June 24, 2019

IMF published its staff report in the context of the 2019 Article IV consultation with the United States. The IMF assessment concluded that the financial system in the U.S. appears healthy, with well-capitalized banks. However, risks are building up among leveraged corporations and, possibly, in the non-bank sector, with little institutional response to counter these growing risks. The IMF Directors emphasized the importance of enhancing the risk-based approach to regulation and supervision, strengthening the oversight of non-banks, and addressing remaining data gaps. An Appendix to the report summarizes the recommendations of the last FSAP assessment and whether and how these recommendations are being addressed by the U.S. authorities.

Assessment of banking sector

The report reveals that medium-term risks to financial stability are rising, although U.S. banks are well-capitalized and asset quality appears to be generally good. Credit remains available to both households and corporations and the cost of borrowing is relatively low. However, corporate leverage is historically high, the share of commercial loans that are non-performing is creeping up, and underwriting standards are weakening. The recent tailoring of financial regulation has led to a steady easing of regulatory constraints at a late stage in the cycle. Given the evident build-up of leverage in the system, most notably in the corporate sector, but also with rising sovereign debt and a significant stock of full-recourse student loans, it is more urgent than ever to ensure that any further changes to the financial oversight regime not only preserve, but enhance, the current risk-based approach to regulation, supervision, and resolution. Risk-based capital and liquidity standards, combined with strong supervision, need to be the central tools in incentivizing financial institutions to manage well the risks they undertake, including through a robust Comprehensive Capital Analysis and Review (CCAR) process.

The report also describes certain topics will be a focus of the ongoing Financial Sector Assessment Program (FSAP) for the United States. Overall, the key highlights of the financial-sector assessment suggest the following: 

  • FSOC should continue its efforts to respond to emerging threats to financial stability and, in this work, there is scope to strengthen and more fully resource OFR.
  • The U.S. should maintain its engagement in developing the international financial regulatory architecture while adhering to the agreed international standards.
  • The oversight of non-banks needs to be strengthened and authorities need to address continuing data blind spot, particularly related to the activities of non-banks, that impede a full understanding of the nature of financial system risks, interlinkages, and interconnections.
  • Progress has been made in money market reform but vulnerabilities—in repo markets and for money market funds—remain. There is also a need to introduce a comprehensive liquidity risk management framework for asset managers (that includes liquidity risk stress tests). Little progress has been made in reforming the housing finance system or the government-sponsored enterprises.

The report highlighted other salient vulnerabilities, which include the potential for a destabilizing cyber-security event, the increased concentration of activities and exposures in central counterparties and in the tri-party repo market, and the ongoing transition away from LIBOR as a reference rate for a range of financial contracts. However, work was ongoing in all of these areas to better understand interlinkages, manage vulnerabilities, and improve risk management practices within financial institutions. U.S. regulators have also taken steps to improve the effectiveness and efficiency of financial regulations, including by tailoring prudential standards for bank holding companies based on size and complexity, better integrating the CCAR process with the rules on regulatory capital buffers, and proposing simplification of the Volcker Rule requirements. However, impediments to data-sharing among regulatory agencies remain. There was agreement that it was critical to continue to make progress in addressing data gaps and U.S. regulators have been working with FSB, BIS, IOSCO, and other international standard-setters to tackle these issues.

Assessment of insurance sector

With respect to regulating the insurance sector, the last FSAP had recommended to set up an independent insurance regulatory body with nationwide responsibilities and authority. However, the supervisory and regulatory architecture for insurance firms has not changed. The potential weaknesses in oversight arising from the absence of harmonized national standards or consolidated supervision for insurance companies must be addressed, as suggested in previous Article IV consultations and as recommended by the previous FSAP. Furthermore, recent proposals to limit the engagement of federal authorities in international supervisory fora could prove cumbersome for the insurance standard-setting process and the development of the global capital standard. 

Another FSAP recommendation was to develop and implement group supervision and group-level capital requirements for insurance companies. Regarding group supervision, as of June 2017, all 50 states, the District of Columbia, and Puerto Rico have adopted the updated NAIC model holding company act, enhancing state insurance regulators’ group supervisory authorities and the NAIC Own Risk and Solvency Assessment (ORSA) model Act. Additional updates to the NAIC model holding company act relating to powers of a group-wide supervisor  of an IAIG have been adopted in 29 states and will be required to be adopted in all accredited U.S. states and jurisdictions by January 01, 2020. Finally, 27 states have adopted the NAIC corporate governance model act, which will also be required to be adopted in all accredited U.S. states and jurisdictions by January 01, 2020. The report also reveals that state insurance regulators are working through the NAIC to develop a group capital calculation, which would be an additional analysis tool for regulators, but not a quantitative capital requirement. The proposed group capital calculation is being tested by over 30 insurance groups and 15 lead states, which is expected to be completed by early October. 

While most large U.S. life insurers perform their own internal liquidity stress testing work, a consistent regulatory liquidity stress test is under development by NAIC. This requirement will exist for any insurance group or legal entity with U.S. results that trigger any of six thresholds (fixed and indexed annuities, funding agreements and GICs, derivatives, securities lending, repurchase agreements, and borrowed money). Once a group triggers the liquidity stress testing requirement, the liquidity stress test will be based on internal company cash flows, will utilize consistent stress tests and “what if” modifications (currently being established), and will be applied at the legal entity level (including the holding company) with results reported individually and as a group. The target date for the proposed liquidity stress testing design is August 2019. 

 

Related Link: Staff Report

 

Keywords: Americas, US, Banking, Insurance, Securities, Article IV, FSAP, EGRRCP Act, Stress Testing, IMF

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