United States
Financial Sector Assessment Program-Financial System Stability Assessment

This paper discusses the results of the Financial System Stability Assessment on the United States made under the Financial Sector Assessment Program. It is found that welcome steps have been taken in strengthening the financial system. The Financial Stability Oversight Council now provides a useful forum for coordination, the regulatory perimeter has expanded, information sharing among agencies has improved, supervisory stress testing is leading changes in risk measurement and management, and new resolution powers have been established. However, new pockets of vulnerabilities have emerged, partly in response to the continuing search for yield. This requires a continuing focus on strengthening the micro and macroprudential framework.


This paper discusses the results of the Financial System Stability Assessment on the United States made under the Financial Sector Assessment Program. It is found that welcome steps have been taken in strengthening the financial system. The Financial Stability Oversight Council now provides a useful forum for coordination, the regulatory perimeter has expanded, information sharing among agencies has improved, supervisory stress testing is leading changes in risk measurement and management, and new resolution powers have been established. However, new pockets of vulnerabilities have emerged, partly in response to the continuing search for yield. This requires a continuing focus on strengthening the micro and macroprudential framework.

Steps Have Been Taken to Enhance Stability…

1. Since the 2010 FSAP, important steps have been taken to restore macroeconomic and financial stability. By 2011, the economy had recovered from one of the deepest recessions in the post-war period, and staff projections have the economy returning to potential in 2017. Bank and insurance capitalization is stronger, household balance sheets are healthier, and progress has been made in addressing key regulatory fault lines. Also, major reforms of financial regulation and supervision have been implemented, and work is ongoing on addressing the misaligned incentives that led to excessive risk taking. The creation of the FSOC has helped coordinate the work of a large number of regulatory agencies and aims to ensure an effective macroprudential response to risks. At the international level, too, the U.S. authorities have played a major role in promoting the post crisis reform agenda and in the discussions on strengthening the global financial system.

…But New Vulnerabilities are Emerging

2. Although systemic risks appear to have eased since the height of the crisis, a number of indicators bear close attention, especially since the protracted low-interest rate environment is again driving a search for yield.

  • Credit risk measures have improved, driven by strengthened bank fundamentals and declining household delinquency; but corporate-sector indicators are less encouraging. There have been large increases in new issues of corporate debt—particularly speculative-grade—and risk spreads suggest overvaluation in some asset-market segments.

  • Market liquidity has declined according to some metrics, raising concerns that trading liquidity could be severely constrained in the event of a market disruption.

  • Equity prices also are approaching levels that may be hard to sustain given profit forecasts and an eventual interest-rate normalization.

  • Spillover risks also remain elevated. The U.S. financial system is closely interconnected with the rest of the global financial system, and asset price co-movements are well above pre-crisis levels.

3. The locus of financial stability risks has moved to nonbank financial institutions and markets. Nonbanks now account for more than 70 percent of U.S. financial sector assets, reflecting an increasing amount of maturity and liquidity transformation taking place via managed funds. Moreover, nonbank financial institutions (including insurance companies) appear to be taking on higher credit and duration risk, and concern remains about the relative opacity of the leverage and other risks embedded in securities lending and cash reinvestment. Indeed, staff analysis illustrates that insurance companies, hedge funds, and other managed funds contribute to systemic risk in an amount that is disproportionate to their size.

A. Households and Nonfinancial Firms: Pockets of Weakness

4. Household balance sheets appear less stretched than at the crisis onset, but pockets of risks have built up. Household debt has been falling since the beginning of the crisis (Figure 1), and household net worth has risen as a share of disposable income, but the improvement has been concentrated in the top two deciles of the income distribution. Housing price indicators are in line with their long-term trends. Households’ delinquency rates have dropped amid a stronger economy and job growth, but are more of a concern for the growing student loans and auto loans. For student loans, risks to lenders are mitigated by factors such as the federal government’s extraordinary collection authority on loans it originates and guarantees; but the strong growth in student loan debt—which has trebled over the past 10 years to some $1.2 trillion—suggests this could become an important contingent liability for the government. Moreover, high student-debt burdens can limit access to other forms of credit, such as mortgages.

Figure 1.
Figure 1.

Household Sector Soundness

Citation: IMF Staff Country Reports 2015, 170; 10.5089/9781513592787.002.A001

Sources: Bloomberg, Datastream, Federal Reserve, Haver Analytics, and IMF staff calculations.

5. Nonfinancial corporate balance sheets have become more leveraged, and the ability to cover debt service is a concern, especially for smaller firms (Figure 2). 2014 was a record year of issuance for U.S. investment-grade corporate bonds and collateralized loan obligations (CLOs) and a near-record year for high-yield corporate bonds. While large companies appear capable of sustaining increased debt loads, smaller corporations appear more vulnerable, especially once interest rates rise. Moreover, surveys show an easing in underwriting standards. Supervisors have taken steps to rein in excessive risk taking, particularly in banking books. Nonetheless, the search for yield has continued, and covenant-lite loans now account for two-thirds of new leveraged loan issuance. Other types of lower-standard loans, such as second-lien loans, are also at near-record issuance rates. Rising leveraged buyouts and mergers and acquisitions activity also remain a concern. Relatively easy financing conditions and slowing earnings growth could encourage further deals at higher leverage.

Figure 2.
Figure 2.

Nonfinancial Firms: Leverage and Issuance

Citation: IMF Staff Country Reports 2015, 170; 10.5089/9781513592787.002.A001

Sources: Bloomberg, Datastream, Federal Reserve, Haver Analytics, Barclays indices, and IMF staff calculations.

B. Banks: Progress in Balance Sheet Repair

6. Bank balance sheet and income positions have improved. Compared to the pre-crisis period, banks have strengthened their capital positions, including relative to their international peers, hold more liquid assets, and are less levered (Figure 3 and Appendix II). Net income has almost doubled in recent years, helped by lower provisions. The nonperforming loan ratio has fallen to just over 2 percent, half the level at its peak in 2010, and the coverage ratio has also improved. However, although the return on assets and return on equity have also strengthened, they are lower than pre-crisis.

Figure 3.
Figure 3.

Bank Soundness

Citation: IMF Staff Country Reports 2015, 170; 10.5089/9781513592787.002.A001

7. Most measures point to a reduction in the systemic risks of banks. Financial cycles and credit-to-GDP gap indicators (Figure 4) do not signal excessive leverage, and indicators of distress based on market prices also provide an encouraging picture. For example, measures of the banking system’s market-implied capital shortfall (Figure 5) suggest that systemic risk posed by banks is declining towards its pre-crisis average.

Figure 4.
Figure 4.

Financial Cycle and Credit-to-GDP Gap

Citation: IMF Staff Country Reports 2015, 170; 10.5089/9781513592787.002.A001

Source: IMF staff calculations.Note: Financial cycles are computed using the BIS bandpass filter methodology and capture the co-movement between bank credit growth and residential property prices. The credit-to-GDP gap is defined according to current Basel Committee on Banking Supervision guidance as the difference between the credit-to-GDP ratio to its long term trend, calculated using a one-sided Hodrick-Prescott filter with a smoothing parameter of 400,000.
Figure 5.
Figure 5.

SRISK Market Implied Capital Shortfalls

Citation: IMF Staff Country Reports 2015, 170; 10.5089/9781513592787.002.A001

Source: NYU Stern Volatility Lab, as of end 2014QNote: SRISK is an estimate of the capital that a financial firm would need to raise if a severe financial crisis were to occur.

C. Insurance Companies: New Risks Emerging

8. Insurance companies, hurt by the prolonged period of low interest rates, are taking on greater risks. The industry continues to consolidate, with many firms exiting the market, and a few firms failing. Searching for yield, some insurers have invested more in private equity, hedge funds, longer duration and lower credit corporate bonds, and real estate related assets. Some life insurers have increased their securities-lending and cash collateral reinvestment activities. Large life insurance groups in particular have expanded nontraditional business, provide complex guarantees, and remain exposed to macroeconomic risks.

9. There are important handicaps to assessing the sector’s health. Capital adequacy at legal entity level, measured by the regulators’ risk-based capital (RBC) requirements, has increased since the crisis, and the number of companies breaching regulatory levels has declined. However, capital adequacy ratios are hard to interpret due to valuation rules, regulatory arbitrage via captives, and lack of regulatory capital adequacy measures at group level.

D. Asset Management: Challenges in Market-Based Financing

10. Maturity and liquidity transformation in short-term wholesale funding markets outside banks is substantial, though it remains hard to measure. Funding comes primarily from Money Market Mutual Funds (MMMFs) and securities lenders reinvesting cash collateral. Borrowing demand comes mostly from broker-dealers and short-term corporate finance. Much of it is intermediated through the repo markets.

11. The systemic importance of mutual funds (MFs) has grown since the crisis. Assets under management have increased, especially in corporate high-yield (HY), and emerging market (EM) bonds and debt funds (Figure 6). There is evidence that herding behavior among U.S. MFs is intensifying, particularly in smaller less liquid markets, and in retail markets. MFs could act as amplifiers to shocks to the financial system through asset liquidation (investors may rush to redeem their shares, while the funds may be invested in illiquid assets) and through direct exposures (funds may exit from risky assets and limit their willingness to fund other key players in the system).

Figure 6.
Figure 6.

High-Yield and Emerging Market Assets Managed by U.S. Open-Ended Mutual Funds

(in US$ billions)

Citation: IMF Staff Country Reports 2015, 170; 10.5089/9781513592787.002.A001

Sources: CRSP, IMF staff calculations.Note: Covers assets held by dedicated high-yield and EM mutual funds, and excludes these asset types that may be held by other types of mutual funds.

12. Open-ended MFs and underlying asset markets could be vulnerable to sudden shifts in investor sentiment. MFs have a regulatory obligation to meet redemption demand in cash within 7 days, which at times of stress they may be unable to meet, given limited liquidity buffers or access to safety nets. Cash and other liquidity buffers are limited, at least for passive MFs, by their need to minimize tracking error; and there are potential problems in borrowing to fund redemptions (see paragraph 53). Some investments appear to be moving to the edges of the regulatory perimeter, for example, into separate accounts and trusts.

13. Liquidity risks in the exchange traded fund (ETF) sector are also on the rise. The traditional U.S. ETF, offering passive equity indexation with physical replication, combines exchange trading and market-maker arbitrage incentives with redemption in-kind to provide liquidity. Investor perception of ETF-structure liquidity appears to have combined with the low-for-long interest rates environment to facilitate rapid growth in fixed income ETFs specializing in EM and HY corporate debt and bank loans, despite the lower liquidity of the underlying assets and limited arbitrage incentives of market makers.

14. Pension funds may also give rise to systemic risks in the U.S. financial system. While many funds are shifting towards defined contribution, defined benefit plans still remain almost half of the industry, and about 20 percent of multi-employer pension funds are underfunded. Pressure to improve returns could spur undue risk taking, whether via direct credit exposure or through securities lending and cash reinvestment. As noted in the 2015 FSOC Annual Report, the transfer of pension risk to the insurance industry, through ‘longevity swaps’ and other insurance products, increases the interconnectedness of the system.

E. Financial Markets: Stretched and Vulnerable to Bouts of Volatility

15. Market valuations are beginning to appear stretched (Figure 7). Stock prices reached all-time highs in early 2015, and measures such as Shiller’s cyclically-adjusted price-to-earnings (P/E) ratio suggest that the stock market is around 1 standard deviation above historical norms. Margin borrowing as a percentage of market capitalization is higher than during the 1990s stock market bubble, and is more worrisome given the decline in market liquidity. The search for yield has also compressed risk premiums across most fixed income classes.

