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Threats to financial sector detailed

By Allison Ross ·
Friday, May 9, 2014
Posted: 5 pm ET

United States Government Work

Treasury Secretary Jack Lew is a member of the Financial Stability Oversight Council.

Innovation has become a buzzword in the business world, including in the financial sector.

And, innovation is a good thing. But at the same time, the development of new products, services and business practices also could mean unforeseeable risks that may affect the stability of the financial markets, the Financial Stability Oversight Council says in its latest annual report.

"New products or services are sometimes developed to circumvent regulation. New practices may move a regulated activity outside of the regulatory perimeter either by moving the activity offshore or by moving it from a heavily regulated entity to an entity that is less regulated," the FSOC report says.

It says the post-crisis financial landscape has seen a particularly large number of changes and developments. "It is important to be alert to the potential adverse effects that may arise with these changes," the report says.

What's the FSOC?

The FSOC was created in 2010 by the Dodd-Frank Act to be the main monitor of financial stability and risk. It is a 10-member council made up of major financial regulators, including Treasury Secretary Jack Lew, Federal Reserve Chair Janet Yellen and Consumer Financial Protection Bureau Director Richard Cordray.

This year's annual report, which comes in at 155 pages, lays out several concerns and recommendations about what policymakers should address to mitigate financial instability. It also looks at the state of the U.S. economy right now, and what needs to be done to bring the U.S. back to pre-recession levels.

Housing finance reform

Among the "significant changes" that the financial sector has undergone in recent years is a growth in loans that nonbank mortgage servicing companies are taking on, the oversight council report says.

"While the CFPB and state regulators have some authority over these companies, many of them are not currently subject to prudential standards such as capital, liquidity or risk management oversight," the report warns. It said regulators should monitor the growth of banks selling servicing rights to nonbank mortgage servicers and consider any unintended consequences for the system.

In February, New York's top banking regulator halted Ocwen Financial's purchase of mortgage-servicing rights from Wells Fargo after the regulator expressed concern Ocwen couldn't handle the additional loan load, according to Reuters.

Impact of low interest rates, other concerns

The FSOC also noted several other concerns, many of which it has addressed in previous reports. For instance, it said it "remains concerned about the risks of funding runs and fire sales in wholesale funding markets."

And it reiterated a common concern about the impact of the low interest rate environment, saying regulators should continue to watch for search-for-yield behaviors among investors and to be wary of any consequences from a potential interest rate shock.

"Duration extension and increased credit risk-taking may increase short-term profits, but at the risk of potentially larger losses in the event of a sudden yield curve steepening, a large rise in rates or a significant widening of credit spreads," the report says.

Be honest: have you ever heard of FSOC? And what do you think about the growth of loans to nonbank mortgage servicers?

Follow me on twitter: @allisonsross.

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