Board of Governors of the Federal Reserve System

Overview

This report reviews conditions affecting the stability of the financial system by analyzing vulnerabilities related to valuation pressures, borrowing by businesses and households, financial leverage, and funding risk. It also highlights several near-term risks that, if realized, could interact with such vulnerabilities.

Investor appetite for risk appears elevated by several measures, and the debt loads of businesses are historically high. However, the financial sector appears resilient, with low leverage and limited funding risk. Despite volatility in financial markets late last year, our assessment of each of the four vulnerability categories is little changed since the November 2018 FSR.⁴

Our view on the current level of vulnerabilities is as follows:

1. Asset valuations. Valuation pressures remain elevated in a number of markets, with investors continuing to exhibit high appetite for risk, although some pressures have eased a bit since the November 2018 FSR.
2. Borrowing by businesses and households. Borrowing by businesses is historically high relative to gross domestic product (GDP), with the most rapid increases in debt concentrated among the riskiest firms amid signs of deteriorating credit standards. In contrast, household borrowing remains at a modest level relative to incomes, and the debt owed by borrowers with credit scores below prime has remained flat.
3. Leverage in the financial sector. The largest U.S. banks remain strongly capitalized, and the leverage of broker-dealers is substantially below pre-crisis levels. Insurance companies appear to be in relatively strong financial positions. Hedge fund leverage appears to have declined over the past six months.
4. Funding risk. Funding risks in the financial system are low. Estimates of the outstanding total amount of financial system liabilities that are most vulnerable to runs, including those issued by nonbanks, remain modest relative to levels leading up to the financial crisis. Short-term wholesale funding continues to be low compared with other liabilities, and the ratio of high-quality liquid assets to total assets remains high at large banks.

References