Figure 7.
Figure 7.

Financial Markets

Citation: IMF Staff Country Reports 2015, 170; 10.5089/9781513592787.002.A001

Source: IMF staff calculations; cut-off date for data is March 2015.Notes: The implied real equity yield is the cost of capital for equities (or the required return to hold stocks), expressed as the number of standard deviations from the country-specific long-term average. The implied bond term premium is defined as 5y5y rates (local currency terms) minus 5y5y survey-based expectations for real GDP growth and inflation, expressed as the number of standard deviations from the country-specific long-term average. Data start in 1989 (1953 for the United States).

16. Important interconnections exist among banks, nonbanks, and financial markets. Banks and nonbanks have substantial holdings of domestic securities that could be subject to heightened volatility in the transition as monetary policy moves to a tightening cycle. Another material transmission channel relates to MMMFs and their sponsors (asset managers and banks), some of which have in the past provided support by lending or by purchasing fund assets, even if not formally obliged to do so. Other important developments include transfers of pension risks by corporate-sponsored pension plans to insurance companies and derivatives markets. The FSAP team’s analysis (see Stress Testing Technical Note) brings out many of these interconnections, as do recent reports by the OFR and the FSOC. However, there are still critical data limitations that the authorities need to address to improve the understanding of interconnectedness.

17. The interconnections would amplify shocks, for example, in the case of sizeable interest rate shocks. The system appears able to withstand moderate increases in interest rates, such as those expected in an interest-rate normalization. In fact, a “low-for-long” scenario is more troublesome for financial stability, particularly the life insurance sector, than orderly interest rate increases. However, in the event of “disorderly” interest rate increases, parts of the system—such as some managed funds and life insurance companies—would be affected materially (Box 1). The team’s stress tests illustrate that cross-sector spillovers amplify the effects of shocks, as U.S. banks, insurers, and other non-bank financial institutions tend to be adversely affected by credit risk shocks originating in other domestic sectors (Stress Testing Technical Note), while a combination of factors has left markets less able to manage swings in interest rates and liquidity.

F. Cross-border Interconnectedness and Spillovers

18. The interconnectedness of the U.S. system with the rest of the world remains key for global stability (Figure 8). U.S. GSIBs account for 22 percent of total GSIB assets; the U.S. insurance market is the largest in the world with premium volume accounting for a third of the global market and the three U.S. G-SIIs account for a third of total G-SII assets; and the U.S. derivatives market also represents one third of the world market. The U.S. banks’ external positions remain sizeable even after the crisis. The U.S. financial sector is one of four jurisdictions at the core of the world’s bank network, as well as at the core of the equity market, debt market, and price correlations networks. Market-price based calculations (see Stress Testing Technical Note) indicate that distress in the U.S. financial system may have strong effects on distress in foreign financial institutions, while the “spillback” is limited. It is hence important that authorities continue to participate actively in the ongoing monitoring and assessment of the impact of regulatory reforms at the global level in order to promote safe and transparent markets and to address any material unintended consequences should they be identified.

Figure 8.
Figure 8.

Interconnectedness and Spillovers

Citation: IMF Staff Country Reports 2015, 170; 10.5089/9781513592787.002.A001

19. Recent years have provided examples of cross-border spillovers from, and spillbacks to, the U.S. financial system. For instance, the direct exposure channel stemming from MMMFs was highlighted during the European sovereign crisis, when U.S. MMMFs cut their exposures to European banks, resulting in severe dollar shortage for those banks. This dollar shortage was also visible in a large increase in euro-dollar basis swaps, until the ECB and the Fed reintroduced USD/EUR swaps in November 2011. More recently, the announcement of the ECB’s QE program has had a measurable impact on long-term U.S. yields.

20. This highlights the importance of cross-border information sharing, cooperation and coordination in regulation, supervision, enforcement, resolution and crisis management. The U.S. authorities are actively engaged in promoting international regulatory coordination, though there remain a few gaps to be addressed.

  • In banking, there is a comprehensive framework of policies and processes for cooperation and exchange of information between the FBAs and foreign supervisory authorities, though state banking agencies with Foreign Banking Organization (FBO) presence do not always inform or coordinate enforcement actions with home supervisors.

  • The SEC and CFTC are signatories to the IOSCO Multilateral MOU (MMOU) and also have several bilateral MOUs with foreign authorities, and have responded to a significant number of information requests from foreign authorities.

  • In insurance, the U.S. authorities’ approach to cross-border coordination and crisis management is at an early stage of development, reflecting the recent establishment of colleges of supervisors for the IAIGs and CMGs for the NBFC-led firms.

  • Further efforts are also needed in coordinating cross-border resolution, which is complicated by the depositor preference rules as well as potential ring-fencing of foreign-owned uninsured bank branches.

  • A solution for mutual recognition of CCPs and a common approach on margin requirements and other risk management requirements, which will help to reduce duplication of rules, regulatory gaps and inconsistencies, is still outstanding, though work is continuing to support the application of deference to foreign regulatory regimes for OTC derivatives.

G. Stress Tests: Illustrating the Fault Lines1

21. Stress tests were used to quantify the potential impacts of risks and vulnerabilities in banks and nonbanks (Figure 9). A broad evaluation of potential risks is embodied in the Risk Assessment Matrix (Appendix Table 2). The FSAP team conducted top-down solvency tests for bank holding companies (BHCs) and insurance sectors, liquidity risk analysis for BHCs and mutual funds, and market-price based stress tests. The exercise was informed by top-down stress tests performed by supervisors for the BHCs and insurance companies, and bottom-up stress tests run by BHCs.

Figure 9.
Figure 9.

Stress Testing Results

Citation: IMF Staff Country Reports 2015, 170; 10.5089/9781513592787.002.A001

Note: Blue lines indicate 25th and 75th percentile values of the distribution of historical estimates of U.S. institution 1-year ahead default probabilities. The dashed black line denotes the median value of the distribution of historical estimates of U.S. institution 1-year ahead default probabilities. The solid red and black lines denote median 1-year ahead default probabilities projected by the CCA stress tests under the stress and baseline scenarios, respectively. To better show projection details, the y-axis has been truncated for the U.S. financial system, domestic banks, insurers, asset managers, and NBFIs. The blue lines denoting the 75th percentile reached maximum values of 2.5%, 4%, 6.5%, 2%, and 16%, respectively, for these five sectors in 2008-2009. Only projections for the overall U.S. financial system model explicitly take into account changes in the estimated default probabilities of other sectors. Individual sector projections were generated exclusively using macroeconomic and connectivity factors.Source: IMF staff estimates based on data from SNL Financial, Bloomberg, Datastream, and Moody’s KMV. Note: For details, see Technical Note on Stress Testing.

22. The results of the 2015 supervisory and company-run stress tests (DFAST) required by the authorities suggest that the banking system is resilient to severe shocks. Even in a “severely adverse” scenario resembling the 2008–09 crisis, all 31 BHCs have sufficient capital to absorb losses—the first time since the start of annual stress tests in 2009 that no firm fell below any key capital threshold.

23. The staff’s analysis benefitted from the relatively wide range of publicly available data, but was nonetheless subject to data constraints. Insurance sector data are limited by the fragmentation of insurance sector oversight between state and federal entities, lack of a consolidated view of companies’ global activities, complexity of U.S. valuation practices, complexity of the insurance business, and absence of group-level risk-based capital. Moreover, banking supervisors were limited in their ability to share confidential supervisory information that could better inform the team of institutional interconnectedness, and liquidity and interest rate risks.

24. For banks, the staff’s solvency stress tests are largely in line with DFAST results, but do point to potential strains which could impact the economic recovery. In the first year, the system-wide CET 1 ratio would fall by 2½ percentage points, but no BHCs would fall below the hurdle rates, reflecting banks’ already high capital positions. Two BHCs would breach the minimum capital requirement in 2016 and an additional eleven BHCs thereafter, with a total capital shortfall that peaks in 2019 at the equivalent of 1 percent of 2019 GDP. To a large extent, the shortfalls reflect the staff’s assumption of continued loan growth even in the face of the adverse shock and impending breaches of regulatory thresholds. Thus, the results are more illustrative of the difficulty that banks would face in contributing to a recovery rather than systemic risk.

25. Network analyses also illustrate the potential for spillovers among the largest domestic institutions. Due to data limitations, the exercise focused on six large BHCs, accounting for some 50 percent of the banking system’s total assets. The results indicate that contagion risks among these institutions are contained, since their direct exposures are not large relative to their initial capital levels. Nonetheless, the calculations also suggest that risk transfer mechanisms, such as credit default swaps, alter significantly the risk profile of financial institutions, illustrating the importance of expanding the data on such exposures.

26. Staff’s liquidity risk analysis suggests that most BHCs now have sufficient liquid assets to meet a shock similar to the 2008/2009 event. A few BHCs would face liquidity pressures due to deposit outflows in the short run and large unused commitments over a longer horizon. In the absence of supervisory data, historical run-off rates and quarterly published data were used in the analysis. However, if run-off rates similar to the ones in the LCR are used then liquid assets for many BHCs would be insufficient to meet liquidity needs due to the large withdrawal of wholesale funding.

27. On the insurance side, stresses may have a significant impact, especially in life insurance. The analysis—which covered 43 insurance groups—was handicapped due to data limitations, but still suggested that life insurers would suffer a substantial reduction of shareholder equity if a “fully market-consistent” valuation was applied (16 life insurers and 1 credit insurer fell into “distressed” levels in the adverse scenario). The current valuation regime would only recognize the impact of these asset shocks over time. Indeed, when the exercise is performed on a statutory-accounting basis, the results appear more benign and are broadly in line with top-down stress tests performed by the NAIC, but mask the economic impact. The authorities are encouraged to develop and perform insurance stress tests on a consolidated, group-level basis.

28. Quantitative analysis highlights the potential for market stress from heightened redemption pressures at mutual funds. The analysis measured whether, in the face of severe redemption pressures wherein open-ended mutual funds are forced to liquidate positions, markets would have enough trading liquidity to absorb the asset sales. The analysis compared assets sold by mutual funds hit by a redemption shock with position data on dealer inventory. It covered some 9,000 mutual funds representing around 80 percent of the industry. Results suggest that municipal bonds and corporate bonds markets may face significant stress in the face of such shocks. This exercise is only preliminary, and the authorities are encouraged to start conducting regular top-down analysis to provide a more holistic picture of the industry’s contribution to systemic risk.

29. Market equity-price based stress tests illustrate the importance of cross-sectoral spillovers under stress. In very active markets such as the U.S. ones, market equity price based stress tests can provide a useful complement of the accounting-data based stress tests. Under the baseline scenario, estimated distress probabilities are expected to either remain stable or trend slightly downward to their pre-crisis levels. Under the stressed scenario, estimated distress probabilities are expected to rise in a manner which is broadly commensurate with—but milder than—the increase in the 2008 financial crisis. The tests suggest that a severely adverse change in the macroeconomic environment would significantly increase the probability of distress of all sectors of the U.S. financial system. Importantly, cross-sector spillovers amplify the effects of shocks. U.S. banks, insurers, and other non-bank financial institutions tend to be adversely affected by credit risk shocks originating in other domestic sectors. Spillovers from the United States to the rest of the world can be large; spillbacks from the rest of the world appear to be relatively modest.

30. The exercise suggests scope for enhancement in the authorities’ stress tests. While the authorities’ solvency stress tests for BHCs are state-of-the art in many respects, enhancements are needed, especially in nonbank stress tests. Improvements include addressing data gaps by collecting interbank exposures for a fuller sample of banks; conducting a network analysis on a regular basis; reexamining some of the solvency stress test assumptions to ensure consistency with historical evidence; implementing both solvency and liquidity stress tests not only for banks but also for nonbanks (such as insurance companies, mutual funds, and pension funds); linking liquidity, solvency, and network analysis in a systemic risk stress testing framework; and examining the spillover risks between nonbanks and banks.

