2017 Financial Stability Report

The OFR’s Financial Stability Report presents our annual assessment of U.S. financial stability. The financial system is now far more resilient than it was at the dawn of the financial crisis 10 years ago. But new vulnerabilities have emerged.

In developing our financial stability assessment this year, we kept in mind that the United States has begun a two-year period of 10-year anniversaries of key events from the 2007-09 global financial crisis. Anniversaries encourage reflection on the events of the past, the reactions to those events, and the lessons learned. Anniversaries of massively disruptive events such as the crisis lead to hard questions: How does today differ? Are we better positioned to withstand the next crisis?

From this perspective, we can see that the crisis was a turning point. In response, both financial regulation and industry practices changed substantially. These changes have brought us closer to a resilient system, one where we are better able to see problems and absorb shocks. But as we explain in this report, there are vulnerabilities that require attention. Some of those vulnerabilities have emerged in reaction to post-crisis innovations in technology, regulation, and business models.

Key Threats to Financial Stability

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Chapter 1 highlights three vulnerabilities that have been building and are of most concern today. First, cybersecurity incidents have become a greater concern for the financial system since the crisis. Second, the disorderly resolution of a failing systemically important financial institution remains a risk. Third, financial market structures are evolving, sometimes lowering costs and promoting efficiency, but also raising potential new concerns.

Cybersecurity incidents rank near the top of our threat assessment because of the potential for disruption of networks and the damage such disruptions could cause to financial stability and the economy.

New tools have been developed to make the orderly resolution of a failing systemically important financial institution more likely. Still, the failure of a large financial firm could amplify and transmit distress and possibly trigger a financial crisis. The resolution process under either U.S. bankruptcy law or a special resolution authority has potential weaknesses for handling a failure of a global systemically important bank.

Financial market structures continue to evolve in response to competitive forces, innovation, regulatory changes, and financial disruptions, among other factors. This report discusses potential vulnerabilities of market structure that bear monitoring. They could make the financial system vulnerable to shocks that threaten liquidity and price discovery.

Financial Stability Assessment

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Chapter 2 concludes that overall financial stability risks remain in a medium range, although market risks are elevated. We based our assessment on our Financial System Vulnerabilities Monitor heat map and related analysis. As described in Chapter 2, our assessment covers the six key risks in the heat map: (1) macroeconomic, (2) market, (3) credit, (4) solvency and leverage, (5) funding and liquidity, and (6) contagion. Vulnerabilities in these areas can originate, amplify, or transmit shocks and stress. These vulnerabilities have been central in many financial crises, not just the recent one. At the same time, our Financial Stress Index — a real-time measure of stress — has been falling in 2017 and is near its lows since the financial crisis. That low reading reflects not only current subdued levels of market volatility, but also, perhaps, complacency about the future.

Improved transparency, regulatory policies, and risk-management practices have also made the system more robust against shocks. Regulators and risk managers now have a greater focus on stress tests and a better understanding of risks. Compared to the pre-crisis period, banks are more resilient, with more capital and better liquidity risk management. At the same time, a handful of complex institutions with a range of nonbank activities increasingly dominate the banking industry.