The Financial Stability Oversight Council (FSOC) was
unanimous in approving its 2023 annual report to Congress, reviewing the
council’s take on U.S. financial market developments, potential emerging
threats to financial stability and vulnerabilities in the financial system, as
well as recommendations for mitigating such threats and vulnerabilities.
The report indicated that, overall, FSOC views the U.S.
financial system as remaining resilient, and the U.S. banking system as
remaining sound. The report also detailed activities undertaken by the council
and summarized notable regulatory developments impacting financial markets.
“The resilience of the U.S. financial system in the face of
this year’s global economic uncertainty and the banking sector distress of the spring
is a testament to the reforms implemented in the aftermath of the global
financial crisis,” Secretary of the Treasury Janet Yellen said in a press
release. “Events over the past year continue to underscore the importance of
the council’s ongoing efforts to enhance the resilience of the financial system
and monitor a wide range of vulnerabilities.”
One of the council’s major priorities has been reviewing
capital rules regulating the banking sector, intended to promote improved risk mitigation,
improved resolution plans, and increased monitoring of uninsured deposit levels
and depositor composition. These efforts are driven by lessons learned from
past turmoil in the wake of the 2008 financial crisis and the need to reduce
financial stability risks, as described by the council.
“The banking system faces a challenging environment that
includes higher interest rates and concerns about the economic outlook and
credit quality,” the report states. “The council recommends banking
supervisors, including credit union supervisors, continue to ensure that banks
maintain adequate capital and liquidity, sound interest rate risk management
practices, and well-developed operational resilience plans.”
Cybersecurity poses pervasive risks within the financial
system. In its report, FSOC advocates for partnerships to share actionable
information, promote resilience and work together to mitigate financial
disruption caused by cyber incidents.
“An incident that causes a loss of customer confidence in
the confidentiality, reliability, and safety of their data, assets, and
transactions at a financial institution could lead to significant withdrawals
of assets, resulting in market losses,” the report states. “Additionally, a
cybersecurity incident involving the theft or unauthorized disclosure of
sensitive data has privacy implications for consumers and could lead to
identity theft and fraud.”
Artificial intelligence (AI) represents perhaps the most
significant source of technological advancement affecting the financial
marketplace and the economy at large. Despite its potential benefits, FSOC also
recognized the possible vulnerabilities AI could introduce to financial markets.
It encouraged monitoring AI development to adapt oversight structures, deepen
expertise and identify emerging risks.
“Financial institutions currently use AI for various tasks,
including fraud prevention and detection, customer service, document review,
and retail credit underwriting,” the report stated. “Some institutions use AI
extensively, while others take a more limited approach. Even within a single
institution, AI may be used to varying degrees in different areas. The use of
AI, however, can introduce certain risks, including safety-and-soundness risks
like cyber and model risks. Other potential risks include consumer compliance
risks, which can be exacerbated by certain characteristics of many AI
approaches, such as difficulty in explaining the model or understanding how it
functions.”
FSOC has increased its focus on nonbank institutions’ role
in financial services and associated risks as well. This includes nonbanks’
role in the mortgage marketplace, which has grown significantly in recent
years.
“[T]he council’s Nonbank Mortgage Servicing Task Force, a
working group including staff from member agencies and other government
agencies such as the Department of Housing and Urban Development, is
facilitating interagency coordination and additional market monitoring of the
risks that nonbank mortgage servicers pose to U.S. financial stability,” the
report notes.
The report further detailed the council’s support for
initiatives geared to assess risks from mortgage servicers, private credit,
hedge funds and money market funds. It also explains its advocacy for data
improvements and more regulatory engagement.
Additionally, FSOC described its increased efforts to
effectively evaluate and address climate-related financial risks in 2023. The
council recommended enhanced data coordination, risk assessment and consistent
disclosures among financial entities to enable informed decisions considering
climate-related financial risks.