WASHINGTON: The possibility of persistent inflation leading to higher interest rates and potential losses in the commercial real estate market are among the top concerns of respondents in a Federal Reserve survey on financial stability, as reported by the U.S. central bank on Friday.
The latest edition of the central bank's semiannual report reveals that three-quarters of survey respondents cited these two issues as prominent near-term risks. Concerns about bank stability following the failure of three large firms earlier this spring were mentioned by roughly half of the respondents, similar to the levels seen in the May version of the report.
Economic weakness in China had grown, with 44per cent of those surveyed citing it as a top risk, compared to just 12per cent in May. However, the war between Russia and Ukraine slipped to the 11th-most cited concern by respondents, after it was the top financial stability concern one year ago.
The Fed noted that its survey of looming risks was concluded in early October, before the conflict between Israel and the Palestinian enclave of Gaza broke out.
Overall, the Fed identified several vulnerabilities within the financial system, including historically high asset valuations, including equities and real estate. Specifically, the Fed found that commercial real estate valuations remain elevated, even as prices have declined amid high office vacancies.
The Fed cautioned that if the economy were to slow unexpectedly, generally high leverage levels could strain or even sink some businesses. It specifically noted that a correction in office property valuations alongside a mild recession could lead to "significant losses for a range of financial institutions with sizable exposures, including some regional and community banks and insurance companies." While the overall banking system remains sound, the Fed mentioned that some banks were still grappling with "sizable" declines in the fair value of some assets as interest rates rapidly increased. Large levels of unrealized losses were a major contributor to the stresses faced by banks, including Silicon Valley Bank, which failed this spring.
The Fed stated that banks overall have substantial levels of liquidity, and deposit outflows and volatility have decreased since the spring. However, some firms are still facing funding pressures, as some depositors have left, and banks have had to pay more to retain depositors or acquire other funding.
The Fed also found that home prices increased from already high levels seen in May, although it noted that credit conditions for borrowers are "considerably tighter" than what was seen leading up to the subprime mortgage crisis of 2007-2009.
In fact, banks reported to the Fed that lending standards are now on the tighter end of historical norms for all loan categories.
The report found that household and business debt burdens remained moderate, despite the uptick in interest rates. It warned, however, that borrowers with low credit scores were beginning to show some signs of stress in various types of consumer debt, such as credit cards and auto loans._Reuters
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