Financial Sector Sensitivity to Interest Rate Increases

Effects of interest rate hikes would differ across sectors, but appear manageable if the hikes are orderly. The long period of low interest rates has impacted sectors differently, depending on their business models and “search for yield.” Orderly increases in interest rates are likely to have a relatively small overall impact, although parts of the financial system are likely to be affected substantially, especially if interest rates rise rapidly (see Stress Testing Technical Note).

Life insurance would be materially affected, if rate hikes were “disorderly.” The market value of bond portfolios would decline, especially for longer duration instruments, but the impact would be mitigated by the fact that these are typically carried on an amortized cost basis. A dramatic rise in interest rates could also increase policy surrenders and drive up funding costs for those issuing bonds. Conversely, high rates would reduce the existing large gap between the market and actuarial rate used to discount liabilities. On balance, the IMF’s stress tests suggest that the effects of higher interest rates, in themselves, would be manageable, if the effects on risk spreads are contained, since economic valuations of assets and liabilities would move in the same direction. A “low-for-long” scenario would be more worrisome because of the continued erosion of life insurance company capital.

Large banks seem well positioned to withstand an interest rate shock. IMF staff calculations for 31 BHCs suggest that even a 4.5 percentage point increase in the 3-month Treasury yields would have only a marginal impact on CET1, because higher losses on credit and AOCI would be largely offset by retained earnings and reduced growth rates of assets. These calculations do not incorporate broader macroeconomic effects of higher interest rates. Authorities’ own calculations suggest that a mild recession with a sharp increase in short term rates (“DFAST adverse scenario”) would lead to only moderate declines in capital ratios of the 31 BHCs.

Small banks could be affected more. They are particularly exposed to interest rate risk as their asset maturities have become longer and liability maturities shorter. This is particularly relevant in the context of the BCP finding that the regime for interest rate risk in the banking book needs updating (Appendix V).

Some managed funds could face difficulties. Redemption demand could jump if there were a disorderly rise in rates, and some funds exposed to leveraged borrowers could also face major losses. Turbulence in longer-term yields could result in significant market risk; if forced to sell assets to meet strong redemption demand, or in the event of default by a repo borrower, managed funds exposed directly or indirectly to longer-term bond yields could suffer losses.

The Fed’s balance sheet would be impacted by a sharp increase in short-term rates and normalization of term yields as QE unwinds. However, its balance sheet is robust to yield curve changes, and the implementation of monetary policy would not be affected.

…Calling for a Strong Response

A. Macroprudential Policy

31. The United States has taken important steps to establish a macroprudential framework. The FSOC provides a key framework for systemic risk oversight, and a critically important forum for collectively identifying risks and encouraging individual agencies to respond. Important progress has been made in defining which entities should be subject to enhanced prudential standards and assigning overarching responsibility for their oversight to the Fed. The efforts by the Office of Financial Research (OFR) to collect data and monitor risk are promising.

32. The FSOC’s governance could be strengthened to ensure timely responses to systemic risk. Operational independence of member agencies is important, but it creates challenges for the operation of the Council. To address these challenges, three steps are recommended:

  • Provide an explicit financial stability mandate to all FSOC member agencies. Several agencies have no explicit legal mandate to support financial stability, which complicates their input to the FSOC, and potentially undermines the agency response to FSOC recommendations and macroprudential coordination.

  • Publish specific follow-up actions to address financial stability threats identified by the FSOC. These recommendations should identify timelines and responsible agencies.

  • Reinforce the collective ownership of the FSOC. It would be helpful to appoint Chairs for each of the supporting staff committees, drawing upon the expertise of the member agencies.2 Moreover, members should consult FSOC as standard practice on the development and implementation of major regulatory rules that could impact financial stability.

33. The macroprudential toolkit needs to be developed further; additional tools to strengthen market resilience to run risks and fire sales should be a high priority. Progress has been achieved in building structural resilience of banks. But “time-varying” tools to address a build-up of financial stability pressures (Box 2) still need to be developed further and implemented. The multiplicity of regulatory agencies with overlapping sectoral mandates underscores the importance of the FSOC in identifying when such tools are needed, and promoting the implementation of effective system-wide ‘time-varying’ macroprudential tools. Importantly, in the present conjuncture, developing additional tools to strengthen market resilience to run risks and fire sales should be a high priority. FSOC could take a more assertive line in promoting a coherent approach to tackling these risks (see paragraphs 52–56), including plans for using existing tools and finalizing the preparation of new instruments for macroprudential purposes. In particular, it will be important to complete the necessary final steps on application triggers required to implement the countercyclical buffer; examine the scope to alter risk weights on particular types of lending; and consider how macroprudential tools could be used in the real estate sector e.g. by varying maximum LTVs and DTI ratios (paragraphs 62, 64).

34. In addition:

  • Initiatives to address the TBTF problem need to be sustained. Strides have been made in addressing the TBTF issue through the DFA Title I designation process, and the requirement to elaborate robust living wills. This is supported by enhancements to resolution capabilities, but it remains a work in progress, and major financial institutions have continued to grow in size. Higher prudential standards have been set for large banks, but heightened standards for designated nonbanks are still not in place.

  • The response to identified threats should be more robust. Progress has been slow in some areas. In relation to MMMFs, a strong initial stance has thus far resulted in planned changes to a part of the market by end-2016, with full implementation nearly 10 years after the initial problems with MMMFs arose in 2007.

  • Further action is needed to address data gaps and impediments to data sharing. There are shortfalls in collection, availability, and ease of manipulation of data. Data gathering on bilateral repo, securities lending, and asset management is at early stages, despite DFA-mandated action to address important gaps. Outstanding obstacles to interagency data sharing need to be reduced.3

  • Systemic risk oversight of FMIs should be expanded.4 It will be important to cover identification and management of interdependencies and interconnections between the FMIs as well as stand-alone risks. Regulations governing FMIs should be completed and implemented consistently by the relevant agencies.

Time-Varying Macroprudential Policy: An Illustration

To illustrate the possible effects of time-varying macroprudential policies in the United States, a hypothetical path of a countercyclical capital buffer (CCB) was estimated using the BCBS formula. Three measures of credit were considered: (i) private sector loans of total financial system; (ii) private sector debt; and (iii) private sector loans of all U.S. chartered depository institutions. In line with the BCBS methodology, a one-sided Hodrick-Prescott filter was used to extract the trend and calculate the credit gap. It was assumed that the CCB increases linearly for a credit gap between 2 and 10 percent. Growth rates of house prices and banks’ stock prices (two standard deviations from the mean) were used as indicators for the CCB release phase.

The CCB could have had significant mitigating effects. If the BCBS proposal had been in place since 1995 (text chart), the buffer would have built up to its maximum 2–4 years before the financial crisis (using the first two measures of credit). A calculation based on 2008 Tier 1 capital shows that the additional buffer would have saved up to 40 percent of the fiscal costs (equivalent to US$250 billion) of the financial crisis. While this is only a hypothetical exercise that has the benefit of hindsight, the savings could be even bigger, because the calculation does not consider the likely effect of the buffer on bank lending behavior: requiring additional capital before the crisis could have discouraged bank lending and mitigated the housing price boom.


Countercyclical capital buffer, United States, in percent of RWA

Citation: IMF Staff Country Reports 2015, 170; 10.5089/9781513592787.002.A001

Source: IMF staff calculations based on U.S. banking system data.Note: For further discussion and other country examples for CCB, see IMF, 2013, “Key Aspects of Macroprudential Policy—Background Paper” (http://www.imf.org/external/np/pp/eng/2013/061013C.pdf). Jurisdictions can impose a CCB higher than 2.5 percent, but mandatory reciprocity will not apply to the additional amounts.

B. Supervision and Regulation

35. The complex regulatory framework continues to present challenges for coordination and group-wide supervision. An opportunity was missed to consolidate the landscape, which consists of a number of overlapping federal agencies and several hundred state regulatory agencies, self regulatory organizations (SROs), and coordinating groups. Consolidation would substantially reduce gaps, overlaps, potential delays in regulatory actions, and barriers to data sharing.

36. The prudential oversight of banks, insurance companies, and securities markets has been strengthened, but needs to be updated to respond to emerging risks. Some gaps have been identified in the assessment of the supervisory and regulatory framework against international standards (Table 2). In addition, a key risk faced by the entire financial system is that of loss and disruption of activity from cyber attacks, which have increased with several major risk events occurring in recent periods. The regulatory agencies are working with the government security establishment to develop and share best practices to deal with such events.

Table 2.

Compliance with International Standards

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KEY: Fully Implemented/Observed/Compliant Broadly Implemented/Largely Observed/Largely Compliant Partly Implemented/ Partly Observed Partly CompliantSource: Detailed Assessments of Observance, published April 2, 2015 (www.imf.org/external/np/fsap/fsap.aspx)


37. The federal banking agencies have improved considerably in effectiveness, and achieve a high degree of compliance with international standards (Table 2). In response to global and domestic reforms, they have stepped up their supervisory intensity. There has also been a marked improvement in the risk management practices (including stress testing practices) of banking organizations. Comprehensive stress testing has been integrated as part of the supervisory toolkit. The resolvability planning exercise is also beginning to influence the complexity of banking organization.

38. But the existence of a complex, multi-agency framework continues to pose challenges for the coordination of timely responses to risk. There is still substantial duplication of supervisory effort, and this can result in uncertainty for institutions when rules or guidance appear contradictory. It would also be beneficial to redefine the federal banking agencies’ mandates so that safety and soundness are given primacy in their supervisory objectives, leaving consumer protection to the CFPB. Finally, charter shopping has not been eliminated, the dual banking structure poses a challenge for international cooperation, and enforcement actions are not always coordinated with home supervisors.

39. There are other pressing gaps in the bank supervisory framework. A clearer delineation of the contribution of boards and senior management in supervisory assessments would aid efforts to improve risk management. The concentration risk framework needs to be strengthened to cover market and other risk concentrations and there remain gaps in the large exposures and related parties framework. Supervisory guidance and reporting requirements in operational risk are very disparate. The approach to interest rate risk in the banking book is in marked contrast to other risks, with no specific capital charges or limits being set under Pillar 2. Differences vis-à-vis Basel III remain in the capital adequacy regime as pointed out by the Basel Committee’s Regulatory Consistency Assessment Program, and an interagency proposal on compensation reform has yet to take shape to supplement supervisory guidance.

40. The enhanced supervisory focus on large banks is welcome, but should not result in supervisors overlooking small deposit takers. Supervisory expectations are tailored to be less strict for smaller, non-systemic banks. This proportionate approach is generally appropriate although small banks with higher risk activities should be encouraged to adopt better practices in corporate governance, risk management, and contingency planning commensurate with their risk profile, especially given that previous episodes of crisis have originated in small and medium banks.


41. The U.S. insurance supervision framework has been strengthened. State regulators—under the aegis of the NAIC—have initiated solvency modernization and taken steps to strengthen group and international supervision. The newly established Federal Insurance Office (FIO) has provided a mechanism for identifying national priorities for reform and development, under the umbrella of the FSOC. The extension of the FRB’s responsibilities to cover consolidated supervision of certain insurance groups should strengthen oversight of systemic risks.

