Large banks ‘well positioned’ to absorb financial shock; CRE risk sizable but manageable, Fed governor says

The capital adequacy and liquidity of the largest and most interconnected financial firms appear “well positioned” to absorb a shock to the financial system, the Federal Reserve Board’s chair of its financial stability committee said Wednesday.

Meanwhile, she added, risk in the commercial real estate (CRE) market – while still sizable with loans at community banks representing 30% of assets – remains manageable but still worthy of monitoring.

Speaking at the think-tank Brookings Institution in Washington, D.C., Federal Reserve Board Member Lisa D. Cook, reported on her view of financial stability across the financial system. She told the group she recently became chair of the agency’s financial stability committee.

Regarding capital adequacy of large financial firms, Cook said the ratio of common equity tier 1 capital to risk-weighted assets has been increasing for all types of banks lately. For the largest banks, she said, the ratio stands at “multidecade highs.” The largest banks also have strong funding profiles, she said, which she attributed in part to the strength of the regulatory regime for these banks.

She said that regional banks seem to have weathered the stress from a year ago when some experienced large deposit outflows amid the failures of three banks (Silicon Valley Bank (SVB) of Santa Clara, Calif., Signature Bank of New York, and First Republic Bank of San Francisco).

“Conditions have improved considerably since then,” she contended. “Bank profitability remains solid, and deposit flows have stabilized.” She said that most banks have lowered their reliance on uninsured deposits since the beginning of 2023. “We remain attuned to vulnerabilities in this sector,” she said. “Supervisors are working closely with the set of banks that have experienced outsized fair-value losses from higher interest rates and with banks that have high concentrations of commercial real estate loans.”

As for other, non-bank large firms, she said available data for hedge funds (even though they are difficult to assess) is near the high end of its range. Large insurers, she said, are well capitalized, but have been increasing their use of liabilities subject to rollover risk at the same time as they have raised the portion of their assets invested in riskier corporate debt instruments.

Money funds, she said, have inherent funding vulnerabilities that regulators have been taking steps to address. However, she said reforms adopted by the Securities and Exchange Commission (SEC) “and coming into force this year will improve funds’ liquidity positions and address the structural first-mover advantages among money fund investors that contributed to some of the runs we have seen in this sector over the years.”

Regarding CRE, she said banks accounted for a bit more than half of the $6 trillion in outstanding debt backed by the loans at the end of the fourth quarter 2023. Much of the exposure, she noted is in smaller regional and community banks, making up about 30% of assets at the smaller banks (compared to about 5% at large banks).

“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,” she said. Data available from SEC Form 10-Q filings, she said, suggest that office exposures account for a small share of most regional banks’ CRE loans.

“All told, I view CRE risks currently as sizable but manageable, and I will be paying close attention to the sector in the short and medium run,” she said.

Federal Reserve Board Gov. Lisa D. Cook: Current Assessment of Financial Stability

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