OCC Report Highlights Key Risks in Federal Banking System

Summary

The OCC reported that the overall condition of the federal banking system remains sound. However, the maturing economic cycle may cause consumer headwinds. It is important for banks to continue identifying material risks and their interconnected impacts. Continuous risk management improvement remains appropriate as this allows banks to guard against complacency.

The OCC highlighted credit, market, operational, and compliance risks, as the key risk themes in the report. Highlights from the report include:

• Credit risk is increasing. Commercial real estate sectors, primarily the office sector and some multifamily property types, are experiencing stress due to a higher rate environment and structural changes. Office and multifamily loans, particularly those with interest-only terms, set to refinance over the next three years pose additional risk. Sticky inflation and elevated interest rates may increase consumer financial stress in some households and weigh on overall consumption growth.
• From a market risk perspective, net interest margins (NIMs) are under pressure due to strong deposit competition. Trends observed, however, indicate that pressure on funding costs and NIMs may be nearing a peak. The future direction, timing, and extent of rate movements and uncharted depositor behavior present risk management challenges. Wholesale funding usage continued to grow albeit at a slower pace going into 2024. Investment portfolio depreciation improved but unrealized losses remain elevated as banks continue to increase asset liquidity and interest rates remain elevated.
• Operational risk is elevated. The financial industry is responding to an evolving and increasingly complex operating environment. Cyber threats continue as malicious actors target the financial services industry and their key service providers with ransomware and other attacks. Increasing digitalization, new and innovative product and service adoption, and third-party use increase bank operating environment complexity creating both opportunities and risks. Continued check and wire transfer fraud and increased payment fraud incidents both underscore the importance of fraud risk management.
• Banks are operating in a dynamic banking environment because of changing customer needs and preferences related to products, services, and delivery channels. Risks are compounded if products and services, including changes, are not delivered or implemented in a fair and equitable manner. It remains important for banks to maintain a compliance risk management framework that is commensurate with their risk profiles and capable of growing and evolving as their risk profiles change. Fraud continues to be significant risk for banks. Effective processes to prevent, identify and file suspicious activity reports on fraudulent activity in a timely manner remain important to protect both banks and consumers. As banks work to process checks and other payments in a safe, fair, and efficient manner, check and wire fraud, and P2P transaction scams have become more prevalent. The OCC continues to assess banks' Community Reinvestment Act performance under the 1995/2021 regulatory framework.

The report highlights the necessity of firmwide resilience efforts as risks may be interconnected and events could simultaneously affect multiple risk categories. It is crucial that banks establish an appropriate risk culture that identifies potential risk, particularly before times of stress. Each stress event may vary (e.g., operational, liquidity, credit, compliance, and other) and resiliency implications need to be proactively considered. Prudent planning from a firmwide perspective can enhance a bank's ability to maintain operations, remain financially sound, and service customers in times of stress.