The 2008 collapse of major financial institutions caught many people by surprise. It was a stupendous failure of risk management analytics and complex financial products that were previously considered state of the art. The polymaths on the Board of Governors at the US Federal Reserve System (Fed) deeply understood and practiced data-intensive forecasting and planning. But they learned that their own financial system guardrails needed fortification.
Once the acute crisis had passed, the grueling reform work got underway. Legislators passed the Dodd-Frank Act, which, among other things, requires the Fed to conduct supervisory stress tests that apply to large and complex firms such as Bank of America and Goldman Sachs. The still-ongoing annual tests aim to provide senior bank executives, boards of directors, the public, and supervisors with status checks and predictions on the stability of financial institutions under various conditions that could materialize.
Crypto fans take note: With many post-crisis reforms now in place, the Fed wants to better understand the likelihood of a collapse in the bitcoin market – and how such a scenario could conceivably impact the stability of the global financial system. That's not saying that bank regulators expect such a collapse. It's simply a formal and cadenced consideration of such a possibility.
New Sheriff in Town
Randal K. Quarles, a Fed Reserve governor, was appointed chairman of the Fed's Financial Stability Board on November 26. He outlined the evolution of the stress tests in light of newly identified risk scenarios in a February 10 address to the Bank for International Settlements' Special Governors Meeting. Quarles said:
"The Global Financial Crisis had exposed fault lines in the financial system that had to be addressed immediately, comprehensively, and vigorously. The body of post-crisis regulation that has resulted … was a tour de force of orchestration, and it has unquestionably made the financial system safer and more resilient."
Like other bank regulators, Quarles notes that the reforms boosted the system's resiliency to some of the types of shocks and vulnerabilities that precipitated the crisis. Some of these measures, like higher bank capital and liquidity requirements, are considered to be effective against a wide range of shocks. "However, we cannot be complacent and assume that we are safe from all shocks."
The FSB chairman went on to say that it's time for the FSB to turn more of its energy and attention to the future. The Quarles view holds that, among other things, cryptocurrencies have taken root to the extent that the FSB wants "to undertake a review of its framework for assessing vulnerabilities to ensure that we are at the cutting edge of financial stability vulnerability assessment."
Describing the level of rigor required to "guide this pivot forward," Quarles said, "We must ensure that our assessment of vulnerabilities is based on cutting-edge thinking and a disciplined methodology." As Mae West might suggest, with so much about crypto asset investing and crypto's role in international trade still under development, it's going to be an interesting ride.