Fed chair (again) points to business debt as possible trouble spot, but stops short of citing risk to financial stability

While rising business debt does not elevate risk to financial system stability, the level of debt could stress borrowers if the economy weakens, the chairman of the Federal Reserve Board said Monday.

In a speech to the 24th Annual Financial Markets Conference in Amelia Island, Fla., Federal Reserve Board Chairman Jerome Powell struck a middle ground about the impact of rising business debt. However, he also made it clear that the increase in debt – described by some as risky – is clearly on the radar of the central bank.

“In public discussion of this issue, views seem to range from ‘This is a rerun of the subprime mortgage crisis’ to ‘nothing to worry about here,’” Powell told the conference, sponsored by the Federal Reserve Bank of Atlanta.

Powell said the truth is likely somewhere in the middle. “The Federal Reserve continues to assess the potential amplification of such stresses on borrowers to the broader economy through possible vulnerabilities in the financial system, and I currently see such risks as moderate,” Powell said.

The central bank leader pointed out that business debt is near record levels, concentrated “in the riskiest segments.” He said that could place some businesses under several financial strain if the economy deteriorates. “Investors, financial institutions and regulators need to focus on this today, while times are good,” Powell said.

At the same time, he asserted, business debt now “does not appear” to present notable risks to financial stability. “The debt-to-GDP ratio has moved up at a steady pace, in line with previous expansions and neither fueled by nor fueling an asset bubble,” he said. “Moreover, banks and other financial institutions have sizable loss-absorbing buffers. The growth in business debt does not rely on short-term funding, and overall funding risk in the financial system is moderate.”

However, Powell concluded, the Fed and others “cannot be satisfied” with the current level of knowledge about the markets for business debit. He cited vulnerability of financial institutions to potential losses and strains on market liquidity and prices should investors exit investment vehicles holding leveraged loans.

“We are committed to better understanding the areas where our information is incomplete,” he said. “This commitment includes coordination with other domestic and international agencies to understand who is participating in business lending and how their behavior could potentially amplify stress events.”

Chair Jerome H. Powell: Business Debt and Our Dynamic Financial System