42. However, there are important gaps in compliance with international standards, and reforms remain a work in progress. At the state level, transition to more principles-based regulation and risk-focused supervision is taking time and faces obstacles. Increased emphasis is being placed on risk management through the introduction of an Own Risk and Solvency Assessment (ORSA) with wide-ranging implications for supervisory work and resourcing. There remain differences in independence, accountability and funding of insurance supervisors across states, as well as variations in their regulations and supervisory approaches. The FRB’s supervisory approach to insurance groups still needs to strike out in its own direction. Staffing regulation and supervision with appropriate skills and expertise is a continuing challenge. The approach to valuation and solvency regulation could lead to regulatory arbitrage.

43. The valuation standard should be changed to reflect the economics of the products better, and solvency regulation extended to groups. Principles-Based Reserving, part of the solvency modernization initiative, would mitigate some of the issues, but its implementation date is uncertain. In relation to capital, there are no group-level capital standards in place, whether supervised by states or the FRB, including for the three insurance groups designated by FSOC. Active usage of affiliate captive reinsurers creates uncertainty whether capital adequacy is sufficient at the group level.

44. And, the regulatory system for insurance remains complex and fragmented. The NAIC continues to promote uniform standards of state regulation, but cannot enforce convergence. FIO can only highlight issues and lacks powers to bring about convergence. The extension of the FRB’s powers to insurance supervision of designated nonbank financial companies has added to the challenges of achieving regulatory consistency. FSOC brings together most of the players, but its mandate is focused on system-wide stability and its membership does not provide for sector-wide coverage of insurance on the same basis as others.

45. An insurance regulatory body with nation-wide remit is needed to deliver enhancements and greater regulatory and supervisory consistency. This agency would require sufficient resources, accountability, and independence, and would have the mandate and powers to establish national standards, ensure regulatory consistency, and coordinate supervisory actions.

Securities and Derivatives

46. The securities and derivatives regulatory and supervisory framework has improved considerably, but would benefit from further enhancements. The regulatory perimeter now covers OTC derivatives markets, hedge fund managers, and advisors in the municipal securities markets. However, the SEC continues to have limited direct authority over disclosure by issuers of municipal securities. The CFTC is well advanced in implementing the new OTC derivatives framework, but shortcomings exist in the framework for commodity pool operators (CPOs) and advisors in commodity markets. Protection of investors in commodity pools could also be enhanced.

47. Risks in the asset management industry and systemic risk monitoring in general require close attention. Explicit requirements on risk management and internal controls do not yet apply to asset managers in either securities or commodities markets. Monitoring asset management risks requires continued work on improving data availability and risk identification tools. The SEC would also benefit from enhancing its mechanisms to ensure a holistic view on emerging and systemic risks. The CFTC should continue to work on improving the quality of swaps data.

48. The SEC faces challenges in dealing with the fragmented equity market structure and the significant use of automated, high-speed trading technology. This requires analyzing whether the degree of dark trading has a negative impact on price discovery and market efficiency. The increased automation of trading and differences in the timeliness of data feeds run the risk that market participants no longer trade on the basis of the same information. The SEC recently established an Equity Market Structure Advisory Committee to advise on these issues.

49. Addressing the gaps requires increasing the SEC’s and CFTC’s resources, and enhanced coordination. SEC needs to be equipped to significantly increase the number of asset manager examinations from the current coverage of only around 10 percent of investment advisers per year. CFTC also needs more resources to effectively discharge its mandate (expanded by the DFA), including supervision of FMIs, responding to cybersecurity risks, and making the necessary investments in technology. Self-funding or multiyear budgeting within the current budget framework would enhance the agencies’ ability to decide on their priorities and plan longer term. With the current complex regulatory and supervisory arrangements, efficiencies can also be reached through enhanced coordination with other agencies and self-regulatory organizations.

C. Market-based Finance and Systemic Liquidity

50. Although it has reduced from its pre-crisis peak (Appendix Figure 7), market-based financing (“shadow banking”) continues to play a very important role in U.S. funding markets. Its component systems were both sources and transmitters of shocks in the GFC, and there remain a number of ways in which the liquidity of these markets could be adversely impacted, either through issues of microstructure or even infrastructure of these markets. Identifying, managing and regulating risks in these markets is complicated by the entity-based regulatory system—increasing the importance of the FSOC oversight and coordination role.

51. The underlying infrastructure of the tri-party repo (TPR) market, a key stress point in the GFC, has been improved. The amount of intra-day credit extended to the collateral providers has been largely eliminated by modifying the settlement cycle and improving the collateral allocation processes. Further, clearing banks are now limited to funding a maximum of 10 percent of a dealer’s notional tri-party book through pre-committed lines (incurring a capital charge).

52. The resilience of the TPR market needs to be enhanced to reduce firesale risk and the reliance on the two clearing banks. Market participants are considering the use of some form of CCP service for government-guaranteed securities, which could reduce (though not eliminate) run-risk. But the proposals do not cover non-government assets used in TPR, where most risk is involved. The authorities should consider how best to address remaining weaknesses: TPR is central not only to short-term funding markets, but to the Fed’s own operations with the market.

53. Measures should be taken to reduce the vulnerabilities of open-ended MFs to runs. MFs have a regulatory obligation to meet redemption requests within 7 days, and to do so at the NAV prevailing when the request is made, rather than at the price at which shares or assets are sold. While redemptions can be funded by borrowing, it is the remaining investors that have to take on loans to purchase the shares redeemed. A change in settlement price to sales-date NAV instead of redemption-date NAV, and to actual sale price (the bid price) instead of mid-price, could reduce run risk by placing the cost of exit onto those who are redeeming shares.

54. The introduction of Variable Net Asset Values (NAVs) across all MMMF categories, together with changes to investment and redemption rules, would help address important structural weaknesses. MMMFs have been made more resilient, but the use of stable NAVs persists. Even after 2016, they may apply to over half the funds managed by MMMFs, allowing both institutional and retail investors to treat these investments as cash-equivalent despite the greater liquidity risks involved than with cash (non-money market open-ended MFs use a variable NAV). Limiting MMMF repo lending to securities that MMMFs are allowed to hold outright could reduce post-default run-risk by allowing for a gradual and orderly liquidation of securities. Currently, MMMFs would be required to sell such assets (mostly, long-term treasury securities) immediately, unless a no action letter is issued by the SEC. Other changes to take effect from 2016 will allow MMMFs to impose fees and redemption gates in the event of stress, but it is not clear how widely these will be used, or whether their potential use could even exacerbate run risks.

55. The capital and liquidity rules covering broker-dealers should be enhanced. Post crisis, the major broker-dealers fall under BHCs, which are subject to FRB consolidated supervision. More recently, the assets of those outside this perimeter have been increasing, though they are still small in absolute terms. Over time, there could be a greater expansion of firms not subject to these tighter controls on BHCs that provide opportunity for regulatory arbitrage. It is thus important that regulations governing all broker-dealers be introduced soon to address the weaknesses revealed during the GFC, including in the area of leverage and liquidity.

56. More also needs to be done in the area of securities lending and cash collateral reinvestment, to ensure that risks are properly appreciated and managed. Since the crisis, investors—whether mutual funds, insurance companies or pension funds—have taken an active interest in requiring safer mandates from asset managers. Repo placements with broker-dealers are no longer an easy option, as the latter are less willing to accept short-term placements on account of their regulatory requirements. Asset managers have reportedly redirected cash collateral raised from securities lending activities into investments in MMMFs. But while on the face of it, this reduces maturity and credit risk entailed in securities lending, the risks may be masked rather than removed. MMMFs themselves can only earn a return on re-investing the funds by taking some credit and/or liquidity risk. Comprehensive disclosure requirements should be placed on funds’ securities lending activities, in the absence of which it is impossible to understand fully the extent and nature of financial risks to investors in the funds and to markets.

57. The U.S. authorities recognize that data limitations prevent a consolidated assessment of trends and risks across repo as well as securities lending markets. The OFR, the FRB, and the SEC are working on pilot surveys for bi-lateral repo and securities lending activities that cover a selection of broker-dealers and agent lenders. These initiatives could be complemented by publishing more granular data on TPR repos.

D. Financial Market Infrastructures

58. U.S. FMIs are among the largest in the world and many are globally systemically important. Most global systemically important financial institutions are among their participants, and these participants represent thousands of customers, including correspondent banks, investment companies, and nonfinancial corporations, both domestic and foreign. Multiple memberships of U.S. banks in CCPs around the world further interlink the U.S. and global financial systems. Disruption of critical operations at one of the U.S. FMIs could have serious systemic implications. The DFA helps reduce systemic risks related to U.S. FMIs, but implementation is still in progress and it is important to promptly complete the rules applicable to designated FMUs and ensure their enforcement.

59. System-wide risks related to interdependencies and interconnections in the U.S. FMI landscape could be further identified and managed. Issues to be analyzed by the relevant authorities include (i) dependency of FMIs on banking services of only a few G-SIBs; (ii) membership of banks in multiple FMIs; (iii) pro-cyclicality of margin calls; and (iv) cross-margining arrangements. Identification of system-wide risks, for example, inclusion of FMIs in the network analysis efforts of the OFR, would further improve the understanding of exposures among financial firms and potential channels of contagion.

60. The provision of Fed accounts to designated FMUs could reduce their dependency on commercial banks’ services by allowing settlement in central bank money. Concentration of service provision by G-SIBs poses a potential threat to the stability of FMIs. The authorities are aware of this risk and are further increasing the number of service providers. Still, given the current system-wide concentration of service provision by only a very few G-SIBs, the default of one of these banks could have system-wide repercussions. The Fed is therefore encouraged to provide accounts to designated FMUs, as permitted by the DFA.

61. Given the increased systemic importance of CCPs, it is crucial to pursue work on further risk mitigation. The U.S. authorities are encouraged to continue efforts to increase the robustness of CCPs. Several issues identified at the domestic and international levels warrant further attention, such as cyber resilience, standardized stress testing, harmonized margin requirements, implementation of recovery and resolution regimes, the adequacy of CCPs’ loss absorbing capacity in resolution, and continued coordination between the supervisors of CCPs and their main clearing members.

E. Housing Finance

62. Mortgage markets—at the epicenter of the 2008–09 crisis—continue to benefit from significant government support. Important steps, such as the QM and QRM rules, have been taken to help address the structural weaknesses exposed by the crisis, but Government-Sponsored Enterprises reform remains the largest piece of unfinished business. There is still no clarity as to when Fannie Mae and Freddie Mac will exit conservatorship or consensus on the shape of a reformed housing finance system. The federal government backs 80 percent of new single-family home loan originations—a high figure. One in five loans originated is insured by the FHA, although it falls short of its capital requirements, which creates fiscal and financial risks due to moral hazard, the distorted competitive landscape, and large subsidies for debt-financed homeownership.

63. The systemic importance of mortgage markets stems from several features. Home mortgages, at some $10 trillion, are the largest component of nonfinancial private sector debt, and most are securitized, generating strong interconnections not only with the rest of the U.S. financial system but also with the rest of the world. The system also facilitates continued provision of 30-year fixed-rate mortgages with no prepayment penalty—unusual by international practice, not needed by borrowers (who nearly all refinance in under 10 years), and imposing unnecessary risks and complexity on the financial system.

