On June 14, the Office of the Comptroller of the Currency (OCC) published the spring edition of its Semiannual Risk Perspective, which discusses key issues facing banks. The good news is that the federal banking system saw historic growth in net interest income in 2022. However, rising interest rates weigh on other aspects of bank performance, such as noninterest income, as mortgage activity continues to slow.
While the OCC emphasized that banking conditions are overall sound, the report zeroed in on liquidity, operational, credit, and compliance risks as key themes.
- Liquidity levels have been strengthened in response to three significant bank failures in Q1 and Q2 2023, but rising long-term rates continue to cause significant depreciation in investment portfolios.
- Liquidity and interest rate risk modeling, stress testing, and sensitivity analysis remain critical to maintain sufficient access to cost-efficient sources of liquidity.
- The OCC wants banks to focus on ensuring operational readiness to access contingent liquidity sources in light of the degree and speed of deposit flight observed in early 2023.
- Operational Risks:
- Operational risk remains high as cyberattacks become more sophisticated and disruptive against the financial sector. The digitalization of banking products and services is expanding, especially as banks increase use of third parties, and with it the OCC reported an increase in cyber security risks. Ransomware continues to target banks and their third-party providers. These attacks have the potential to render critical data inaccessible as well as threaten the confidentiality of customer data.
- To mitigate these risks, banks should adopt heightened threat and vulnerability monitoring processes and implement effective security measures, including the use of multifactor authentication, hardening of systems configurations, and timely patch management.
- Banks also should consider implementation and routine backup testing of key systems, including maintaining immutable backup of critical data. While leveraging new technology can offer benefits to banks and their customers, banks are reminded to implement due diligence and change management and risk management processes when adopting new products and services.
- Credit Risks:
- Credit markets and loan portfolios remain resilient and problem loan levels remain manageable. Nonetheless, persistent high inflation and rising interest rates may cause conditions to deteriorate.
- Accordingly, prudent underwriting and effective portfolio management can reduce the impact of economic volatility. Banks should closely analyze borrowers’ repayment abilities and obtain reliable collateral valuations.
- Bank management teams should monitor the potential impact on credit quality from changing unemployment levels, declining asset values, inflation impacts on disposable income, and changes in payment rates, and consumers’ payment prioritization.
- Compliance Risks:
- Compliance risk elevate as banks expand their partnerships with third parties, such as financial technology companies (fintechs). As a result, it is important for banks to conduct appropriate due diligence, as well as ongoing monitoring and oversight of third parties. Oversight should be aligned with the nature and importance of the third parties’ activity.
- Further, because heightened focus on ensuring fair access to credit may contribute to elevated fair lending risk, the OCC recommends fair lending controls that include evaluating loan applications (from originations through the life of the loan) to assess whether the bank is marketing, soliciting applications, offering, and extending credit on an equal basis.
In closing, the OCC highlighted climate-related financial risks, recommending that banks establish risk management programs to identify, measure, monitor, and control climate-related risks. The OCC acknowledged the progress made by banks in this area, but notes that large banks (as a class) have significant additional work to do to incorporate climate-related financial risks into their risk management policies.
We will continue to monitor and report on important developments involving risk measures within the banking industry.