Fragility and funding stress in nonbank financial sectors during the coronavirus crisis – resembling the same effects to the same sectors during the global financial crisis of 10 years ago – highlights the importance of renewed commitment to financial reform, a Federal Reserve Board governor said Monday.
In releasing the Financial Stability Report (FSR), Gov. Lael Brainard tied addressing challenges to nonbank financial sectors to financial reform. She said the Fed saw runs on prime money market funds, which she said had grown rapidly in preceding years, that were as large or larger than those in 2008.
“We also saw record outflows from open-ended funds that offer daily redemptions against less liquid underlying assets, such as the $1.7 trillion in corporate bonds held by mutual funds in the second quarter,” she said.
The report, issued twice each year by the Fed, is designed to present the agency’s latest assessment of the resilience of the U.S. financial system.
Brainard said turmoil in the markets last spring, when the financial impact of the coronavirus crisis was becoming apparent, “highlights the importance of exploring reforms in the critically important Treasury market, which could include wider use of central clearing in Treasury cash markets and wider access to platforms that could promote forms of ‘all to all’ trading, as well as innovations such as the recent FIMA repo facilities.”
In other comments, Brainard noted the report’s inclusion of risks presented by climate change to the financial system. “Climate change poses important risks to financial stability,” she said. “A lack of clarity about true exposures to specific climate risks for real and financial assets, coupled with differing assessments about the sizes and timing of these risks, can create vulnerabilities to abrupt repricing events.”
The Fed governor said storms, floods, wildfires, and other “acute hazards” can cause investors to “update their perceptions of the value of real or financial assets suddenly.” Chronic hazards, which she said included slow increases in mean temperatures or sea levels, or a gradual change in investor sentiment about those risks, “introduce the possibility of abrupt tipping points or significant swings in sentiment.”
“Supervisors expect banks to have systems in place that appropriately identify, measure, control, and monitor their material risks, which for many banks is likely to extend to climate risks,” she said.
By contrast, she said right now financial markets face challenges in analyzing and pricing climate risks, but financial models may lack the necessary geographic granularity or appropriate horizons. “Increased transparency through improved measurement and more standardized disclosures will be crucial,” she said. “It is vitally important to move from the recognition that climate change poses significant financial stability risks to the stage where the quantitative implications of those risks are appropriately assessed and addressed.”