Overall risk to U.S. financial stability remains moderate although threats like cybersecurity and increased corporate debt among firms outside the financial sector have grown over the past year, according to the Financial Stability Oversight Council's annual report released Wednesday.
Regulators warned valuations might be elevated in key U.S. financial markets, including equities, corporate debt, and some commercial and residential real estate. "Downturns in these markets can occur with little warning and in response to a range of factors," the report said. "Elevated leverage and asset valuations can make such downturns more severe."
A sharp downturn in the corporate credit cycle could be accompanied by broad-based declines in asset prices. "Elevated valuations in U.S. equity, corporate bond, and certain residential and commercial real estate markets could make them susceptible to larger price declines in the next major correction," the report said.
Total borrowing by the private non-financial sector has risen for seven years and the increase in borrowing in the non-financial business sector has outpaced the rise in nominal GDP, according to the report.
"While strong interest coverage and liquidity positions have allowed businesses to service this debt with low delinquency rates, these factors may not prevent a wave of defaults in the event of a recession or a similarly large shock to business earnings," the report said.
The risk of a cybersecurity attack that brings severe negative consequences, potentially entailing systemic implications for the financial sector and the U.S. economy, has also risen as the financial system has increased its reliance on information technology, according to the report.
Financial stability risks outside the U.S. appear to have increased, the report said. Most notably, the uncertainty surrounding the U.K.'s planned withdrawal from the European Union could have "serious implications for the functioning of some global financial markets and firms."
A "no-deal" Brexit could create risks that may have immediate and significant spillover effects into the U.S., including an interruption in financial contracts, undermined financial relationships and potential reversals of cross-border financial flows, the report noted.