64. As called for in the 2010 FSAP, it is important to complete the reform of the U.S. housing finance system. Public policy objectives—such as affordable housing for the less well-off—would be better served by targeted subsidies, rather than insurance and securitization activities which dominate the national market, distorting economic incentives. Key features of a future housing finance system, with an appropriate role for and supervision of the private sector (including the resumption of Private Label Securitization)5, should include:

  • Winding down the Fannie Mae and Freddie Mac investment portfolios within a well-defined time period and supervising them commensurate with their systemic importance in the interim;

  • Leveraging the government’s role in the market to support standardization and computerization of mortgage data;

  • Introduction of a sizeable first-loss risk borne by private capital, with a public backstop that is strictly limited to catastrophic losses and is funded by risk-based guarantee fees;

  • Ensuring the maintenance of appropriate incentives for loan originators and those involved in the securitization chain, including ‘skin in the game’;

  • Clear separation of regulatory roles for promoting access to credit and ensuring the stability and safety of the mortgage market;

  • Reduction in cross-subsidization and market distortion by charging separately and appropriately for prepayment of fixed-rate mortgages.

F. Financial and Market Integrity

65. The U.S. authorities have played a key role in the ongoing international review of financial benchmarks to reinforce market integrity. They have pledged to fight market abuse, including benchmark manipulation. They have been active participants in the multilateral engagement on benchmark reform and are exploring options for strengthening major interest rate benchmarks with the private sector, including both rates incorporating bank credit risks and risk-free rates.

66. Work is underway to strengthen financial integrity, but more rapid progress is needed to enhance transparency. Draft regulations have been produced to strengthen financial institutions’ obligations to identify and verify the identity of beneficial owners; and policy intentions announced to improve the authorities’ access to information on the beneficial ownership and control of U.S. companies. But these measures—to address deficiencies identified in the last Financial Action Task Force (FATF) mutual evaluation report of June 2006—are progressing slowly. Even when completed, the intended changes may not address fully all of the deficiencies identified in the last FATF mutual evaluation report.6 The lack of sufficient transparency may impact the authorities’ effectiveness in identifying and prosecuting persons who commit money laundering using U.S. companies and trusts, including laundering associated with taxes evaded in the United States and abroad, by U.S. citizens and foreigners respectively, and to cooperate effectively with their foreign counterparts in this regard.

G. Financial Inclusion, Literacy, and Consumer Protection

67. Promoting greater financial inclusion should feature more prominently on the policy agenda. The Global Findex survey ranks the United States only 27th out of 147 countries in terms of the percentage of adults with a bank account in a formal financial institution, and a 2013 FDIC survey finds that some 20 percent of U.S. households are “underbanked” and 8 percent are “unbanked”. More work is needed to identify barriers to inclusion. The enhanced focus on consumer protection, including the setting up of the CFPB, is an important part of the crisis response, and is beneficial for both financial stability and financial inclusion. Improving financial literacy will also support these goals, and the activities of the Financial Literacy and Education Commission are welcome steps in this direction.

…And for Reinforcing Safety Nets and the Resolution Framework

A. Liquidity Backstops

68. The Primary Credit Facility could be repackaged to clarify that it is a monetary policy/payments system facility. The history of the ‘Discount Window’ (which in 2003 was split into Primary and Secondary Credit Facilities) means that depository institutions may be reluctant to use the Primary Credit Facility. The goal of the repackaging would be to remove the risk of stigma from the Primary Credit Facility, which serves primarily to cover unanticipated end-of-day liquidity shortfalls, and to distinguish it more clearly from the Secondary Credit Facility. The latter would remain as a short-term lender of last resort facility for (solvent) banks, and so involve regulatory intervention as well as carrying a more penal interest rate.

69. Consideration should be given to relaxing the restrictions that the DFA places on the Fed’s ability to provide liquidity to designated nonbank institutions. The DFA strictly limits Fed support to programs or facilities with “broad-based eligibility,” but this could constrain the Fed from taking action to avoid or minimize contagion. At minimum, the authorities are encouraged to consider enabling the Fed to provide liquidity support—subject to appropriate conditionality—to solvent non-banks that have been designated as systemic by the FSOC.

70. The DFA permits the Fed to provide liquidity backstopping to designated FMUs; any technical obstacles to this should be removed. Private sector backstops should be the first line of defense for any FMI; Fed support to designated FMUs should be at its discretion and, as with any other lender of last resort support, only to solvent and viable institutions, against good collateral.

71. The Federal Home Loan Banks (FHLBs) were an important source of funding (doubling to some $1 trillion) during the crisis. The FHLBs benefit from an implicit government guarantee and from a super lien over the assets of borrowers, and their loans to borrowers receive favorable treatment under the LCR. Regulators should review the liquidity and capital requirements imposed on FHLBs, given an apparent increase in the interconnectedness between the FHLBs and their members.

B. Crisis Preparedness and Management

72. Agencies have taken steps to enhance crisis preparedness and management, but more formal arrangements should be established and the FSOC assigned responsibility for system-wide coordination. While the response to the 2008–2009 crisis was flexible, it suffered from a lack of preparation in some respects. Agencies have since then developed strategies for handling the failure of individual systemic institutions, but there are no formal arrangements at a system-wide level. Several contingency planning exercises have been conducted. However, existing inter-agency crisis preparation arrangements remain informal, with the risk that inter-linkages and gaps may not be fully covered on a systematic basis, possibly hampering system-wide crisis management. Coordinating work could be undertaken by one of the FSOC committees under the oversight of the Council, building on rather than replacing existing practices and efforts made by individual agencies.

C. Resolution

73. The resolution regime for financial institutions has been significantly strengthened. Title II (“Orderly Liquidation Authority”, OLA) of the DFA sets forth a new resolution regime for “covered financial companies”, granting resolution powers to the FDIC. The OLA powers are extensive, align broadly with best international practice, and reflect experiences obtained over many years by the FDIC in resolving banks. The FDIC has published a top down or “single point of entry strategy” as one option for resolving covered financial companies and their groups using these powers. Under such a strategy, loss absorbing creditors would be bailed-in to recapitalize a bridge bank and capital and liquidity streamed down to entities within the group, including overseas. However, effectively resolving large, complex, cross-border financial firms, entails significant challenges that continue to warrant further attention.

74. Effective planning and significant efforts at the group level are required to implement orderly resolution. The DFA requires certain financial companies to prepare plans for their orderly resolution under ordinary insolvency law in the event of material financial distress or failure, but the agencies’ review of the plans of the largest domestic banking groups and FBO’s highlighted significant shortcomings. As a result, the FRB and the FDIC reported in August 2014 and March 2015, respectively, that the plans failed to address significant structural and organizational impediments to orderly resolution—prompting a need for further actions to improve resolvability. In addition, and in accordance with emerging international consensus, minimum levels of total loss absorbing capital (TLAC) need to be put in place, at the right levels in systemic groups, to enable effective resolution.

75. Further improvements are needed with respect to cross-border issues. Notwithstanding the progress made, a number of critical aspects are not in place, including statutory powers to give prompt effect to actions taken by foreign resolution authorities. The deposit preference rules applicable to insured depository institutions under the Federal Deposit Insurance Act, as well as ring-fencing of foreign-owned uninsured bank branches can complicate effective coordination by typically ranking claims of creditors in the United States above those abroad. Efforts to enhance resolution preparedness, including by coordinating—to the maximum extent possible—institution-specific resolution strategies on a cross-border basis are ongoing. The finalization of such agreements, setting out the process for information-sharing before and during a crisis as well as the progress on effective group-wide resolution plans and enhancing resolvability, will mark important progress.

76. Not all financial firms that could be systemic are subject to effective resolution regimes or planning. U.S. insurance companies cannot be resolved using the full OLA powers and the fragmented state based resolution regimes lack important tools necessary to deal effectively with a systemic entity. Furthermore, some potentially systemic firms such as asset managers are not yet subject to DFA’s Title I resolution planning requirements, and may not be resolvable effectively using OLA powers. Finally, U.S. agencies are currently discussing how FMIs would be resolved in the event of a failure.

D. Deposit Insurance

77. Welcome measures have been enacted to strengthen deposit insurance for banks.7 Deposit insurance funds were substantially depleted during the crisis. The DFA increased the minimum reserve ratio for the FDIC fund and removed its hard cap. The FDIC Board set a higher target at 2 percent of insured deposits—although on current plans this may not be reached before the end of the next decade. Consideration should be given to raising assessments, as bank profitability recovers, to reach the target sooner.

78. Measures should also be taken to strengthen the funding and coverage of the deposit insurance scheme for credit unions. In the case of credit unions, which have a separate fund, a much lower amount is paid-in (as the first one percent is structured as deposits from members), a hard cap of 1.5 percent remains, and membership is not compulsory. With some credit unions potentially becoming systemic, there is a need to enhance the deposit insurance regime by removing the cap, targeting a significantly higher level of paid-in funds, and making membership mandatory for all credit unions.

Appendix I. Financial System Profile

Appendix Table 1.

Financial System Assets, 2002–2014

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Source: Federal Reserve (Flow of Funds), IMF staff calculations.1 Total financial assets; some assets may be double-counted if they appear on the balance sheet of more than one group of financial intemediaries

Federal home Loan Banks, Fannie Mae, Freddie Mac, Farmer Mac, Farm Credit System, the Financing Corporation, and the Resolution Funding Corporation. The Student Loan Marketing Association (Sallie Mae) was included until it was fully privatized in 2004:Q4.

GNMA, Fannie Mae, Freddie Mac, Farmer Mac, and Farmers Home Administration pools. Beginning 2010:Q1. almost all Fannie Mae and Freddie Mac mortgage pools are consolidated on Fannie Mae’s and Freddie Mac’s balance sheets (table L.123). Also includes agency- and GSE-backed mortgage pool securities which are used as collateral for agency- and GSE-backed and privately issued CMOs. Excludes Federal Financing Bank holdings of pool securities, which are included with federal government mortgages and other loans and advances.

Funding subsidiaries, custodial accounts for reinvested collateral of securities lending operations, Federal Reserve lending facilities, and funds associated with the Public-Private Investment Program (PPIP)

Appendix Figure 1.
Appendix Figure 1.

Financial System Size

(% of GDP)

Citation: IMF Staff Country Reports 2015, 170; 10.5089/9781513592787.002.A001

Source: Flow of Funds. Data in the bottom chart are for 2013, except for the United Kingdom (end 2012).
Appendix Figure 2.
Appendix Figure 2.

Pension Funds

Citation: IMF Staff Country Reports 2015, 170; 10.5089/9781513592787.002.A001

Source: Haver Analytics.
Appendix Figure 3.
Appendix Figure 3.

Banks: Number and Distribution by Size

Citation: IMF Staff Country Reports 2015, 170; 10.5089/9781513592787.002.A001

Source: FDIC
Appendix Figure 4.
Appendix Figure 4.

Banks’ Balance Sheets and Income Statement

Citation: IMF Staff Country Reports 2015, 170; 10.5089/9781513592787.002.A001

Source: FDICNote: 2014 data are 2014/Q3 annualized.
Appendix Figure 5.
Appendix Figure 5.

Bank Funding

Citation: IMF Staff Country Reports 2015, 170; 10.5089/9781513592787.002.A001

Appendix Figure 6.
Appendix Figure 6.

Money Market Funds and Mutual Funds

(Billion US$)

Citation: IMF Staff Country Reports 2015, 170; 10.5089/9781513592787.002.A001

Source: Federal Reserve (Flow of Funds data).
Appendix Figure 7.
Appendix Figure 7.

Market-Based Financing: Evolution and Components

Citation: IMF Staff Country Reports 2015, 170; 10.5089/9781513592787.002.A001

Source: Federal Reserve (Flow of Funds data).
Appendix Figure 8.
Appendix Figure 8.

Structure of Financial Markets

Citation: IMF Staff Country Reports 2015, 170; 10.5089/9781513592787.002.A001

Source: Federal Reserve (Flow of Funds)
Appendix Figure 9.
Appendix Figure 9.

Debt Securities Market

Citation: IMF Staff Country Reports 2015, 170; 10.5089/9781513592787.002.A001

Source: Fed Flow of Funds
Appendix Figure 10.
Appendix Figure 10.

