Weakness among some non-bank FIs being closely watched for financial stability impact, Fed governor reports

Vulnerabilities at certain non-bank financial institutions (NBFIs) could amplify stress resulting from any economic downturn, a member of the Federal Reserve Board said Monday, adding that she is “closely monitoring” the entities.

Speaking at Duke University in Durham, N.C., about financial stability, Fed Gov. Lisa D. Cook said she is watching NBFIs with “pronounced liquidity mismatches.” In particular, she named those with certain money market funds and open-end funds, as well as those with significant leverage, such as hedge funds.

“For example, several indicators suggest that Treasury cash-futures basis trades—trades that involve the sale of a Treasury future and the purchase of a Treasury security deliverable into the futures contract—likely gained in popularity recently,” she said. “Because the basis trade is often highly leveraged, a funding shock or heightened volatility in Treasury markets could force hedge funds to abruptly unwind their positions at potentially distressed prices.”

Cook also said she would focus on monitoring vulnerabilities at NBFIs and the functioning of Treasury markets. “I strongly support continued efforts across the regulatory agencies to share more information and to boost resilience of the entire financial system,” she said.

Regarding the banking sector, Cook asserted that it has stabilized since the failure of three, large regional banks last spring. She said the banking system has plenty of capital and liquidity to withstand economic shocks. However, she added, “I think it is particularly important to enhance resilience at large banks, and I support seeking public comment on federal banking agencies’ Basel III endgame proposal on bank capital requirements.”

Federal Reserve Gov. Lisa D. Cook: Financial Stability: Resilience and Challenges