US bank regulator reports key risks and effects of COVID-19 The US Office of the Comptroller of the Currency’s Semi-annual Risk Perspective for Fall 2020 reports risky times for banks – from terrorist financing to cyberattacks and shady cryptocurrency activity.
The Office of the Comptroller’s (OCC) Semiannual Risk Perspective addresses key issues facing banks in the US, focusing on those that pose threats to the safety and soundness of banks and their compliance with applicable laws and regulations. Published in November 2020, this edition is something of a COVID ‘special issue’, with the report noting increased risk exposures in the areas of credit risk, strategic risk, operational risk and compliance risk, and highlighting emerging areas of risk fuelled by the new realities of the COVID era. Credit risk According to the OCC, credit risk is increasing in the US as the COVID induced economic downturn impacts on customers’ ability to service their debts. COVID – and efforts to contain its spread –triggered a historic economic downturn from March. “The private service sector suffered the most, with massive job losses in high-touch industries, such as leisure, hospitality, and retail trade,” the report stated. Placing the impact in historical context, real GDP in the US declined 10.1 percent between the fourth quarter of 2019 and the second quarter of 2020, compared with a peak-to-trough decline of 4.0 percent during the 2008–2009 recession.
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Despite a rebound in economic growth due to businesses reopening after initial lockdowns, commercial, retail, and mortgage credit risks are all increasing. Added to this, states the report, unprecedented government stimulus packages are likely masking significant losses within financial services. In terms of commercial lending, there are challenges in most sectors. According to the OCC, businesses that were weak before the pandemic, including highly leveraged borrowers, are especially vulnerable. “Commercial real estate, oil and gas, retail businesses, transportation, leisure and hospitality, and agricultural lending are areas of increasing risk exposure,” it stated. “Commercial borrowers’ cash flows have been negatively affected, including businesses that do not offer telework flexibility.” Its guidance to banks is that they continue to work prudently with borrowers that are or may become unable to meet payment obligations, and that they maintain accurate and timely loan risk ratings based on the borrower’s repayment ability and ability to manage through the COVID crisis. Strategic risk Strategic risk is an emerging issue, says the OCC, due to historically low interest rates, potential credit stress, extent of asset growth in low yielding assets, and weak loan demand.
These all negatively impact on bank profitability. “During the second quarter of 2020, net income declined sharply due to higher loan loss provisions and lower net interest margins (NIM) primarily due to banks holding high levels of low yielding assets. Secondquarter NIM was the lowest measured in the past 30 years.” Banks will face pressure to improve earnings by cost cutting and increasing risk. As asset managers seek alternative revenue sources or ways to reduce costs, risk exposure will increase. “In response to similar challenges, banks have traditionally cut costs to maintain margins. Key control functions and processes, such as risk management, audit, compliance, and staff development, should be maintained to ensure risk management oversight during times of economic stress.” Operational risk The move to remote working and an evolving and complex operating environment are elevating financial institutions’ exposure to operational risk. Cybersecurity threats are a key contributor to this heightened operational risk environment. “Financial institutions are adjusting to a changing cyber landscape to protect their operations and customers from cyber criminals and fraud while many employees are working remotely,” observed the OCC. “Growth in bank employees’
February/March 2021