Mortgage Market

Citation: IMF Staff Country Reports 2015, 170; 10.5089/9781513592787.002.A001

Source: Federal Reserve (Flow of Funds)

Appendix II. Financial Soundness Indicators vs. Peer Countries

Data for 2008–2014, in percent

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Source: IMF staff based on country authorities data.Note: Financial soundness indicators methodology as per http://fsi.imf.org/fsitables.aspx.

Appendix III. Risk Assessment and Stress Testing

To quantify the impact of the threats to financial stability, the FSAP has carried out a set of stress tests, focusing spillovers and correlations in the system. The stress tests followed the principles of recent FSAPs; used new methodologies from the 2010 U.S. FSAP; and made use of the stress testing efforts by the U.S. authorities. The stress testing work was guided by the Risk Assessment Matrix (Appendix Table 2). The key features of the stress testing approach are summarized in the Stress Testing Matrix (Appendix Table 3).

Appendix Table 2.

Risk Assessment Matrix

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Note: The risks are ordered first by impact (high to low), and second by likelihood (high to low).
Appendix Table 3.

Stress Testing: Overview of Coverage, Scenarios, and Dates

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Note: for details on the methodologies, see the Stress Test Matrix (Stress Testing Technical Note). The table focuses on IMF-run stress tests and does not include the authorities-run and companies-run stress test.

Stress test scenario design approach followed the principles spelled out in IMF policy papers on stress testing and applied in recent FSAPs.1 A baseline and a “stressed” scenario were considered. The “severely adverse scenario” in the U.S. authorities’ 2015 Annual Stress Tests under the DFA is comparable in terms of severity with what is usually described as “extreme but plausible” scenario in FSAPs. Therefore, and for reasons of comparability and simplicity, the FSAP used the DFA scenarios as a reference point. Alternative scenarios and single factor shocks, to examine sensitivity of results to assumptions, were also introduced, and the calculations covered both solvency and liquidity tests.

Reflecting the authorities’ confidentiality requirements, the analysis—similarly to the 2010 FSAP—utilized publicly available data. While an impressive range of information is publicly available on U.S. financial institutions, the lack of access to more granular supervisory information was a constraint. For example, due to the lack of access to comprehensive data on the extent to which financial institutions are connected to each other through lending and other relationships, the team’s assessment of “interdependencies” and contagion relied largely on statistical models that are subject to uncertainty and rely on equity market-based data. These limitations need to be understood when interpreting the stress test results.

To obtain a more comprehensive assessment than possible with any single approach, the U.S. FSAP stress tests combined three broad approaches:

  • Bottom-up. The FSAP critically reviewed the results of the U.S. authorities’ CCAR and DFA stress tests.

  • Top-down cross-check using balance sheet data. Similarly to the 2010 FSAP, this was carried out largely by the FSAP team. Resembling in essence the DFA stress test, but relying on publicly available data, it modeled the effects of macroeconomic developments on financial institutions’ health. In addition to scenario analysis, the calculations included single-factor shocks. The modeling took into account methodological improvements since the 2010 FSAP. The team considered firm-specific differences in earnings and losses, based on portfolio composition and historical performance. The calculations were complemented by a network analysis based on a matrix of exposures among six large banks. On insurance, the team developed an IMF stress tests of major insurance companies. These tests included an adverse scenario combining negative shocks to the companies’ assets, a liability-side shock impacting variable annuity writers, and major insurance shocks such as catastrophic events and pandemics. For consistency and comparability, the macroeconomic parameters of these tests were the same as those used for the DFA tests; however, some simplifications had to be made to accommodate the lower level of granularity of publicly available information.

  • Top-down calculations using market-based data. Calculations by the FSAP team covered feedbacks among banks and nonbanks, including with entities abroad. The analysis adds depth by providing estimates of unexpected losses, correlations and potential spillovers. It highlights the correlations between banks and nonbank financial sector, between the financial and nonfinancial sector, and the international dimension. To do this, the team derived measures of estimated probabilities of default from equity market data. The methodology followed up and expanded on the techniques used in the first U.S. FSAP. Both the “systemic macro-financial stress test framework” and the “contingent claims analysis (CCA)” employed in the 2010 U.S. FSAP have been subsequently used in FSAPs for other jurisdictions and other IMF work. In the process, both techniques have been further strengthened. The equity market-based calculations complemented the balance-sheet based approaches by assessing correlations and by using this information to estimate the magnitude of potential systemic impact to the financial system.

The stress scenario reflected the severely adverse scenario from the DFA stress test that was characterized by a typical post-war U.S. recession. 2 In the scenario the unemployment rate rose by 4 percentage points over a two-year period. Real GDP was 4.5 percent lower than the baseline by the end of 2015 (GDP growth rates were negative for 5 quarters), equity prices fell by 60 percent in one year, house prices declined by 25 percent over the first two years, corporate spreads rose by 330 basis points, and mortgage rates increased by 80 basis points. The baseline scenario was informed by the Blue Chip Economic Consensus and broadly reflected the IMF’s World Economic Outlook projections as of January 2015.

Banking tests covered the largest 31 BHCs (85 percent of sector assets). The institutions were subjected to credit and liquidity risks in the context of a tail risk scenario. All tests were conducted based on publicly available, consolidated data as of September 2014. The solvency stress tests assessed the level of banks’ Basel III Common Equity Tier 1 ratios against a hurdle rate consisting of the regulatory minimum consistent with the Basel III transition schedule augmented by the capital conservation buffer and a capital surcharge for Globally Systemically Important Banks (GSIBs) which are both phased in over the forecast period.

Appendix IV. Key Regulations Where Implementation is Ongoing

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Appendix V. Report on the Observance of Standards and Codes

A. Introduction

This report summarizes the assessments of the current state of the implementation of the Basel Core Principles for Effective Banking Supervision (BCP); the IOSCO Principles of Securities Regulation and the IAIS Principles of Insurance Supervision in the United States. These assessments have been completed as part of a FSAP undertaken by the International Monetary Fund (IMF) and reflect the regulatory and supervisory framework in place as of the date of the completion of the assessment in November 2014. The full Detailed Assessment Report (DAR) has been published on April 2, 2015,1 which also detail the Overview of the Institutional Setting and Market Structure and the Preconditions for Effective Banking Supervision.

B. Basel Core Principles for Effective Banking Supervision

Information and Methodology Used for the Assessment

An assessment of the effectiveness of banking supervision requires a review of the legal framework, and detailed examination of the policies and practices of the institutions responsible for banking regulation and supervision. In line with the BCP methodology, the assessment focused on the three FBAs as the main supervisors of the banking system, and did not cover the specificities of regulation and supervision of other financial intermediaries, which are covered by other assessments conducted in this FSAP. The assessment did not cover supervision conducted by local State regulators,2 the supervision of credit unions, or the activities of the CFPB.

The assessment was carried out using the Revised BCP Methodology issued by the BCBS (Basel Committee of Banking Supervision) in September 2012. The U.S. authorities chose to be assessed and rated against not only the Essential Criteria, but also against Additional Criteria. The assessment team3 reviewed the framework of laws, rules, and guidance and held extensive meetings with U.S. officials, and additional meetings with banking sector participants and other stakeholders (auditors, associations, etc.). The authorities provided a self-assessment of the CPs, as well as detailed responses to additional questionnaires, and facilitated access to supervisory documents and files, staff, and systems. The very high quality of cooperation received from the authorities is appreciated.

Main Findings

The U.S. federal banking agencies (FBAs)4 have improved considerably in effectiveness since the previous FSAP. In response to global and domestic reforms, particularly the Dodd-Frank Act (DFA), the FBAs have stepped up their supervisory intensity, especially of large banking organizations, putting emphasis on banks’ capital planning, stress testing, and corporate governance. To match, the FBAs have also enhanced their supervisory capacity, adding significantly to their staffing numbers and skills base. These improvements are reflected in the high degree of compliance with the Basel Core Principles for Effective Banking Supervision (BCP) in this current assessment.

The Dodd-Frank reforms have resulted in some rationalization of supervisory responsibilities but they did not address, fundamentally, the fragmented nature of the U.S. financial regulatory structure. The FBAs are committed to making the arrangements work and cooperation has clearly improved. Nonetheless, there is substantial duplication of supervisory effort, particularly in respect of entities in major banking groups, and the ongoing risk of inconsistent messages from the agencies.

The U.S. prudential regulatory regime is a complex structure of federal statutes, regulations and reporting requirements, and policy statements and supervisory guidance. Since the crisis, the DFA and other initiatives have introduced various “tiers” of prudential requirements for banks and bank holding companies, which underpin the heightened supervisory focus on large banking organizations but have added to the complexity of the regime. Many requirements of the BCP are in practice, however, determined by the supervisor under a principles-based approach. Such an approach provides flexibility for supervisors to tailor their actions to each individual situation and be more nuanced in their response. Yet, in many cases, this principles-based approach is reflected in a lack of specificity in the regime, for example, the absence of guidelines or supervisory “triggers” for various risks.

Mandate, independence, and cooperation (CP 1-3)

The U.S. system of multiple FBAs with distinct but overlapping responsibilities continues to put apremium on effective cooperation and collaboration. The FBAs will need to ensure that the significant improvements in collaboration in recent years become fully engrained in the modus operandi of each agency. Internationally, the establishment of supervisory colleges and crisis management groups (CMGs) has given greater urgency to information-sharing arrangements, and there are no legal or other impediments to the ability and willingness of the FBAs to cooperate and collaborate with foreign supervisors. The dual banking structure does pose a challenge for international cooperation, and state banking agencies with Foreign Banking Organization (FBO) presence do not always inform or coordinate enforcement actions with home supervisors.

The FBAs are operationally independent, and have clear mandates for the safety and soundness of the banking system. However, the FBAs also have other objectives, and the primacy of the safety and soundness objective needs to be better enshrined in legislation or mission statements to ensure a clear focus on this objective through different phases of the business cycle. In principle, the creation of a stand-alone Consumer Financial Protection Bureau (CFPB) should help establish a greater delineation between individual consumer issues and prudential issues, and give the FBAs a clearer sense of purpose, but the delineation is not yet sharp. There is no evidence of direct interference by industry and government in supervisory priorities or decisions. The high level of public and congressional scrutiny and resulting sentiment may have an indirect effect in creating a perception of “cyclical” supervisory responses.

Licensing, permissible activities, transfer ownership, and major acquisitions (CP 3-6)

The dual banking structure with charter choice adds to the challenge of cooperation and collaboration across multiple agencies. Banks may in principle choose to operate under a federal or state charter that best accommodates their business or strategic needs. Further, state-chartered banks may choose between being supervised primarily by the FDIC or primarily by the Federal Reserve as a member bank, in addition to the supervision of their state supervisory authority. Concerns have been raised that this choice can give rise to “regime shopping” that can undermine the integrity of U.S. regulatory arrangements. The DFA has restricted the ability of weak and troubled banks to change charters, but charter conversions of (well-rated) banks and savings associations continue on a modest scale. The FBAs need to guard against perceptions of differences in supervisory style or treatment in their regional offices that could sway the choices made by banks in charter conversions.

Supervisory approach, processes and reporting, and sanctioning powers (CP 8-10)

The FBAs have significantly increased their level of resources and intensity of supervision of the largest firms, and have articulated a tiered approach built on asset-based thresholds to achieve the desired proportionality. The traditional focus on on-site examinations has changed a little as there has been a shift towards more stress testing, analysis, and horizontal reviews. Overall, the supervisory regime is effective and risk-based, and this is coupled with an increasing focus on resolution (for the larger firms). However, there remains scope for better prioritization of matters requiring attention and their communication to banks, and for aligning supervisory planning cycles across agencies.

