OFR Sees Europe, Systemic Risks From Big Banks as Key Threats

By Jeff Bater

Dec. 13 — Potential spillover from Europe and the interconnectedness of large Wall Street banks are among important vulnerabilities to U.S. financial stability, an Office of Financial Research report said.

The OFR, created by Dodd-Frank to measure risks to the financial system, said in its annual report to Congress that overall risks to stability remain in a medium range.

In June, the U.K. voted to leave the European Union. Uncertainty and potential instability in Europe could be transmitted to the U.S., the report said. For instance, a recession in Europe could decrease the demand for U.S. goods and services, a potential drag on U.S. economic growth.

Furthermore, the OFR report said, the systemic footprint of the largest banks—that is, their size, complexity and interconnectedness—makes up a key threat to stability.

“Reforms after the financial crisis have made the largest banks significantly more resilient,” it said. “Although these requirements have reduced the likelihood of a large bank failing, the potential impact of a large bank failure remains substantial.”

U.S. interest rates remain at or near historic lows. While loose monetary policy acted as a spur to economic growth, the downside is historically low rates encourage risk-taking because investors make increasingly risky investments to increase their returns.

“Sustained low rates have also combined with growing competition from shadow banks and other factors to undermine profits from the traditional bank services of accepting deposits and making loans,” the OFR said.

And because financial institutions are entwined in networks that rely on electronic transactions, they are vulnerable to cyberattacks.

“Cybersecurity incidents pose a clear threat to financial stability because financial institutions exist within complex networks and rely on electronic transactions that often occur on a rapid, just-in-time basis,” the report said. “Three possible risks to financial stability are lack of substitutability, or the ability of the financial system to replace lost services; loss of confidence in financial institutions; and impact on data integrity.”

To contact the reporter on this story: Jeff Bater in Washington at jbater@bna.com

To contact the editor responsible for this story: Michael Ferullo at MFerullo@bna.com

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