Hsu, who leads the Office of the Comptroller of the Currency, said in a speech to an American Bankers Association risk management conference that the likelihood and correlation of certain so-called tail risks — low-probability, high-impact events — have become "elevated" in the wake of the Russian invasion.
Not only has it heightened cyberthreats and raised the specter of broader conflict in Europe, but it has also led to additional upward commodity price pressures that could exacerbate inflation expectations and make interest rate hikes more likely, according to Hsu.
"A combination of any or all of the above could increase the chances of a broad market sell-off, which could trigger a recession," Hsu said. "It doesn't take a lot of mental gymnastics to envision scenarios where multiple tail risks materialize simultaneously or in rapid sequence. Joint events are now plausible."
Hsu, who ran the Federal Reserve's big-bank supervision program before his arrival at the OCC almost a year ago, said such outcomes are still far from inevitable. In addition, post-2008 stress testing has helped ensure that big banks are stocked with enough capital for "a range of shocks," he said.
But Hsu also cautioned that banks lacking "dynamic and robust risk management functions" nevertheless run a greater risk of being caught off guard.
"Greater caution and risk management vigilance is warranted today, perhaps more than at any time in recent memory," Hsu said, adding that bank risk managers should be updating their scenario analyses and internal stress tests in part to assess the threat from overlapping tail risks.
Senior leaders inside banks should give "special heed" to these analyses and make sure they have access to the latest, most complete data, while boards of directors should be digging in to understand their banks' joint tail risk exposures, according to Hsu.
The acting comptroller also sounded a warning about banks getting involved with the trading of derivatives linked to cryptocurrency, saying these financial institutions should "carefully consider" the associated tail risks before they "move too much farther down this path."
For one, Hsu said that because crypto-assets don't have the kind of robust price histories that most risk models rely on, it could be easier to underestimate how risky a crypto position actually is and undershoot how much capital needs to be held against it.
Hsu also said he is "worried" about how certain crypto positions are being netted for risk aggregation purposes and sees a heightened potential with crypto derivatives for so-called wrong-way risk, where what a counterparty owes to its dealer bank is growing at the same time as it's getting likelier to default.
"Russia's invasion of Ukraine is changing the landscape for tail risks, so is the rise of crypto trading," Hsu said. "Strong, independent risk management can help the banking system successfully navigate these risks and avoid surprises."
--Editing by Steven Edelstone.
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