U.S. banks remain in good shape despite more market volatilty, but prime brokers could face more risk.
U.S. banks remain in good shape with ample liqudity despite increased geopolitical concerns and market volatility, the Federal Reserve said on Friday.
The Fed said in a 42-page bank supervision report that the banking system has robust capital and liquidity and the quality of its assets has improved.
It said uncertainty has increased due to geopolitical issues.
“Capital and liquidity positions are robust, allowing banks to continue to support the economy and preparing them to withstand potential adverse market events,” the Fed wrote in the report.
The Federal Reserve.
Shutterstock
The Geopolitical Issues Are Key
The central bank said the risk for financial institutions rose due to Russia’s invasion of Ukraine.
The exposure to Russia by banks in the U.S. has been limited, but the ongoing war could lead to more volatility in commodity prices and more risk of cybersecurity.
The increased geopolitical tensions will be monitored by the Fed’s supervisors.
The Fed did warn that banks which have prime brokerage services geared for large investment funds have “significant risks” due partly because of the collapse of Archegos Capital Management in 2021.
Several banks wound up with $10 billion in losses.
“The investment funds typically obtain loans secured by equities or other securities through the prime broker,” the report said.
“Prime brokerage services can pose significant liquidity and credit risks to the bank providing these services,” it reads.
“These risks are heightened by the complexity of prime brokerage services and lack of transparency into the trading and investing activities of the investment fund clients, particularly trading activities with other counterparties.”
Risk Management Closely Watched
Banks need to ensure there is strong risk management and controls when they provide prime brokerage services, the Fed wrote.
Last December the Fed issued a warning to banks with large derivatives portfolios and relationships with investment funds.
The Fed said the banks should not count on information that is either incomplete or unverified information from the clients of these funds.
“Banks need to understand the risk posed by their clients and have adequate tools to manage it,” the Fed wrote. “Tools include ongoing due diligence on clients, risk-sensitive margining practices, and strong independent risk-management oversight of the business.
