WASHINGTON – The Financial Stability Oversight Council (Council) today unanimously approved its 2023 annual report. The annual report reviews financial market developments, describes potential emerging threats to U.S. financial stability, identifies vulnerabilities in the financial system, and makes recommendations to mitigate those threats and vulnerabilities. Overall, the Council finds that the U.S. financial system remains resilient, and the U.S. banking system remains sound. The report also details the activities of the Council and summarizes significant regulatory developments. The report was developed collaboratively by Council members and their agencies and staffs.
"The resilience of the U.S. financial system in the face of this year's global economic uncertainty and the banking sector distress of the Spring is a testament to the reforms implemented in the aftermath of the global financial crisis,” Secretary of the Treasury Janet L. Yellen said. “Events over the past year continue to underscore the importance of the Council’s ongoing efforts to enhance the resilience of the financial system and monitor a wide range of vulnerabilities.”
The Council’s recommendations in the annual report include the following:
- Banking: The banking system is critical to the supply of credit and financial services to households and businesses and is central to the stability of the U.S. financial system. There are key lessons to be learned from the turmoil in the Spring that can contribute to reducing financial stability risks emanating from this sector. The Council supports member agencies’ plans to review whether capital measures appropriately reflect an institution’s ability to absorb losses, as well as agencies’ proposed measures to improve resolvability at large, complex, or interconnected banks, such as by requiring long-term debt and improved resolution plans. In addition, the Council recommends that banking agencies closely monitor uninsured deposit levels and depositor composition and collect additional data as necessary.
- Cybersecurity: Cybersecurity risk is pervasive throughout the economy, and reducing cyber vulnerability is particularly critical within the financial system. Ransomware, malware, denial-of-service attacks, and data breaches can disrupt the operations of financial institutions, including those that are systemically important. Such incidents have the potential to disrupt financial market functioning and pose a risk to financial stability. Sharing timely and actionable cybersecurity information can reduce the risk of disruptive cybersecurity incidents and mitigate the impacts of those that do occur. The Council supports ongoing partnerships between state and federal agencies and private firms and recommends they continue to promote information sharing related to cyber risk and undertake additional work to mitigate cyber-related financial stability risks. The Council also supports the G7 Cyber Expert Group’s international efforts to help financial institutions better understand cybersecurity risks and improve the cyber resilience of the financial system.
- Artificial Intelligence (AI): For the first time, the Council has identified the use of AI in financial services as a vulnerability in the financial system. Financial institutions have rapidly adopted innovative technologies in recent years, and the use of AI in financial services has increased. AI offers potential benefits, such as reducing costs and improving efficiencies, identifying more complex relationships, and improving performance and accuracy. However, the use of AI can introduce certain risks, including safety-and-soundness risks like cyber and model risks. The Council notes that existing requirements and guidance may apply to AI and recommends monitoring the rapid developments in AI to ensure that oversight structures account for emerging risks to the financial system while also facilitating efficiency and innovation. The Council recommends financial institutions, market participants, and regulatory and supervisory authorities deepen expertise and capacity to monitor AI innovation and usage and identify emerging risks.
- Nonbank Financial Intermediation: The evolving participation of nonbank financial institutions in the provision of financial services is an important area to monitor for vulnerabilities and potential risks to the broader financial system. This year’s report discusses the activities of nonbank mortgage servicers and the rise in private credit in contributing to financial system vulnerabilities. The Council supports ongoing efforts to better assess and address the risks associated with both of these activities. The Council also supports the initiatives undertaken by the Securities and Exchange Commission (SEC) and other agencies to address risks presented by a variety of investment funds, including the use of leverage by certain hedge funds and the liquidity and maturity transformation that money market funds and open-end funds engage in. These include data collection improvements to Form PF, as well as actions taken this year by the SEC to address the liquidity mismatch in money market funds (MMFs) and to reduce the risk of investor outflows from MMFs during periods of market stress. The Council supports the SEC’s continued engagement regarding potential reforms of open-end funds. The Council’s Hedge Fund Working Group will also continue to evaluate potential risks to financial stability posed by hedge funds.
- Climate-related Financial Risk: More severe and frequent climate-related events are imposing significant costs on the public and the economy, with economic costs from climate change expected to grow. The Council and its member agencies have significantly increased their capacity to evaluate and address climate-related financial risks. The Council’s Climate-related Financial Risk Committee (CFRC) is developing a framework to identify and assess these risks, and the Council recommends enhanced coordination of data and risk assessment through the CFRC. The Council also recommends state and federal agencies continue to coordinate to identify, prioritize, and procure data necessary for monitoring climate-related financial risks. At the same time, financial regulators should continue to promote consistent, comparable, and decision-useful disclosures that allow investors and financial institutions to consider climate-related financial risks in their investment and lending decisions.
- Digital Assets: The Council notes that financial stability vulnerabilities may arise from crypto-asset price volatility, the market’s high use of leverage, the level of interconnectedness within the industry, operational risks, and the risk of runs on crypto-asset platforms and stablecoins. Vulnerabilities may also arise from token ownership concentration, cybersecurity risks, and the proliferation of platforms acting outside of or out of compliance with applicable laws and regulations. The Council emphasizes the importance of agencies’ continuing to enforce existing rules and regulations applicable to the crypto-asset ecosystem. The Council reiterates its recommendation that Congress pass legislation to provide for the regulation of stablecoins and of the spot market for crypto-assets that are not securities.
In addition, the Council identified certain vulnerabilities related to the nonfinancial corporate credit sector and commercial real estate sectors. The Council recommends supervisors and financial institutions continue to monitor credit risks and exposures to these sectors.
The full report can be viewed here.
Secretary Yellen’s remarks on the report during the open session can be viewed here.
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