What is the OCC concerned about?

OCC Spring 2019 Semiannual Risk Report

Background: The Office of the Comptroller of the Currency (OCC) publishes a report (Semiannual Risk Perspective) twice a year to share their view on the state of the federal banking system and the key risks from their point of view. This report is published by the National Risk Committee (NRC) of the OCC which is responsible for monitoring threats to the safety and soundness of the banking system. This is an eagerly awaited (in some circles) report since it is a concise summary of the key risks and issues that the OCC is thinking about and brings transparency for the banks on the focus areas in coming months by the regulator (OCC).

The most recent OCC semiannual report (Spring 2019 Seminannual Risk Perspective) notes that the banks performance remains strong with increases in capital ratios, ROE and NIM while delinquencies and non-performing loans continue to be lower than long term average trend. The key concerns are – rising Credit Risk, elevated Operational Risk, challenges in meeting Consumer Protection Requirements (BSA/AML/OFAC) and the volatility in bank deposits and impact on costs/funding for banks. In emerging risk, OCC cites elevated strategic risk due to rapid developments in Fintech and BigTech (previous post – BigTech, FinTech and the Banks) and greater use of new products, vendors or services without proper risk management. From my read, the following are the noteworthy points related to these key risk and details are in the report which is worth a read.

Key Risks

• Credit Quality is Strong but Risk has been Building

  • Nonbank entities have increased their participation in leveraged lending and retail credit risk and now for both of areas more risk is outside the regulated banking system. Case in point, Fintech lenders are now the largest lenders of unsecured personal loans; this is in line with a broader trend of the disruption in financial services through technological innovation which is expected to continue (BigTech, FinTech and the Banks).
  • The portion of weak loans as a portion of total loans is still high and at risk from a downturn in economy. However credit quality as measured by ratio of ALLL loans, NPL’s and delinquencies remains strong

• Operational Risk is Elevated as Banks respond to Evolving and more Complex Operating Environment

  • Cyber threat is increasing and evolving; this is now the main threat to banking system (see earlier post – Cybersecurity – not a technology problem). This threat is also enabled and exacerbated due to the increasing use of third party services and increasing reliance on vendors by banks.
  • Third Party Risk  is increasing due to concentration of third party service providers for technology (e.g. cloud computing, payment processing). These 2 factors make the case for Risk Management to be more active in Operation Risk in these non-traditional risk areas.

• Advances in Technology pose Challenges for AML/BSA/OFAC and Compliance with Consumer Protection Regulations

  • The rapidly changing dynamics in payment processing and money transfer are challenging the current BSA/AML/OFAC requirements for banks and compliance risk for them remains High.
  • The use of Artificial Intelligence for underwriting increases risk of not meeting fair lending requirements and also use of alternative data raises data privacy, transparency and security concerns.

• Increased Competition for Deposits could result in changes in Funding Mix and Costs

  • Deposit funding is at a historically high level of 78% however there are signs that this changing and banks with $10 billion or more experienced a 2.3% drop since end of 2016.
  • Use of new technology has made it easier for customers to switch and also offerings by FinTech will make deposits less sticky and predictable in the future.

Full report is available at OCC Spring 2019 Seminannual Report.