Staff Reports
Financial Stability Monitoring
February 2013  Number 601
Revised August 2013
JEL classification: E58, G01, G23, G28

Authors: Tobias Adrian, Daniel Covitz, and Nellie J. Liang

We present a forward-looking monitoring program to identify sources of systemic risk and to develop preemptive policies to promote financial stability. The program reflects that private incentives can lead market participants to react to changes in financial regulations and economic conditions in ways that would increase systemic risk, and that the Dodd-Frank Act raised the standards for ex-post government intervention in a crisis. To guide such a program, we develop a framework that distinguishes between shocks, which are difficult to prevent, and vulnerabilities that amplify shocks, but can be reduced by preemptive actions. Building on substantial research, we focus on leverage, maturity transformation, interconnectedness, complexity, and the pricing of risk as the primary vulnerabilities in the financial system. These vulnerabilities are tracked in four areas: systemically important financial institutions (SIFIs), shadow banking, asset markets, and the nonfinancial sector. The framework also highlights the policy tradeoff between reducing systemic risk and raising the cost of financial intermediation by taking preemptive actions.

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