Financial Stability Report02April 2024BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEMThe Federal Reserve System is the centralbank of the United States.It performs five keyfunctions to promote the effective operationof the U.S.economy and,more generally,thepublic interestThe Federal Reserveconducts the nation's monetary policy to promote maximum employmentand stable prices in the U.S.economy;promotes the stability of the financial system and seeks to minimizeand contain systemic risks through active monitoring and engagement inthe U.S.and abroad;promotes the safety and soundness of individual financial institutionsand monitors their impact on the financial system as a whole;fosters payment and settlement system safety and efficiency throughservices to the banking industry and the U.S.govemment that facilitateU.S.-dollar transactions and payments;andpromotes consumer protection and community development throughconsumer-focused supervision and examination,research and analysis ofemerging consumer issues and trends,community economic developmentactivities,and administration of consumer laws and regulations.To learn more about us,visit www.federalreserve.gov/aboutthefed.htm.ContentsPurpose and Framework...........1 Asset Valuations .................2 Borrowing by Businesses and Households..............................153 Leverage in the Financial Sector.............4 Funding Risks......................Box 4.1.The Bank Term Funding Program.........5 Near-Term Risks to the Financial System...............................45Box 5.1.Survey of Salient Risks to Financial Stability...........................47Note:This report generally reflects information that was available as of April 1,2024.Purpose and FrameworkThis report presents the Federal Reserve Board's current assessment of the stability of the U.S.financial system.By publishing this report,the Board intends to promote public understand-ing by increasing transparency around,and creating accountability for,the Federal Reserve'sviews on this topic.Financial stability supports the objectives assigned to the Federal Reserve,including full employment and stable prices,a safe and sound banking system,and an efficientpayments system.A financial system is considered stable whenbanks,other lenders,and financial marketsMore on the Federalare able to provide households,communities,Reserve's Monitoring Effortsand businesses with the financing they needto invest,grow,and participate in a well-See the Financial Stability section of theFederal Reserve Board's website for morefunctioning economy-and can do so eveninformation on how the Federal Reservewhen hit by adverse events,or "shocks."monitors the stability of the U.S.and worldfinancial systems.Consistent with this view of financial stabil-The website includes:ity,the Federal Reserve Board's monitoringframework distinguishes between shocks to,a more detailed look at our monitoringframework for assessing risk in eachand vulnerabilities of,the financial system.category:Shocks are inherently difficult to predict,more data and research on related topics:while vulnerabilities,which are the aspectsinformation on how we coordinate,cooper-of the financial system that would exacerbateate,and otherwise take action on financialsystem issues;andstress,can be monitored as they build up orrecede over time.As a result,the frameworkpublic education resources describing theimportance of our efforts.focuses primarily on assessing vulnerabilities,with an emphasis on four broad categoriesand how those categories might interact toamplify stress in the financial system.11.Valuation pressures arise when asset prices are high relative to economic fundamentals orhistorical nomms.These developments are often driven by an increased willingness of investorsto take on risk.As such,elevated valuation pressures may increase the possibility of outsizeddrops in asset prices (see Section 1,Asset Valuations).For a review of the research literature in this area,see Tobias Adrian,Daniel Covitz,and Nellie Liang(2015),"Financial Stability Monitoring,"Annual Review of Financial Economics,vol.7(December),pp.357-95.iFinancial Stability Report2.Excessive borrowing by businesses and households exposes the borrowers to distress iftheir incomes decline or the assets they own fall in value.In these cases,businesses andhouseholds with high debt burdens may need to cut back spending,affecting economic activityand causing losses for investors (see Section 2,Borrowing by Businesses and Households).3.Excessive leverage within the financial sector increases the risk that financial institutions willnot have the ability to absorb losses without disruptions to their normal business operationswhen hit by adverse shocks.In those situations,institutions will be forced to cut back lending,sell their assets,or even shut down.Such responses can impair credit access for householdsand businesses,further weakening economic activity (see Section 3,Leverage in theFinancial Sector).4.Funding risks expose the financial system to the possibility that investors will rapidlywithdraw their funds from a particular institution or sector,creating strains across marketsor institutions.Many financial institutions raise funds from the public with a commitmentto return their investors'money on short notice,but those institutions then invest much ofthose funds in assets that are hard to sell quickly or have a long maturity.This liquidity andmaturity transformation can create an incentive for investors to withdraw funds quickly inadverse situations.Facing such withdrawals,financial institutions may need to sell assetsquickly at "fire sale"prices,thereby incurring losses and potentially becoming insolvent,aswell as causing additional price declines that can create stress across markets and at otherinstitutions (see Section 4,Funding Risks).The Federal Reserve's monitoring framework also tracks domestic and international develop-ments to identify near-term risks-that is,plausible adverse developments or shocks that couldstress the U.S.financial system.The analysis of these risks focuses on assessing how suchpotential shocks may spread through the U.S.financial system,given our current assessment ofvulnerabilities.While this framework provides a systematic way to assess financial stability,some potentialrisks may be novel or