The Financial Stability Oversight Council touted strong economic growth over the past two years and the strength of the U.S. financial system in its 2018 annual report, but warned that financial stability risk stemming from international causes is up, particularly with the potential for a disorderly Brexit.
Other FSOC warnings: Cybersecurity is a perennial key financial stability vulnerability, and the growing federal debt could become a problem.
Brexit, the United Kingdom’s exit from the European Union in March 2019, “could have serious implications for the functioning of some global financial markets and firms,” FSOC’s 145-page report, released Wednesday, stated.
However, looking forward in the U.S., the council, chaired by Treasury Secretary Steven Mnuchin, zeroed in on the potential for the government’s increasing debt to cause financial stability issues down the road.
By September, federal government debt held by the public stood at 76% of GDP, similar to the previous September, but the Congressional Budget Office has forecast the debt burden growing “in an accelerating manner in the coming decades,” the FSOC report warned. Publicly held U.S. sovereign debt outstanding had reached $15.8 trillion by October, the report noted.
“Achieving long-term sustainability of the national budget is important to maintain global market confidence in U.S. Treasury securities,” the report noted.
Cybersecurity is a perennial key financial stability vulnerability identified by the FSOC in its annual report.
This year, FSOC outlined three ways an event could wreak havoc in the financial system.
These include disruption of a key financial service or utility, a loss of confidence in a swathe of market players that might have a cascading effect and a disruption or compromising of critical data upon which the financial firms and systems rely.
Digital assets like Bitcoin don’t appear to threaten financial stability, as their market capitalization is still small, according to FSOC.
However, Treasury and some U.S. regulators are considering potential regulations or rules for digital assets and the financial activities involving them, according to the report, while continuing to aggressively combat fraudulent digital asset activities.
The FSOC, which has 10 voting members including Mnuchin and Securities and Exchange Commission Chairman Jay Clayton, and five nonvoting members, recommended that financial services agencies continue to monitor levels of leverage among nonfinancial businesses and trends in asset valuations.
Nonfinancial business leverage is at the upper end of historical ranges, increasing the risk of default, the report found. In a recession, this could cause a wave of defaults or a similarly large shock to business earnings, FSOC said, although there is strong interest coverage and liquidity now.