Fed’s Cook: Nonbanks pose financial stability concerns

The banking sector has stabilized since bank failures earlier this year, but the vulnerabilities at certain nonbank financial institutions could play “a key role” in amplifying stress associated with tightening financial conditions and slowing economic activity, Federal Reserve Governor Lisa Cook said today. During a speech on financial stability at Duke University, Cook said that while she will continue to watch the banking sector for signs of renewed stress, she is closely monitoring nonbanks with “pronounced liquidity mismatches,” such as certain money market funds and open-end funds, as well as those with significant leverage, such as hedge funds.

At the same time, Cook said that the Financial Stability Oversight Council and the federal agencies represented on the council should continue to work together to ensure regulators have the appropriate information to assess the financial stability risks posed by nonbank activities and their interconnectedness with banks. “The financial system is substantially more resilient than it was in the mid-2000s,” she said. “However, vulnerabilities have risen somewhat in recent years, as highlighted by fragilities at [nonbanks], in the Treasury market and—most notably this year—at some banks.”

Cook also said it is important to enhance resilience at large banks, so she supports seeking public comment on the Basel III “endgame” proposal on bank capital requirements. “We cannot—and do not expect to—foresee all potential risks,” she said. “The financial system is too complex and evolves too rapidly for that to be possible. What we can do is remain vigilant to emerging vulnerabilities and build resilience to a variety of potential shocks.”