The FBAs have a long-established and effective regulatory reporting framework, with the flexibility to expand reporting requirements in response to pressing supervisory needs. There are safeguards built in to guard against redundant data items and information overreach. A lacuna is that supervisory data is not collected from banks at the solo level (i.e., at the level of the bank excluding its subsidiaries), which means supervisors and market participants may not have the information to test whether a bank is adequately capitalized on a stand-alone basis. In practice this omission has little prudential significance under current circumstances, as bank subsidiaries tend to be small relative to the parent bank and can only undertake limited activities that the bank itself could undertake in its own name; but supervisors should closely monitor the development of banking groups and consider introducing solo level reporting if the number or size of bank subsidiaries were to expand, or banking groups become less transparent.

The FBAs have a wide range of supervisory actions available to address safety and soundness concerns and do not hesitate to use them, although follow-up needs to be stricter. The PCA framework is the main plank of the early intervention framework and has clear triggers. The authorities could consider implementing rules for promoting early action for other triggers than bank capital as well as introduce more explicit rules and processes to deal with ageing of MRAs/MRIAs.

Consolidated and cross-border supervision (CP 12-13)

Since the 2010 FSAP, there have been major improvements in the ability of the FBAs to implement a comprehensive framework for consolidated supervision. Work still remains outstanding, though, on developing regulatory and supervisory rules, guidance, and a formal rating system for SLHCs, as well as on developing a capital rule for corporate and insurance company SLHCs.

Reflecting the large cross-border activities of U.S. banks and of foreign banking groups in the U.S., there is a comprehensive framework of policies and processes for co-operation and exchange of information between the FBAs and foreign supervisory authorities. As noted above, this is currently being strengthened by the work in supervisory colleges and in CMGs. The authorities should continue their efforts to establish agreements with their foreign counterparts on a framework of communication strategies, especially for crisis situations. While national treatment is the underlying principle, there remain some instances in which specific rules apply only to foreign institutions, such as the shorter run-off period for foreign branches in liquid asset requirements and requirements on FBOs to set up intermediate U.S. holding companies.

Corporate governance (CP 14)

Reflecting a global response to the crisis, major changes have taken place in supervisors’ demands on banks’ corporate governance and in the banks’ own approaches. Laws and regulations have gradually raised the requirements and there is clearly heightened focus by boards and management on corporate governance issues. The demands on board involvement and skills have increased substantially and this has, in many instances, led to changes in board composition and calls for wider skill sets of directors. In general, supervisory expectations are tailored to be less strict for smaller, non-systemic banks: while this means that there is a shortfall compared with the criteria, the assessors judged that this was not sufficiently material to alter their overall conclusions. The assessors welcome that supervisors are encouraging medium- and small-sized banks with higher risk activities to adopt better practices in corporate governance and risk management that are appropriate for the risk profile of these firms, moving them closer to the criteria and some of the principles outlined in the requirements for the larger banks.

Risk management, capital adequacy, and prudential framework (CP 15-25)

There have been substantial improvements in the risk management processes of banks, and risk aggregation has been greatly facilitated by the stress testing requirements. Given the enormity of the task of achieving and sustaining meaningful risk aggregation across the Global Systemically Important Banks (GSIBs), this remains very much work in progress and may take years to complete. Other areas in which progress needs to be made are a better delineation in supervisory guidance of the responsibilities of the board and management and more emphasis on contingency planning, particularly for smaller banks. The level of commitment to stress testing is substantial and there is considerable consensus that the outputs and outcomes of that process have improved risk aggregation. Supervisors and firms have become more efficient with each iteration and standards required were also increasing, although there is some way to go before supervisory led stress tests achieve an optimum level of data granularity. There is still room for improvement in firm-led stress testing, where firms seem to be struggling to determine the appropriate severity, while maintaining a scenario that remains business-relevant.

There is a robust and comprehensive approach to setting capital adequacy requirements, although the U.S. capital regime is in a state of transition. The FBAs have implemented major elements of the Basel II advanced approaches from January 1, 2014 and the U.S. standardized approach based on Basel II began to come into effect from January 1, 2015. The broad adoption of the Basel III definition of capital, when applicable to most banks from January 1, 2015, will improve the quality of bank capital by limiting the extent to which certain intangibles, which had previously counted for a high proportion of bank capital, can be included in capital. Stress testing is entrenching a forward-looking approach to capital needs and engaging boards and senior management more fully in the capital planning process. The introduction of risk-based capital rules based on Basel standards for most savings and loan holding companies removes an anomaly created by the previous case-by-case determination of capital requirements for such companies, although a comprehensive capital framework for all savings and loan holding companies is not in place. There are a number of differences between the new U.S. capital regime and the relevant Basel framework, particularly the absence of a capital charge for operational risk and for Credit Value Adjustment (CVA) risk in the U.S. standardized approach, which provides the “floor” for the advanced approach banking organizations and applies to all other banking organizations.

The long-established and rigorous process for evaluating banks’ approaches to problem assets and the maintenance of adequate provisions and reserves will be bolstered by accounting changes currently on the anvil. The FBAs have shown a consistent willingness to challenge unrealistic bank estimates of provisions and reserves and to secure increases they judge necessary. This steadfastness in approach will be tested as the U.S. economy continues to improve. Supervisory judgments in this area have been constrained by the “incurred loss” approach of U.S. GAAP, but the introduction of the FASB’s proposed Current Expected Loss Model (CELM) will permit more forward-looking provisioning.

The supervisory framework to guard against concentration risk and large exposures needs to be strengthened. The FBAs have an effective supervisory framework for dealing with credit concentration risk. Guidance has been issued on specific areas of concentration of credit risk and this is followed up in supervisory reviews. Supervisors are also giving more attention to the treatment of concentration risk in counterparty credit risk management and stress testing frameworks. However, the new BCP methodology has expanded this Core Principle to also include market and other risk concentrations “where a bank is overly exposed to particular asset classes, products, collateral, or currencies.” While there is some evidence of punctual supervisory action on this front (for instance, funding concentration), at this point a detailed supervisory framework and supervisory guidance for these other risk concentrations is not well developed. Although the widening of the definition of large exposures under the DFA has brought the large exposure thresholds more into line with the requirements of the BCP, some anomalies and omissions remain. The separate and additional limits available to banks for money market investments and security holdings continue to leave open the possibility of excessive risk concentrations. The 50 percent limit on exposures to a corporate group is also problematic. The authorities are also encouraged to finalize the large exposures framework, with legal limits, for large bank holding companies and foreign banking organizations.

In addition, there remain gaps in the related party exposure framework that may heighten concentration risk in the system. There are no formal requirements for prior board approval of transactions with affiliated parties or the write-off of related party exposures exceeding specified amounts, or for board oversight of related party transactions and exceptions to policies, processes and limits on an ongoing basis. However, in practice the FBAs expect banks to apply a high degree of board oversight and monitoring of affiliate and insider transactions and review this as a matter of practice on offsite and onsite examinations. Statutes impose a set of limits on a bank’s exposures to affiliates and insiders that, with one exception, are at least as strict as those for single counterparties or groups of counterparties. The exception is the aggregate limit for lending to insiders of 100 percent of a bank’s capital and surplus (and 200 percent for smaller banks). As noted in the 2010 FSAP, this limit is higher than prudent practices and creates the risk that a small group of insiders could deplete the own funds of a bank. There is no formal limit framework for holding company transactions with their affiliates or insiders, which is needed for a comprehensive framework for transactions with related parties. Finally, the “related party” regime in the U.S. regulatory framework does not appear as broad as required by this CP.

The approach to interest rate risk in the banking book (IRRBB) is in marked contrast to other key risks and could be usefully updated, given the current conjuncture. The regimes for market and liquidity risks are tiered to support a risk-based approach and are comprehensive and robust, though the former would benefit from the introduction of a de-minimis regime for all banks and the latter from more granular and frequent reporting. The framework for IRRBB stands out with no tiering for example (although supervisory practice seems proportionate to the risk) and the philosophy is firmly principles-based. No specific capital is being set aside against a change in interest rates, nor are any supervisory limits set. Given the stage of the U.S. economic cycle, the inherent interest rate exposure is high and there are particular concentrations in the small bank sector. Updating the 1996 guidance to include more quantitative guidance is merited, as the risk of a principles-based approach is its inconsistency across a sector and across time; as such banks, or a group of banks may be overly exposed.

Similarly, the overall regime for operational risk outside the AMA banks has not reached a sufficient level of maturity. There is no overall definition of operational risk, or structured guidance on identification, management and mitigation of operational risks. Guidance for banks under AMA (at the time of this assessment, only 8 banks) is well specified, however for all other bank operational risk management falls within the scope of “general” risk management. Guidance for other banks is disparate, and the weakness is compounded by the absence of a comprehensive reporting regime. There is not a standardized capital charge for operational risk. At the time of the assessment, several initiatives were underway. The FBAs are placing increasing emphasis on operational risk issues and are coordinating on the production of additional inter-agency guidance, as well as identifying and seeking mitigation of a number of issues in their vertical and horizontal reviews. They are also alert to the changing threat landscape, such as the escalation of fines and other penalties from litigation as well as cyber risks. Dealing with cyber risk is a top priority across all agencies and will pose coordination and operational challenges given the nature of the risk and the pressing need to collaborate with other arms of government.

Controls, audit, accounting, disclosure and abuse of financial services (CP 26-29)

The bar for audit and control functions has clearly been raised in the wake of the crisis, while further refinements are needed in the framework for abuse of financial services. The internal audit function is the subject of greater supervisory attention and expectations have been significantly raised though, in contrast, there is little mention of the compliance function except with reference to the regime of the Bank Secrecy Act and Anti-Money Laundering. Further, while significant resources are deployed by both the authorities and the firms to meet the BSA/AML standards, the attention to vulnerabilities to other forms of criminal abuse (e.g., theft, burglary) is more disparate. In addition, the regulatory framework at the time of the assessment did not include adequate identification of the ultimate beneficiary owner of legal entity clients, or processes for dealing with domestic Politically Exposed Persons (PEPs). On the external audit front, there is no requirement for an external auditor to report immediately directly to the supervisor, should they identify matters of significant importance, although this gap is mitigated by the frequent contact between supervisors and auditors in the course of planning and examinations.

The disclosure regime represents best practice in some respects. The public disclosure of supervisory call reports promotes market discipline and is worthy of global emulation. There remain a few gaps though. Not all banks are required to issue full financial standards that are reviewed by an independent accountant in accordance with independent audit requirements and the U.S. definition of “reporting on a solo basis” differs in that it does not collect or disclose data on a “bank stand-alone basis.”

Summary Compliance with the Basel Core Principles
Appendix Table 4.

Summary Compliance with the Basel Core Principles—ROSC

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Recommended Actions
Appendix Table 5.

Recommended Actions to Improve Compliance with the Basel Core Principles and Effectiveness of Supervision

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Authorities’ Response to the Assessment

The U.S. authorities strongly support the IMF’s Financial Sector Assessment Program (FSAP), which promotes the soundness of financial systems in member countries and contributes to improving supervisory practices around the world. The authorities appreciate the complexity of assessing the U.S. financial system and the time and resources dedicated by the IMF and its assessment teams to this exercise. The authorities commend the IMF on its diligence and constructive approach in undertaking the assessment. The U.S. authorities welcome the opportunity to provide the following comments.

The IMF rightly holds the United States to the highest and most stringent grading standard, given the complexity, maturity, and systemic importance of our financial sector. Despite this higher grading standard, the assessment found the U.S. regulatory system to be very strong and, in many ways, more rigorous than international standards.

