Board of Governors of the Federal Reserve System

3. Leverage in the Financial Sector

Vulnerabilities associated with financial leverage remained notable

Leverage for hedge funds remained stable at record-high levels over the period for which comprehensive data have been collected, as a decrease in the cash-futures basis trade was largely offset by other relative value trades, such as swap spread trades. Leverage at the largest life insurance companies remained well into the upper quartile of its historical distribution.

The banking system remained sound and resilient as banks have reduced exposure to interest rate risk by shortening asset duration. Leverage at broker-dealers stayed near historically low levels. Dealers' ability and willingness to intermediate remained robust, as they maintained adequate levels of market making capacity.

Table 3.1 shows the size and growth rates of assets held by selected financial institutions discussed in this section as of the fourth quarter of 2025.

Table 3.1. Size of selected sectors of the financial system, by types of institutions and vehicles

Banks maintained historically high levels of regulatory capital, with declining fair value losses and exposure to interest rate risk

Robust capital positions allow banks to pursue growth opportunities while providing a cushion against unexpected losses. The common equity Tier 1 (CET1) ratio, a regulatory risk-based measure of bank capital adequacy, remained at historically high levels (figure 3.1). Banks' return on equity—a measure of profitability—remained within recent historical ranges through the fourth quarter of 2025 (figure 3.2). Continued strong income-generating capacity is an additional potential source of resiliency for banks, as they can more easily accrete capital by retaining a portion of their current earnings than by raising external funds.

Banks have continued to reduce exposure to a potential rise in interest rates by shortening duration as their balance sheets moved toward less interest rate sensitive short-duration securities. These actions, combined with some decreases in interest rates, helped reduce fair value losses on banks' fixed-rate assets relative to peaks in 2022, but these losses remain sizable. The fair values of banks' available-for-sale (AFS) and held-to-maturity (HTM) portfolios were below their book values by a combined $300 billion at the end of 2025 (figure 3.3). An alternative measure of bank capital—the ratio of tangible common equity to total tangible assets, which, unlike the CET1 ratio, does not factor in the riskiness of assets but does include fair value declines on AFS securities—remained stable for global systemically important banks (G-SIBs) and close to its median level over the past decade, and it increased for large non–G-SIBs and other regional banks (figure 3.4).

Banks maintained strong credit quality

Recent responses from the SLOOS indicated that overall bank lending standards eased again in the fourth quarter of 2025 (figure 3.5). At the same time, delinquency rates on bank loans declined across key categories (figure 3.6).

Delinquencies of loans backed by commercial properties were largely stable at the end of 2025. Banks modified their CRE loan terms to manage exposure, including by requiring additional collateral from some borrowers.

Broker-dealers' leverage remained low

Broker-dealer leverage remained roughly unchanged, with asset-to-equity ratios at a level slightly below its median over the past decade (figure 3.7). Trading profits declined at the end of the year, in line with seasonal trends (figure 3.8). In addition, the distribution of trading profits remained balanced across equities; fixed income, rates, and credit; and other business lines (figure 3.9).

Dealers are important intermediaries in Treasury markets, serving in key roles that support orderly market functioning. Measures of dealer intermediation activity in Treasury markets increased further due to growth in secured lending, particularly repurchase agreement (repo) lending to hedge fund clients. Dealers' value-at-risk (VaR) remained below internal risk limits, suggesting dealers' intermediation capacity remains adequate for market functioning in normal times.⁸ That said, VaR can rise rapidly when volatility increases, so dealers' willingness and ability to intermediate can be tested if VaR approaches those limits during periods of market stress.

According to the March 2026 Senior Credit Officer Opinion Survey on Dealer Financing Terms (SCOOS), dealers report that overall use of financial leverage and financing terms remained mostly unchanged.⁹ In response to a special question on funding in securities financing transactions, dealers indicated that they expect demand for securities financing across different asset classes to increase over the coming year, while also reporting that they expect to increase their capacity to supply such funding.

Leverage at large life insurance companies remained elevated

Leverage at the largest life insurers remained well into the upper quartile of its historical distribution over the second half of 2025, while leverage at property and casualty insurers remained at historically low levels (figure 3.10). Life insurers have also steadily increased their investments in risky and illiquid assets over the past decade, and their activity has contributed to the expansion of private credit.

Hedge funds' leverage was elevated

In the third quarter of 2025, the most recent quarter for which comprehensive data from the Securities and Exchange Commission's Form PF are available, gross notional leverage, measured as gross notional exposure divided by net asset value (NAV), was about unchanged at near all-time high levels (figure 3.11). Leverage in the sector also remained skewed to larger funds (figure 3.12). The use of leverage over the past couple of years has increased across a range of strategies and supported significant positions in key markets, such as Treasury securities, interest rate derivatives, and equities. According to data from the March 2026 SCOOS, dealers reported that hedge funds' use of financial leverage remained unchanged since the end of 2025 (figure 3.13). High leverage can lead to spillovers if the fund suddenly loses access to funding.

Issuance of non-agency securitized products remained strong

Issuance of non-agency securities remained robust through March 2026 (figure 3.14).¹⁰ Credit performance was mixed, with delinquencies increasing for CMBS deals and auto asset-backed securities but decreasing for securitized credit card products.

Bank lending to other financial entities continued to grow at a robust pace

Bank credit commitments to other financial entities grew appreciably in the fourth quarter of 2025 to $2.6 trillion, reflecting the growth in market-based finance and other forms of private nonbank lending (figure 3.15). Private equity, BDCs, and other private credit vehicles constituted the largest portion of bank lending to other financial entities; see the box "Updates in the Classification of Nonbank Financial Institutions" for clarification on methodological changes. Yearly growth of commitments has been notably robust for the special purpose entities, collateralized loan obligations (CLOs), and asset-backed securities category, followed by the other financial vehicles category and the private equity, BDCs, and private credit category (figure 3.16).

 

References

 

 8. VaR is a statistical measure that estimates the maximum potential loss in the value of a trading portfolio over a specified time horizon at a given confidence level. Dealers set internal risk limits based on their risk appetite, capital adequacy, and regulatory requirements. Return to text

 9. The SCOOS is available on the Federal Reserve Board's website at https://www.federalreserve.gov/data/scoos.htm. Return to text

 10. Securitization allows financial institutions to bundle loans or other financial assets and sell claims on the cash flows generated by these assets as tradable securities, much like bonds. By funding assets with debt issued by investment funds known as special purpose entities (SPEs), securitization can add leverage to the financial system, in part because SPEs are generally subject to regulatory regimes, such as risk retention rules, that are less stringent than banks' regulatory capital requirements. Examples of the resulting securities include collateralized loan obligations (predominantly backed by leveraged loans), asset-backed securities (often backed by credit card and auto debt), commercial mortgage-backed securities, and residential mortgage-backed securities. Return to text