The U.S. Office of Financial Research ("OFR") reported that overall risks to financial stability remain moderate, consistent with its assessment from last year. The OFR noted that while the risk of market disruption remains high and cybersecurity vulnerabilities are a concern, resilience in the financial system has improved. The findings were presented in two related reports: The 2017 Annual Report to Congress and the 2017 Financial Stability Report.

The OFR used two new resources to develop its assessments: (i) the Financial System Vulnerabilities Monitor, which identifies warning signals that can lead to financial system disruptions, and (ii) the Financial Stress Index, which provides a "daily snapshot" of global financial market stress. The OFR was able to identify three key threats to financial stability:

  • Vulnerabilities to cybersecurity incidents. These could disrupt the operations of financial institutions and markets, and jeopardize the stability of the entire financial system and the broader economy.
  • Obstacles to resolving failing global systematically important banks ("GSIBs"). Both resolution paths – (i) bankruptcy and (ii) through the orderly liquidation authority – have shortcomings that could have implications regarding stabilizing the economy in the wake of a failing GSIB.
  • Structural changes in markets and within an industry. Three aspects could pose threats: (i) the lack of substitutability of certain service providers, (ii) the fragmentation of trading activities through multiple channels and products, and (iii) potential difficulties in transitioning away from LIBOR to a new reference rate.

The OFR also reported the following key findings:

  • Network analysis could help to identify potential systemic vulnerabilities to cybersecurity and operational threats.
  • Concerns raised by industry participants about regulatory reporting burdens may be justified, and are deserving of further analysis and potential remedial measures.
  • LIBOR needs to be replaced by an alternative reference rate, and a successful transition will require broad market acceptance, including through an active derivatives market that utilizes the new rate.
  • Full adoption of the Legal Entity Identifier (a financial data standard) should be facilitated through both voluntary and mandated measures.
  • Regulators should assess the systemic importance of banks based on a multifactor evaluation rather than solely based on a $50 billion asset size threshold.
  • The Financial Stability Oversight Council should adopt initiatives to facilitate appropriate data sharing and accessibility.

Commentary / Steven Lofchie

The extent to which significant regulatory risks are created by the regulators themselves is a point rarely mentioned in these annual reports. For example, the fragmentation of markets is a problem that is, if not created, at least exacerbated by the regulators. This is a result, in part, of arbitrary lines of jurisdiction that do not serve any policy purpose, but which survive because no part of the government is willing to sacrifice jurisdiction (and influence) to another.

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