OCC Report Identifies Key Risks Facing Federal Banking System

The Office of the Comptroller of the Currency, OCC, has published its semi-annual risk perspective which describes the current and expected operating environment of financial institutions in the U.S. and outlines the key risks faced by financial institutions in this context (with data provided for the analysis as of June 30, 2023). In brief, these are:
(1) operational risks: these risks remain elevated as banks are faced with an increasing number of cyber attacks. Additionally, banks are more and more relying on third-party service providers for performing certain functions leaving them with more risk and vulnerability to cyber threats, including ransomware. Furthermore, banks are increasingly deploying AI and engage in various digitization efforts to meet the demands of their customers and to enhance internal operational efficiency (see compliance risk). These engagements bring about more risks, particularly in relation to operational resilience and cyber security.
(2) credit risks: these risks are increasing, so the OCC, particularly due to rising interest rates and rising inflation which in turn have increased borrower stress in servicing existing loans. In this context, the Office also notes that high interest rates are dampening corporate outlooks and the profitability of companies, leaving them more vulnerable to servicing existing credit engagements and less likely to engage in new ones. At the same time, the OCC sees a decline in the demand for private multi-residential property which causes pressure on housing prices and on construction / real estate firms. Finally, and somewhat away from the actual credit risks, many financial institutions lack experienced personnel to evaluate credit risk appropriately.
(3) compliance risks: these risks are clearly elevated as many institutions have outsourced numerous functions to third party service providers. Such arrangements naturally raise the risks of compliance as the outsourcing firm does not have direct control over the third party’s operations. Furthermore, many banks are dealing with new technologies, products, and services such as the use of FinTech for purposes of monitoring operations which – at least at first – elevate compliance risks. In addition, banks are faced with new regulatory requirements such as the assessment of climate-related risks, the identification of beneficial ownership, or the compliance with new fair lending standards under enhanced Community Reinvestment Act requirements, which leaves them vulnerable to compliance risk.
(4) performance risks: so far, banks have withstood the negative impacts of high inflation and interest rates very well. In fact, they have increased their profitability and capital reserves during the first half of 2023. However, it remains to be seen, how well banks are able to deal with the situation, particularly in view of decreasing corporate credit demand and weak global economic outlooks.
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For more detailed information, please consult the enclosed report.