We are pleased to note that the Report acknowledges that the U.S. federal banking agencies have improved considerably in their effectiveness since the previous FSAP was completed in 2010. This is particularly noteworthy since, compared to the 2010 assessment, the federal banking agencies were assessed against four additional Core Principles for Effective Banking Supervision (29 total) and significantly more Essential Criteria and Additional Criteria. This assessment also is more rigorous than the one completed in 2010 since the revised Core Principles have a heightened focus on risk management. The U.S. authorities are pleased that, even under these more stringent principles and when applying a higher standard, the IMF’s assessment of the U.S. system broadly indicates compliance with the Core Principles. Moreover, while the approach of the federal banking agencies is principles-based, the Report reaches its conclusions against the backdrop of an assessment regime that places a premium on specificity in regulations.

The Report recognizes that global and domestic reforms implemented since the 2010 assessment, particularly the Dodd-Frank Act (DFA), have increased the intensity of the supervisory programs of the federal banking agencies. Since the previous review, substantial improvements have been made in risk management and the oversight of large bank organizations by putting enhanced emphasis on banks’ capital planning, stress testing, and corporate governance. The U.S. authorities concede that some reforms are still pending and will take time to fully implement. Notably, the Report acknowledges that additional implementation of the reform programs will further improve the United States’ compliance with the Core Principles.

The Report acknowledges that the federal banking agencies are operationally independent and have clear mandates for safety and soundness of the banking system. However, it concludes there are duplicative efforts by the federal banking agencies and a lack of delineation between safety and soundness and other missions. Although there is not a formal statement that safety and soundness is the sole or primary mission of a federal banking agency, there is no confusion on the part of the agencies, the public, or the industry that the focus of supervision and regulation relates to safety and soundness. The U.S. authorities believe that responsibilities, such as assuring compliance with consumer laws and taking account of financial stability considerations, in no way conflict with the assessment of safety and soundness. Indeed, given the potential high level of operational and reputational risk associated with significant consumer compliance weaknesses, considerations related to such compliance are part of an overall safety and soundness risk assessment.

Furthermore, in practice, there is clarity of mission among the agencies. Clear distinctions exist between prudential safety and soundness responsibilities and consumer protection responsibilities that are shared between the Consumer Financial Protection Bureau (CFPB) and the federal banking agencies. In the view of the U.S. authorities, the federal banking agencies have met the requirement of collaboration required by DFA and have addressed the issue of duplicative efforts by coordinating with each other and the CFPB, as evidenced by interagency Memoranda of Understanding.

The federal banking agencies have taken a number of substantive actions that are not fully reflected in the Report. These include:

  • Establishing forward-looking stress testing requirements for banks with less than $10 billion in assets. Although banks with assets less than $10 billion are not required to complete formal DFA capital stress tests, federal banking agencies require stress testing on certain high-risk and volatile activities, and all banks are expected to have appropriate capital planning processes.

  • Publishing federal banking agencies’ examination manuals and directors’ guides, and conducting outreach and training initiatives, which articulate the responsibilities of boards of directors.

  • Issuing extensive guidance on business resumption planning, which is included in the Federal Financial Institutions Examinations Council’s booklets.

  • Requiring institutions with total assets of less than $500 million in certain instances to have an independent audit of their financial statements.

  • Applying stricter regime standards for affiliate transactions, which include, among other things:

  • tighter U.S. quantitative limits of 10 percent of bank capital for transactions with a single affiliate and 20 percent of capital for the aggregate transactions with all bank affiliates, instead of 25 percent of the bank’s capital,

  • inclusion of asset purchases by a bank from affiliates in the 10/20 limit structure noted above,

  • prohibition on a bank having any unsecured credit exposure to an affiliate,

  • prohibition on a bank purchasing low-quality assets from an affiliate.

Additionally, U.S. authorities not only meet many Basel III international standards, but significantly exceed some of the most important ones, especially those related to capital and liquidity. Examples include:

  • Requiring the largest U.S. bank holding companies to have risk-based capital ratios that exceed Basel minimum capital requirements via the Federal Reserve’s Comprehensive Capital Analysis and Review and annual stress tests programs.

  • Utilizing a Global Systemic Important Bank surcharge to reflect short term wholesale funding, which increases banks’ capital conservation buffer.

  • Exceeding the Basel standard, the largest, most global, systemic U.S. bank holding companies must maintain a supplementary leverage ratio buffer greater than 2 percentage points above the 3 percent minimum, for a total of more than 5 percent, to avoid restrictions on capital distributions and discretionary bonus payments. Insured depository institution subsidiaries of these firms must maintain at least a 6 percent supplementary leverage ratio to be considered “well capitalized.”

The U.S. authorities look forward to continuing a dialogue with the IMF and global counterparts to jointly promote the mission of the FSAP to enhance global financial sector stability and supervisory practices. In terms of this Report’s recommendations, specifically, the U.S. authorities will review them carefully. Action will be taken, where permissible, on items that enhance communication and information sharing among the agencies and ensure more effective oversight of systemic risk.

C. IOSCO Objectives and Principles of Securities Regulation

Information and Methodology Used for the Assessment

This assessment was conducted on the basis of the IOSCO Principles approved in 2010 and the Assessment Methodology adopted in 2011.5 As has been the standard practice, Principle 38 was not assessed due to the existence of separate standards for securities settlement systems and central counterparties. A review of the regulatory and supervisory framework in place at the state level was outside of the scope of this assessment. Given the relatively limited role played by state regulation and supervision (as described below), this limitation in the scope of the assessment has not materially affected the overall judgment of the U.S. regime. Given that the IOSCO Principles and Methodology do not specifically address over-the-counter (OTC) derivatives, the adoption and implementation status of the U.S. OTC derivatives framework has not impacted the grades.

Overview and Institutional Setting

The regulatory and supervisory arrangements remain quite complex, involving two agencies and a number of important SROs. Two federal agencies, the SEC and the CFTC, share the primary responsibility for the regulation and supervision of the U.S. securities and derivatives markets. Broadly speaking, the SEC is in charge of the regulation and supervision of securities markets and single security based options, futures and swaps markets. The CFTC is responsible for the regulation and supervision of futures, options and swaps markets (except for narrow-based security indices). The SEC’s and CFTC’s mandates were significantly expanded as a result of the enactment of the DFA. The Act provided the SEC and CFTC with shared responsibility over the swaps markets and brought HF managers and municipal advisors under the jurisdiction of the SEC. State securities regulators maintain responsibility for issuances that are conducted at the state level only. Both state and federal legislation provide a regulatory framework for BDs and IAs, but not for futures and derivatives intermediaries. The role of state regulators has recently increased for smaller IAs.

The CFTC and SEC rely to a significant degree on SROs for the regulation of the markets and their participants. The SROs include exchanges, clearing organizations, and securities and futures associations. There are two registered associations with SRO functions: the Financial Industry Regulatory Authority (FINRA) and the National Futures Association (NFA). FINRA has authority over BDs, while the NFA has authority over all intermediaries in the futures and swaps markets. Membership in an SRO is mandatory for the corresponding intermediaries.6 In addition to member registration and supervision, FINRA also has a role in market surveillance due to agreements with different exchanges and for OTC trading. The NFA is developing a similar role for some SEFs.

Criminal enforcement is the responsibility of federal, state and local authorities. The SEC and CFTC have significant administrative and civil enforcement powers. In addition, criminal prosecution is available by other U.S. authorities to pursue securities and derivatives market violations. Federal, state and local prosecutorial authorities play an active role in criminal (and in some cases civil) enforcement of securities laws, working both with the regulators and on their own initiative.

Main Findings

Post crisis, the legal mandates of the Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC) have significantly expanded. Enhancements have been made to prudential requirements applicable to some key regulated entities and the agencies are taking an increasingly forward looking risk-based approach to supervision and enhancing their risk identification processes and have also worked on improving the use of the enforcement function. Many of these improvements can also be observed at the self-regulatory organizations (SROs).

But the level of funding of both the SEC and CFTC is a key challenge affecting their ability to deliver on their mandates in a way that provides confidence to markets and investors. Funding limitations have impacted the timely delivery of new rules and the implementation of registration programs for the new categories of participants. In this context, the number of expert staff in the SEC and CFTC does not appear to be sufficient to ensure a robust level of hands-on supervision, which has become clear in the case of investment advisers (IAs). Leveraging on technology can mitigate but not replace the need for additional human resources. Consideration should be given to making both agencies self-funded and allowing for multi-year budgeting.

The fragmented structure of equity markets remains a key challenge for the SEC. The framework developed by the SEC has served its purpose of enhancing competition and providing a framework for best execution. However, the markets have evolved and the framework needs to be updated accordingly to ensure sufficient operational transparency for all types of trading venues as well as fair and objective access. At the same time, the SEC needs to remain vigilant about the impact dark trading may have on overall price formation. The recently-announced Equity Market Structure Advisory Committee is an important step.

It is important that both agencies continue to strengthen their ability to identify emerging and systemic risks. This is critical for the effective discharge of their respective mandates, but also to enhance their contributions to the mandate of the Financial Stability Oversight Council (FSOC). Enhancing mechanisms to ensure a holistic view of risks is recommended, in particular by the respective Commission (as a whole) of each agency becoming more involved in the process of assessing and monitoring responses to risks.

Principles for the regulator. The SEC and the CFTC are independent agencies, with clear mandates stemming from the law. Both have sufficient powers to fulfill their mandates, including rulemaking, registration, examination and enforcement powers. They operate under a high level of accountability, which is supported by public transparency of a wide range of regulatory actions and decisions. Strong ethics rules apply to Commissioners and staff of both the SEC and CFTC. The agencies are taking an increasingly forward looking risk-based approach to supervision and enhancing their risk identification processes, which in turn is helping them to contribute more effectively to the FSOC. Both have processes to review the perimeter of regulation. However, the current level of resources poses challenges for the SEC and CFTC to effectively discharge their functions, particularly in light of their expanded mandates.

Principles for self-regulation. The U.S. system relies strongly on SROs, such as FINRA and the NFA, for supervision of markets and intermediaries. This result in a complex set of arrangements; but SROs are subject to oversight, including approval or notification of rules, and ongoing monitoring of their self-regulatory activities via reporting and examinations.

Principles for enforcement. The SEC and CFTC have broad inspection powers over regulatees and investigative and enforcement powers over regulated entities, regulated individuals, and third parties. Both agencies make extensive use of their enforcement powers; and the SEC, the CFTC, and criminal authorities are active in pursuing securities and derivatives violations. Overall, the agencies, along with the SROs, have put in place robust supervisory programs to monitor ongoing compliance by regulated entities and individuals and to monitor market activity. The programs for regulated entities are risk-based. In most cases, the coverage of the examination program is such that no entity goes without inspection for a long period of time, even if it is low risk. The situation is different for IAs, as the coverage of their examination program is more limited—covering only a small percentage of the population each year. Market surveillance relies primarily on SROs’ automated tools.

Principles for cooperation. The SEC and CFTC have the ability and capacity to share information and cooperate with other authorities domestically and internationally. They are signatories to many Memoranda of Understanding (MOU), including the IOSCO (MMOU) and a number of bilateral MOUs with domestic and foreign authorities, and have records of active cooperation. The SEC and CFTC do not need the permission of any outside authority or an independent interest to share or obtain information. Access to the financial records of individuals and small partnerships requires notifying the customer; delaying such notice is also possible in certain circumstances.

Principles for issuers. Generally issuers of public offerings, including asset-backed securities (ABS), are subject to strong disclosure