Fed’s Powell sees a stronger, more resilient financial system at ‘moderate level’ of vulnerabilities

The financial system is much stronger today in the wake of the crisis a decade ago, thanks to 10 years of concentrated effort, the chairman of the Federal Reserve Board said Wednesday. However, he also pointed to vulnerabilities to the system, and near-term risks, as outlined in a report issued the same day.

In a speech to The Economic Club of New York in New York City, Jerome H. (“Jay”) Powell said that, while overall vulnerabilities to the financial system are moderate, “there are reasons for concern” regarding debt load increases at businesses with high leverage and interest burdens over the past year. The majority of his remarks focused on financial stability, in conjunction with the release earlier in the day by the Fed of the agency’s first Financial Stability Report.

In the 30-second video, Federal Reserve Board Chairman Jerome H. (“Jay”) Powell discusses his agency’s inaugural Financial Stability Report, which calls vulnerabilities to the system “moderate” and which Powell said are worth keeping an eye on.

“In addition, other measures of underwriting quality have deteriorated, and leverage multiples have moved up,” Powell told the group. “Some of these highly leveraged borrowers would surely face distress if the economy turned down, leading investors to take higher-than-expected losses – developments that could exacerbate the downturn.”

The question, he said, is whether or not higher business bankruptcies and outsized losses would risk undermining the financial system. “For now, my view is that such losses are unlikely to pose a threat to the safety and soundness of the institutions at the core of the system and, instead, are likely to fall on investors in vehicles like collateralized loan obligations with stable funding that present little threat of damaging fire sales,” Powell said. “Of course, we will continue to monitor developments in this sector carefully.”

Overall, however, Powell reiterated that the financial system remains strong, buttressed by lower risks of destabilizing runs on financial institutions, greater resilience among financial institutions generally, and capital and liquidity levels at the largest banks at a level to weather “extremely severe downtowns in business credit” (as evidenced by results of stress tests).

“Because this core resilience is so important, we are committed to preserving and strengthening the key improvements since the crisis, particularly those in capital, liquidity, stress testing, and resolution,” Powell said.

Powell remarks: The Federal Reserve’s Framework for Monitoring Financial Stability