The U.S. Financial System Persist Despite Economic Gains

The U.S. financial system remains exposed to vulnerabilities stemming from commercial real estate strains and digital asset risks in 2024, Treasury Secretary Janet Yellen stated on Friday. While cooling inflation and robust employment figures have bolstered the broader economy, Yellen emphasized persistent areas of concern.

Vigilance on Credit Risks

Yellen noted that top regulators on the U.S. financial Stability Oversight Council (FSOC) remain vigilant in monitoring credit risks in commercial real estate, urging continued efforts to ensure Wall Street’s resilience in addressing these challenges. FSOC’s intensified focus extends to emergent risks from technological advancements, including digital assets and artificial intelligence. While acknowledging the potential efficiencies these innovations offer, Yellen warned of significant concerns, such as cyber threats and vulnerabilities from third-party service providers.

Comprehensive Legislation for Digital Assets

“The council advocates for comprehensive legislation to establish a federal prudential framework for stablecoin issuers and to address identified cryptoasset risks,” Yellen remarked. She also emphasized the importance of enhancing inter-agency expertise to assess systemic risks tied to AI in financial services while supporting innovation.

Addressing Systemic Risks

FSOC, comprising leaders from the Federal Reserve and the SEC, was established after the 2008 financial crisis to address systemic risks. The panel has flagged AI’s potential to exacerbate issues, such as discriminatory lending biases, particularly with opaque “black-box” algorithms. This marks FSOC’s final annual report under the Biden administration. Yellen reaffirmed her stance on fortifying FSOC through expanded staffing and advanced tools like analytic frameworks for financial stability.

Commercial Real Estate Challenges

The commercial real estate sector struggles with rising vacancies, slow rent growth, and elevated borrowing costs, causing increased delinquencies. CRE loan delinquencies have reached their highest in a decade, with major banks reporting 11% during 2024’s second quarter. U.S. banks have expanded credit reserves to address potential losses and ensure stability amid declining property values. FSOC’s report highlights the importance of sustained regulatory attention to strengthen industry resilience against deteriorating loan quality.

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Shadow Lending and Private Credit Risks

Private credit lenders, emerging as alternatives to traditional banks, present unique risks due to their opacity. FSOC expressed concerns over the growing interconnectedness of these lenders with banks and insurance companies, limited transparency in valuations, and increased retail investor participation through semi-liquid vehicles. The panel called for enhanced data collection to assess these risks more comprehensively.

Cybersecurity Threats

FSOC also flagged cybersecurity as a critical threat to the U.S. financial stability. A cyberattack on Industrial & Commercial Bank of China Ltd. last year disrupted U.S. Treasury transactions, illustrating the potential for such incidents to destabilize financial infrastructure. “Severe incidents at major institutions could significantly threaten financial stability given the interconnectedness of global systems,” FSOC stated, citing heightened risks from geopolitical tensions. The council recommended stronger information-sharing protocols and additional measures to mitigate cyber threats.

Safeguarding Innovation and Stability

This report underscores FSOC’s dedication to addressing evolving risks while promoting innovation and safeguarding market stability. The financial landscape continues evolving, demanding the council’s unwavering commitment. FSOC focuses on balancing resilience with progress to ensure long-term economic stability. Its proactive measures aim to align financial innovation with robust regulatory frameworks.