Cyber, big bank resolutions among top stability risks, watchdog agency says

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WASHINGTON — Cybersecurity risks, challenges in large institution resolution planning and unforeseen changes in market structure are the most significant threats to the stability of the financial system, the Office of Financial Research said Tuesday.

In the agency’s annual report to Congress, OFR Director Richard Berner — who announced his retirement from the agency last month — said that, while the financial system is overall safer this year due to ongoing progress in implementing post-crisis regulatory reforms, there are still areas that could be a source of acute stress that regulators have not fully addressed.

“Threats to financial stability are moderate,” Berner said. “But underneath that assessment are changes in the balance between financial-system vulnerabilities and resilience.”

The report said that the financial system is an “attractive target for cyber thieves” and other hackers because of the system’s centrality in people’s lives and its increasing reliance on information technology as a means of transacting business.

“A large scale cyberattack,” the report warns, “could disrupt the operations of one or more financial companies and markets and spread through financial networks and operational connections to the entire system, threatening financial stability and the broader economy.”

The report also said that tools developed after the crisis to aid in the resolution of failed financial institutions remain “works in progress,” and that while much progress has been made and confidence in those tools is growing, “orderly resolution may still be difficult in some scenarios.”

Resolving a global systemically important bank, for example, would still be a challenge, even with post-crisis tools like orderly liquidation authority and a reformed bankruptcy code, the report said.

Structural changes in the financial markets may also pose a threat to financial stability, the report said. If certain services lack substitutable alternatives, for example, it could pose a challenge if the remaining providers choose to get out of that business. By contrast, fragmentation of business activity across multiple carriers can also lead to reduced liquidity in any one carrier.

The report also noted that the ongoing transition of reference interest rates away from the London interbank offered rate to an alternative rate. While the “risks and costs” of using Libor — a reference rate that was systematically rigged by global banks for years, leading to multibillion-dollar settlements with the government — make the move “essential,” the report said, the transition to a universally accepted alternative poses risks.

“Obtaining widespread market acceptance and reliance could take years,” the report said.

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Cyber attacks Cyber security Credit derivatives Treasury Department