Fed’s Cook: More study needed on bank-nonbank interreliance

Federal Reserve Gov. Lisa Cook said that financial markets fared well in the face of uncertainty sparked by President Trump’s evolving tariff regime, but that more study is needed to understand how risks from nonbanks affect the banking system and vice versa.

Speaking at a conference at New York University on Friday, Cook said that the recent market volatility that took place in April after President Trump’s “liberation day” tariff announcement was significant; stock market indices shed nearly 20% of their value, volatility indices were the highest since the onset of the COVID pandemic in 2020 and highly leveraged investors unwound their positions. But she said the underlying fundamentals of household and business finances, as well as the functioning of critical markets like Treasury bonds, made the fallout manageable and showed the system’s resilience. 

“The episode provided a real-life example of the large asset-price declines and sudden bursts of volatility that can result from shocks when asset valuations are stretched, as well as the importance of stable and resilient funding markets in absorbing shocks,” Cook said. “The experience will surely help us hone our ongoing assessment of financial system vulnerabilities and areas of resilience.”

Cook went on to say that there are several pockets of interconnectedness between the banking and nonbank sectors that would benefit from further study in order to prevent volatility in one sector from affecting the other. 

“Episodes of strain in U.S. Treasury markets over the past several years illustrate the importance of nonbank financial intermediaries, a term that encompasses hedge funds, mutual funds, life insurers, finance companies, and money market funds,” Cook said. “This is particularly true in the U.S., where credit is provided by a combination of banks and nonbanks that are often connected through counterparty relationships or common exposure.  It would be helpful to have deeper insights into the potential macroeconomic consequences of the shifting interaction between banks and nonbanks.”

Cook added that greater understanding of the roles that private credit and private equity play in the marketplace — and their interwoven business relationships with banks and other nonbank actors — would be beneficial to regulators and their ability to forestall economic calamity.

“Efforts to incorporate private credit and private equity into macroeconomic models could spur important lines of research. Layered leverage in intermediation chains involving private equity, private credit funds, banks, and businesses can transmit and amplify real-economy shocks to different parts of the financial sector,” Cook said. “In addition, private equity and private credit are macro-relevant sectors that can transmit shocks to the real economy.”