Financial Stability Oversight Council Releases 2023 Annual Report

The Financial Stability Oversight Council has released its 2023 annual report on the state of play of the U.S. financial system and the soundness of the U.S. banking system in accordance with Section 112 of the Dodd-Frank Act. The report is published on a yearly basis to
(1) outline major trends in financial markets and in particular the U.S. market;
(2) identify and describe risks that may impact financial market stability such as cyber attacks, inflation, or the growing use of AI;
(3) suggest (regulatory) measures to mitigate such risks; and
(4) describe the activities the Council has been involved in during the last year of operation.
##### Key issues addressed and recommendations provided include the following:
(1) Banking: The Council supports member agencies‘ plans to review whether capital measures adequately reflect a bank’s ability to absorb losses, particularly following the bank failures early 2023. This review should help ensure that banks maintain sufficient capital buffers to weather financial shocks and maintain stability in the financial system. In this same context, the Council recommends improving the resolvability of large, complex, or interconnected banks by requiring long-term debt and enhanced resolution plans to facilitate the orderly resolution of troubled banks and to minimize the impact on financial stability and taxpayers. Furthermore, the Council suggests that banking agencies closely monitor uninsured deposit levels and depositor composition, collecting additional data as necessary in order to identify potential vulnerabilities and mitigate risks associated with large uninsured deposits.
(2) Cybersecurity: The Council stresses the importance of reducing cyber vulnerabilities within the financial system. The potential for ransomware, malware, denial-of-service attacks, and data breaches to disrupt financial institutions‘ operations, including those that are systemically important, is currently quite high which is why the Council recommends rigid measures to reduce the risk of disruptive cybersecurity incidents. Such measures may include information sharing between regulators and financial institutions and international efforts to help financial institutions better understand cybersecurity risks.
(3) Artificial intelligence: The Council identified the use of AI in financial services as a vulnerability, for the first time, acknowledging the risks associated with its use. As financial institutions have adopted innovative technologies, including AI, at an increasing pace in recent years, there are increasing risks relating to cybersecurity and the use of appropriate models e.g. to evaluate credit applications. Therefore, the Council recommends to closely monitor these development in AI to ensure that oversight structures account for emerging risks to the financial system. In this context, the Council also suggests that financial institutions, market participants, and regulatory and supervisory authorities „deepen their expertise and capacity to monitor AI innovation and usage“.
(4) Nonbank financial intermediation: The Council supports ongoing efforts to assess and address risks related to nonbank mortgage servicers and private credit. It also endorses initiatives by the Securities and Exchange Commission (SEC) and other agencies to address risks presented by various investment funds, money market funds, and open-end funds. This includes „data collection improvements, such as those related to Form PF, as well as actions taken to address liquidity mismatch in money market funds and reduce the risk of investor outflows during periods of market stress“.
(5) Climate-related financial risks: The Council and its member agencies have increased their capacity to evaluate and address climate-related financial risks. In this context, the Council recommends enhanced coordination of data and risk assessment through the Council’s Climate-related Financial Risk Committee, as well as promoting consistent, comparable, and decision-useful disclosures for investors and financial institutions.
(6) Digital assets: The Council highlighted financial stability vulnerabilities related to crypto-asset price volatility, market leverage, interconnectedness, and operational risks. The report emphasizes the importance of enforcing existing rules and regulations applicable to the crypto-asset ecosystem and reiterates the recommendation that Congress pass legislation to regulate stablecoins and the spot market for crypto-assets.
The Council also acknowledged vulnerabilities related to the nonfinancial corporate credit sector and commercial real estate sectors, encouraging supervisors and financial institutions to monitor credit risks and exposures to these sectors.