Financial system faces economic, technological risks

The stability of the global financial system continues to be tested by high inflation, slowed economic growth, and cryptocurrency safety risks, according to the Financial Stability Board’s 2022 annual report. 

The increased digitalization of banking and use of fintech providers are increasing efficiency while posing risks to banks’ business models and cybersecurity, according to the report. “Traditional financial institutions face a need to adapt their business models, and this creates potential incentives for excessive risk-taking by those institutions to preserve profitability,” the FSB stated. 

The FSB, an international body of G20 major economies and the European Commission, found that cryptocurrencies continue to be plagued by “inappropriate and unsustainable business models;” liquidity/maturity mismatches that subject platforms and protocols to run risk; and highly-leveraged positions which lead to automatic liquidations or margin calls.

“These vulnerabilities were amplified by the lack of transparency and disclosure in the crypto-asset sector, flawed governance, inadequate investor protection, and weaknesses in risk management,” the FSB stated.   

 The crypto market lost half of its value in May and June alone as the economy weakened and a number of crypto firms failed. Earlier this month, the large crypto trading platform FTX collapsed, leading to the bankruptcy of the crypto lending platform BlockFi. 

Regulators have taken issue with the unregulated structure of the industry and the security threats they say it poses both to consumers and the broader financial system. In October, leaders from the U.S. Treasury Department, Federal Reserve and Securities and Exchange Commission found that crypto-assets could threaten the stability of the U.S. financial system if regulators don’t enforce current regulations and aren’t granted more power over the space. 

The report comes as the Federal Reserve continues raising interest rates to cool the economy and ease decades-high inflation readings. In early November, the Fed raised interest rates by 0.75 basis points for the fourth straight time, to 3.75 to 4.00 percent. According to the FSB, the tightening economic policy of central banks, high inflation and other challenges could either worsen existing financial vulnerabilities or cause new threats to emerge.

 “Market turbulence could be amplified by still-elevated valuations of some assets, forced sales from sudden unwinding of leveraged positions of non-bank financial institutions, and liquidity mismatches in some types of funds,” the board stated. “Further stress in commodities, bond and repo markets could spill over to the financial system, and requires close monitoring.”