difficult to quantify and therefore are not captured by the current approach.Given these complications,we rely on ongoing research by the Federal Reserve staff,academ-ics,and other experts to improve our measurement of existing vulnerabilities and to keep pacewith changes in the financial system that could create new forms of vulnerabilities or add toexisting ones.Purpose and Framework viiFederal Reserve actions to promote the resilience of thefinancial systemThe assessment of financial vulnerabilities informs Federal Reserve actions to promote the resil-ience of the financial system.The Federal Reserve works with other domestic agencies directlyand through the Financial Stability Oversight Council to monitor risks to financial stability and toundertake supervisory and regulatory efforts to mitigate the risks and consequences of financialinstability.Actions taken by the Federal Reserve to promote the resilience of the financial system includeits supervision and regulation of financial institutions.In the afterath of the 2007-09 financialcrisis,these actions have included requirements for more and higher-quality capital,an innova-tive stress-testing regime,and new liquidity regulations applied to the largest banks in the UnitedStates.In addition,the Federal Reserve's assessment of financial vulnerabilities informs deci-sions regarding the countercyclical capital buffer(CCyB).The CCyB is designed to increase theresilience of large banking organizations when there is an elevated risk of above-nomal lossesand to promote a more sustainable supply of credit over the economic cycle.1OverviewThis report reviews vulnerabilities affecting the stability of the U.S.financial system related tovaluation pressures,borrowing by businesses and households,financial-sector leverage,andfunding risks.It also highlights several near-term risks that,if realized,could interact with thesevulnerabilities.A summary of the developments in the four broad categories of vulnerabilities since theOctober 2023 Financial Stability Report is as follows:Overview of financial system vulnerabilitiesBorrowing by businessesLeverage in theAsset valuationsand householdsfinancial sectorFunding risks·Equity price-to-The ratio of totalThe banking systemMost domestic banksearnings ratios movedprivate debt to grossremained sound andmaintained high levelsto the upperenddomestic productresilient,with risk-basedof liquid assets andof their historicalcapital ratios well abovestable funding.distributions.further,approachingits historical average·However,concerns overCorporate bond spreads·Nonetheless,someuninsured deposits andfell to levels that are。The business debt-to-banks continued to faceother factors continuedlow relative to theirGDP ratio remaineds立able fair value lossesto generate fundinghigh,but businesson some fixed-ratepressures for a subsetdebt continued toassets held on theirof banks.Prices of residentialdecline in real termsbalance sheets.real estate remainedamid subdued riskyStructuraldebt issuance.F月mms'ability to service their·Leverage increasedvulnerabilitiesfrom already elevatedpersisted at moneydebt remained robustlevels at the largestmarket funds,some。Prices of commercialhedge funds.other mutual funds,real estate declined·Household debt wasand stablecoins.amid deterioratingat modest levelsfundamentals.relative to GDP andBroker-dealer leverageconcentrated amongremained nearcontinued to hold ahistorically low levels.and risky assets.2Financial Stability Report1.Asset valuations.Valuations rose further to levels that were high relative tofundamentals across major asset classes.Equity prices grew faster than expectedearnings,pushing the forward price-to-earnings ratio to the upper end of its historicaldistribution.Corporate bond spreads narrowed and currently stand at levels that are lowrelative to their long-run averages.Residential property prices remained high relative tofundamentals and prices continued to rise in recent months.Prices of commercial realestate(CRE)declined amid weak demand for office properties(see Section 1,AssetValuations).2.Borrowing by businesses and households.The balance sheets of nonfinancialbusinesses and households remained solid,as the ratio of total private debt to grossdomestic product (GDP)declined further,approaching its historical average.Althoughbusiness debt remained high when measured relative to GDP(or to business assets forpublicly traded corporations),business debt declined in real temms throughout last year.Firms'ability to service their debt remained robust owing to strong earnings and lowborrowing costs on existing debt.Household debt remained at modest levels relativeto GDP,and most of that debt is owed by households with strong credit histories orconsiderable home equity(see Section 2,Borrowing by Businesses and Households).3.Leverage in the financial sector.The banking sector remained sound and resilientoverall,and most banks continued to report capital levels well above regulatoryrequirements.Nevertheless,fair value losses on fixed-rate assets remained sizablefor some banks,and some banks with concentrated exposure to loans backed bycommercial real estate properties experienced stress.Outside the banking sector,available data suggest that hedge fund leverage grew to historic highs,driven primarilyby borrowing by the largest hedge funds.Leverage at life insurance companies remainedaround its median,while they continued to take on credit and liquidity risk.Broker-dealerleverage remained near historical lows(see Section 3,Leverage in the Financial Sector).4.Funding risks.Liquidity at most domestic banks remained ample,with limited relianceon short-term wholesale funding.Nevertheless,some banks continued to facefunding strains,likely owing to vulnerabilities associated with high levels of uninsureddeposits,declines in the fair value of assets,and elevated exposure to CRE.Structuralvulnerabilities remained in other short-term funding markets.Prime and tax-exemptmoney market funds(MMFs),as well as other cash-investment vehicles and stablecoins,remained vulnerable to runs.Bond and loan funds that hold assets that can becomeilliquid during periods of stress remained susceptible to large redemptions.In addition,life insurers continued to rely on a higher-than-average share of nontraditional liabilities(see Section 4,Funding Risks).