U.S. Financial Stability Threatened by Brexit: U.S. Monitor, According to Reuters

U.S. Financial System Faces Increased Risks Due to Brexit and Low Interest Rates

The U.S. financial system is facing heightened potential instability due to Britain’s decision to exit the European Union, alongside concerns raised by low and negative interest rates, according to a U.S. government report released on Monday.

In its biannual assessment of U.S. financial stability, the Office of Financial Research indicated that overall risks are currently in the medium range but have been elevated by the Brexit vote. Richard Bermer, the director of the office, emphasized at a press conference that these risks have remained at this level for over 18 months.

Bermer noted that the ramifications of Brexit could have a prolonged impact on the U.S., as the process of finalizing the details of the UK’s departure from the EU is likely to take several years. He cautioned that "larger shocks to confidence are possible" as negotiations unfold, given the strong connections between the U.K. economy and its financial systems with those in Europe and the U.S. Adverse outcomes in the U.K. could lead to spillover effects that compromise U.S. financial stability.

Following the Brexit referendum, financial markets experienced significant disruption, resulting in long-term interest rates in the U.S., U.K., and Germany plummeting to historic lows. Recently, however, markets have returned to a more stable condition.

The report outlined that financial claims from American banks, insurance companies, asset managers, hedge funds, and other entities on U.K. institutions amount to approximately $2.1 trillion, which is about 11.3% of the U.S. economy. Additionally, claims on European Union entities, excluding the U.K., total around $2.9 trillion, or 15.9% of U.S. GDP. These figures do not account for derivatives or guarantees.

The potential upheaval from Brexit could expose banks to greater vulnerability, as a downturn in the British economy could slow loan growth. While banks are currently facing challenges from low interest rates, Bermer expressed that they are generally more resilient compared to the situation a decade ago.

"Long-term U.S. interest rates have declined to ultra-low levels, which may encourage excessive risk-taking and borrowing," he stated. He also pointed out that many key foreign interest rates are now negative, leading to uncertain implications for financial stability.

Since 2014, long-term U.S. interest rates have dropped significantly, partly due to declining and negative rates in Europe. The Office of Financial Research warned that Brexit could extend negative interest rate policies in Europe and beyond, contributing to increased risk-taking and inflated prices in key sectors such as equities and commercial real estate.