Fed Governor Cook details financial stability committee work and nonbank risks

Federal Reserve Governor Lisa D. Cook reflected on the central bank's approach to financial stability, including the Financial Stability Report and scenario analysis, during a speech at Yale University. She highlighted the ongoing work to understand vulnerabilities from nonbank financial intermediaries and the complexity of policy-making.

The committee's evolving mandate

Federal Reserve Governor Lisa D. Cook, chair of the Board's Committee on Financial Stability since 2023, shared reflections on her role.

Following the Global Financial Crisis, the Board revised its approach to financial stability, integrating insights from economists, market experts, and bank supervisors across the Federal Reserve System.

This evolution led to the committee's creation in 2014, establishing a dedicated forum for discussing financial stability issues.

Cook honored the committee's first chair, Stanley Fischer, who recognized the importance of such a forum.

Fischer notably highlighted that post-crisis regulatory measures, while bolstering bank resilience, could push certain activities into less regulated nonbank intermediaries.

He warned that data gaps and limited visibility into these nonbank activities posed their own systemic risks.

The Fed continues to address these challenges, examining issues like hedge fund trading strategies and private credit arrangements to improve monitoring.

Tracking vulnerabilities with the FSR

Governor Cook detailed the Federal Reserve's twice-yearly Financial Stability Report (FSR), which Chair Powell introduced in 2018 to enhance transparency.

The FSR serves as a platform for policymakers to develop individual views on systemic resilience, rather than presenting a single centralized perspective.

It meticulously monitors four key vulnerabilities: asset valuations, borrowing by businesses and households, financial sector leverage, and funding risk, assessing their levels relative to historical trends.

Cook highlighted the FSR's "rainbow chart," which illustrates the rapid growth of bank lending commitments to nonbank financial institutions.

This category has expanded at an annualized rate of approximately 9 percent over the last decade, significantly outpacing commercial and industrial lending.

This consistent monitoring offers deeper insights into private credit evolution and inter-sector linkages, proving valuable for scenario analysis.

Navigating unseen risks

Cook contrasted financial stability scenario analysis with supervisory stress tests, which address "known unknowns" with precision.

Financial stability analysis, however, delves into scenarios without historical precedent, such as "What if AI disappoints?", to explore tail risks and challenge assumptions about the future.

This approach, while inherently imprecise due to data gaps and complex interdependencies, is crucial for understanding how severe shocks could ramify through the financial system and amplify original impacts.