Most banks see inflation and potential commercial real estate losses as their top financial stability concerns, according to the Federal Reserve’s semiannual financial stability report.
According to the Oct. 20 report, 72 percent flagged ongoing inflation and the Federal Reserve’s responding tightening of financial policy as stability issues. The same share of respondents also identified weakness in the CRE and residential real estate markets as stability issues. Those were both increases from the 56 percent and 52 percent, respectively, who listed inflation and real estate as stability issues in May. Fifty-six percent cited banking sector stress as a risk to the financial system, unchanged from May.
The survey included professionals at broker-dealers, investment funds, research and advisory firms and academics. CRE remains in limbo as property values fall as companies continue with hybrid and work-from-home arrangements. According to the report, regional and small banks with concentrated CRE exposures could be especially vulnerable as stress tests show the largest banks are well-positioned to handle a contraction.
“A correction in office property valuations accompanied by even a mild recession could result in significant losses for a range of financial institutions with sizable exposures, including some regional and community banks and insurance companies,” the Fed stated. “Lenders that experience large losses may reduce their willingness to supply credit to the broader economy, which would further weigh on economic activity.”
Though most banks have ample liquidity and rely only minimally on short-term wholesale funding sources, some continue to face funding challenges due to high levels of uninsured deposits and declines in the fair value of assets.
“The banking sector remains sound and resilient overall, and most banks continued to report capital levels well above regulatory requirements,” the Fed stated. “That said, the increase in interest rates over the past two years has contributed to declines in the fair value of long-maturity, fixed-rate assets that, for some banks, were sizable.”