The banking sector has been resilient this year, supported by high levels of regulatory capital, sufficient liquidity buffers, and strong profitability, according to the Financial Stability Oversight Council’s 2024 annual report.
According to FSOC, the resilience of the financial system comes as high funding costs relative to the previous decade are compressing net interest margins. The performance of some consumer loans has worsened at banks, compared to pre-pandemic figures.
FSOC listed several challenges the banking sector faces, including cryptocurrencies, cyberattacks and artificial intelligence. FSOC recommended stablecoins and the spot market for crypto-assets face requirements for reporting, reserves and capital to mitigate security risks. The council suggested federal legislation create a framework for issuers to address deposit run risks while implementing investor and consumer protections.
Stablecoins are vulnerable to runs without proper risk management standards, according to the report. Run risks are amplified from both market concentration and the market’s lack of transparency and compliance with financial regulations. As of July, the global market value of crypto assets was nearly $2 trillion, a fraction of the $48 trillion market cap of the S&P 500. The total market value for spot crypto-asset exchange-traded products increased nearly $80 billion since the SEC approved trading and listing of several in January.
Tether holds two-thirds of the total value of the stablecoin sector. “Given that firm’s market dominance, if it continues to grow, its failure could disrupt the crypto-asset market and create knock-on effects for the traditional financial system,” according to the report.
The number of global cyberattacks has nearly doubled since before covid-19, according to the report. The threat environment is worsened by global conflicts in Ukraine and the Middle East. “A significant cyber attack, if successful, has the potential to disrupt operations, challenge access to liquidity, increase the likelihood of bank failures and market dysfunction, and generally erode confidence in the financial system,” according to FSOC.
Artificial intelligence poses benefits and concerns, according to the council. FSOC recommended regulatory agencies monitor the quick development of AI technology to address emerging risks to the financial system. “The lack of explainability and the high complexity of AI approaches have the potential to heighten financial instability beyond effects on individual financial actors,” according to the report. “Likewise, concentration in models or providers may lead to additional interconnections, herding behavior and contagion.”
Third-party providers can introduce new risks or worsen existing ones, according to the report. Relying on a third party could reduce a bank’s direct control and oversight of its data, according to FSOC, and make that information less transparent for both regulators and the firm. The council is calling on Congress to ensure regulators have adequate examination and enforcement authority to oversee third parties.
Commercial real estate credit conditions are weakening in the banking industry, and leverage is growing in insurance companies and private funds. Higher expenses and weakening revenue are weighing on net operating income and could make it harder for borrowers to repay their loans, according to the report.
Due to a rise in remote work, vacancy rates for office properties are reaching 10-year highs. The impact of that trend is especially being felt in large urban metro areas, posing disproportionate risks for larger banks.
“Signs of increasing CRE credit risk became more evident in 2024, with a continued rise in vacancies, slower rent growth and increased borrowing costs,” according to FSOC. “These pressures on borrowers have led to increased delinquencies, loan losses and provision expenses for banks.”