households and businesses.
Owing to these actions and the resilience of the banking and financial sector, financial markets normalized, and deposit flows have stabilized since March, although some banks that experienced large deposit outflows continued to experience stress. These developments may weigh on credit conditions going forward.
A summary of the developments in the four broad categories of vulnerabilities since the last report
is as follows:
- Asset valuations. Yields on Treasury securities declined in March amid heightened financial
market volatility. Measures of equity prices relative to expected earnings were volatile over
the period but remained above their historical median, while risk premiums in corporate bond
markets stayed near the middle of their historical distributions. Valuations in residential real
estate remained elevated despite weakening activity. Similarly, commercial real estate (CRE)
valuations remained near historically high levels, even as price declines have been widespread
across CRE market segments (see Section 1, Asset Valuations). - Borrowing by businesses and households. On balance, vulnerabilities arising from borrowing
by nonfinancial businesses and households were little changed since the November report
and remained at moderate levels. Business debt remained elevated relative to gross domestic
product (GDP), and measures of leverage remained in the upper range of their historical
distributions, although there are indications that business debt growth began to slow toward
the end of last year. Measures of the ability of firms to service their debt stayed high.
Household debt remained at modest levels relative to GDP, and most of that debt is owed by
households with strong credit histories or considerable home equity (see Section 2, Borrowing
by Businesses and Households). - Leverage in the financial sector. Concerns over heavy reliance on uninsured deposits, declining
fair values of long-duration fixed-rate assets associated with higher interest rates, and poor risk
management led market participants to reassess the strength of some banks (discussed in the
box “The Bank Stresses since March 2023”). Overall, the banking sector remained resilient,
with substantial loss-absorbing capacity. Broker-dealer leverage remained historically low.
Leverage at life insurance companies edged up but stayed below its pandemic peak. Hedge
fund leverage remained elevated, especially for large hedge funds (see Section 3, Leverage in
the Financial Sector). - Funding risks. Substantial withdrawals of uninsured deposits contributed to the failures of
SVB, Signature Bank, and First Republic Bank and led to increased funding strains for some
other banks, primarily those that relied heavily on uninsured deposits and had substantial
interest rate risk exposure. Policy interventions by the Federal Reserve and other agencies
helped mitigate these strains and limit the potential for further stress (discussed in the box
Overview 3
“The Federal Reserve’s Actions to Protect Bank Depositors and Support the Flow of Credit
to Households and Businesses”). Overall, domestic banks have ample liquidity and limited
reliance on short-term wholesale funding. Structural vulnerabilities remained in short-term
funding markets. Prime and tax-exempt money market funds (MMFs), as well as other cashinvestment vehicles and stablecoins, remained vulnerable to runs. Certain types of bond and
loan funds experienced outflows and remained susceptible to large redemptions, as they hold
securities that can become illiquid during periods of stress. Life insurers continued to have
elevated liquidity risks, as the share of risky and illiquid assets remained high (see Section 4,
Funding Risks)
Source: Federal Reserve Financial Stability Report
From the TradersCommunity News Desk