Fed's Cook cites CRE and cyber as financial stability risks

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Federal Reserve Gov. Lisa Cook told attendees of a panel at the Brookings Institution Wednesday that commercial real estate, private credit and cybersecurity are among the most pressing risks to the financial system.
Bloomberg News

WASHINGTON — Federal Reserve Governor Lisa D. Cook Wednesday cited the rise of private credit, the impacts of deteriorating commercial real estate assets on small bank portfolios and cyber risks as top financial stability concerns.

The remarks, delivered during a speech at the Brookings Institution in Washington, D.C., outlined her agency's current assessment of financial stability. 

In addition to its monetary policy role, the Federal Reserve has an ongoing role in watching for vulnerabilities among and between the banks it regulates and the financial system more broadly. As the newly appointed chair of the Federal Reserve's Committee on Financial Stability, Cook's assessment shed light on how the agency is thinking about risks to the system as the banking industry continues to recover from turbulence in 2023.

Cook delineated four key areas of focus: household and business leverage, financial institution leverage, funding risk and asset valuations.

Analyzing household debt, Cook noted household borrowing — as measured by comparing household debt with the GDP level — is lower now than in previous years, suggesting American families' financial indebtedness is increasingly manageable. She did note, however, she is keeping her eye on a few areas of retail borrowing which she believes are worth monitoring. 

"I am closely watching the rising delinquency rates on auto loans and credit card debt — both of which partially reflect a normalization from recent lows," she said. "They imply increasing household borrower stress, especially among some lower- and moderate-income households."

In contrast to historically low household debt, the Fed official noted businesses have a high level of debt compared to the average over time. Most firms, she noted, nevertheless demonstrate resilience in part owing to long-term funding in low-interest rate environments.

With regard to financial institution's leverage and funding risk, Cook said despite challenges facing regional banks last year — including rapid deposit outflows — overall sector resilience has improved, with firms reducing their reliance on uninsured deposits since the failures of Silicon Valley Bank, Signature Bank and First Republic. She stressed the need for capital adequacy and liquidity, particularly among the largest banks.

Cook did touch on an asset class whose deteriorating value has drawn critical concern in recent years. Asset valuations of commercial real estate, she said, require vigilant risk management and supervision, but the degree of distress varies greatly based on the type of CRE and the type of bank holding such assets. Downtown office spaces are more distressed than suburban medical offices, she noted, and smaller regional banks retain significantly higher CRE exposures on average.

"CRE loans make up only about 5% of total assets at large banks but around 30% of assets at smaller banks," said Cook. "Those high concentrations have caused us to step up our supervisory work with community and regional banks that have significant CRE concentrations and to augment our regulatory data for this sector."

Cook also emphasized the need for monitoring and understanding the evolving dynamics of private credit markets to mitigate risks effectively. In recent years, U.S. private credit funds have experienced rapid growth in their assets under management — an estimated $1.1 trillion as of September 2023 — making them comparable in size to high-yield bond and institutional leveraged-loan markets.

Finally, Cook addressed cyber risks, acknowledging the increasing frequency and sophistication of cyberattacks targeting financial institutions. She emphasized the importance of operational resilience and capital adequacy in mitigating the adverse effects of cyber incidents on financial stability.

The Fed — along with fellow regulators the Federal Deposit Insurance Corp. and the Office of the Comptroller of the Currency — issued comprehensive guidelines for community banks to effectively manage risks associated with third-party relationships, which Fed Vice Chair for Supervision Michael Barr has noted open firms up to enhanced cyber risk.

Cook's remarks also follow the Fed's release of its semiannual financial stability report. The report — which surveys various financial professionals, including brokers, investment managers and academics — identified CRE concerns as well, though inflation and policy uncertainty were the primary concerns survey respondents identified. 


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