Rising credit risk threatens US financial stability: federal monitor

WASHINGTON: Businesses around the world have been ravenously borrowing in recent years and elevating credit risk to a level that could be hazardous to the health of the US financial system, according to a report released on Tuesday by the federal office monitoring the country’s financial stability.

Overall, the Office of Financial Research found “threats to US financial stability remain moderate that is, in a medium range.”

Particular threats have grown in the last year, though, and a shock to US corporate or emerging market credit quality could harm the stability the country has slowly rebuilt since the financial crisis, the office, created by the 2010 Dodd-Frank Wall Street Reform law, said.

Business debt growth “continues at a rapid pace,” as underwriting standards and low interest rates allow for easier borrowing. Now, the ratio of corporate debt to GDP has reached an historic high, it found.

Borrowers in the United States and emerging economies, which have also seen private-sector debt levels rise, may struggle to pay off that debt because of “slower global growth and lower inflation, a stronger dollar, and the plunge in commodity prices,” it added.

The Federal Reserve is poised to raise interest rates, expected this week, which could curb some eagerness to borrow. But the report warned the rise may be so gradual that investors will still reach for yield in riskier debt.

This is the office’s first annual financial stability report, which provides an in-depth analysis drawing on a wide range of data and research and which will supplement its report to Congress in January.

Specifically, the report said energy and commodity companies have become a weak link.

They took advantage of easy borrowing more than companies in other sectors and then a plunge in energy prices that began in 2014 hurt their credit quality, it said.

The office found regulatory reforms and other changes have led to more resilient institutions
and markets.

Still, there are patches of vulnerability alongside credit risk, it found. The report said liquidity which has suddenly dried up in major financial markets “in a number of episodes, amplifying market shocks.” Securities financing markets still face possible runs and fire sales, and interconnections among financial firms are evolving in ways not fully understood.

Meanwhile, risks are moving to smaller institutions that are not subject to the same regulatory scrutiny as big banks, it added.

While the office’s indicators show that contagion risk – that the failure of one institution could trigger problems in others – is low, it has increased since 2014 because of pronounced financial market volatility.

Reuters

 

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