Regulators Point to New Financial Risks Outside Traditional Banks

By Dow Jones Business News, 
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By Ryan Tracy

Washington--A council of senior U.S. regulators highlighted emerging risks outside the traditional banking system, signaling growing concern that Washington's crackdown on banks might be driving risky activity beyond its legal reach.

Regulators on the Financial Stability Oversight Council are monitoring new practices by mortgage servicing companies, insurers and asset managers for potential emerging threats posed by dabbling in riskier investment areas without sufficient oversight or capital, a council staff member said at a public meeting Wednesday.

The council's members, who approved an annual report highlighting the risks that will be released later Wednesday, include the heads of the Treasury Department, Federal Reserve, Securities and Exchange Commission, and other agencies.

Since the 2008 financial crisis, U.S. regulators have subjected banks to stricter rules, including requiring that they hold more loss-absorbing capital and reduce their exposure to riskier businesses. Now, regulators are watching to see whether financial firms that don't face the same restrictions are stepping into some of those areas to fill the void left by big banks.

Among the areas cited in the council's report are a shift by nonbanks into handling the billing and collection of mortgages, said Joao Santos, a Federal Reserve Bank of New York official who assists the council. So-called mortgage servicing rights "are increasingly being transferred" to nonbank firms that don't have to follow the same capital and risk-management rules as traditional banks, he said.

The shift has largely been driven by regulators, who have pushed banks out of mortgage servicing by introducing new rules dictating how servicers interact with borrowers and by raising capital costs for servicing loans. The shift has prompted concern among federal and state regulators who worry the nonbank firms moving into this business--like hedge funds--don't have the capital cushions or regulatory oversight to withstand a market downturn.

The report also expresses concern about the securities lending markets that investors tap for hedging and short- selling, saying asset-management firms have begun to provide investors with protection against the risk of losing their collateral, Mr. Santos said. "Unlike banks, asset managers are not required to set aside capital when they provide indemnification," Mr. Santos said, noting that such guarantees "may be a source of stress" on the asset managers in rough times.

The council didn't make any specific recommendations for regulators to act on the newly identified vulnerabilities, instead saying that the regulators were listing the new practices to illustrate the need to monitor them more closely.

The council does have some authority to take action of its own. It has already drawn in two large insurers, American International Group Inc. and Prudential Financial, for stricter oversight by the Fed and is in the early stages of considering whether to do the same for big asset managers like Fidelity Investments and BlackRock Inc. It can also single out risky activities and recommend that member agencies take action.

Members of the council, including Treasury Secretary Jacob Lew and Federal Reserve Chairwoman Janet Yellen, said U.S. financial stability has improved since the 2008 crisis, but areas of risk remain.

They highlighted the need for action on priorities the council has previously identified, including risks associated with rising interest rates, money-market mutual funds, cybersecurity, and repurchase agreements and other forms of short-term wholesale funding. Officials at the Fed in particular have said they are examining new rules for short-term funding markets, while the SEC is weighing rules for money-market funds.

"While we have made considerable progress in recent years, our job is not done," Ms. Yellen said. "We must continue our collective efforts to monitor risks."

Stephanie Armour contributed to this article.

Write to Ryan Tracy at ryan.tracy@wsj.com


  (END) Dow Jones Newswires
  05-07-141522ET
  Copyright (c) 2014 Dow Jones & Company, Inc.


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