Federal Reserve focuses on emerging risks

Federal Reserve focuses on emerging risks

Late last year, the Federal Reserve released its inaugural Supervision and Regulation Report. The report is designed to summarize banking conditions and the Fed’s supervisory and regulatory activities.

Worth Noting

Here are some highlights from the report:

Banking system conditions. The Fed reports that the U.S. banking system is generally strong, that loan growth remains robust, that the volume of nonperforming loans has declined over the last five years, and that overall profitability is stable. Banks continue to maintain high levels of quality capital and have significantly improved their liquidity since the financial crisis.

Large financial institution (LFI) soundness. According to the report, the safety and soundness of LFIs continues to improve. Capital levels are strong and significantly higher than before the financial crisis. Recent stress test results demonstrate that LFIs’ capital levels would remain above regulatory minimums even after a hypothetical severe global recession.

Regional and community banking organization liquidity risk. The Fed reports that most regional banking organizations (RBOs) and community banking organizations (CBOs) are in satisfactory condition, and that 99% are “well capitalized.” Although liquidity risk is generally low or moderate for RBOs, examiners have observed some deterioration of liquidity positions.

The Fed also has identified opportunities for improving RBO risk management. In 2019, the Fed’s RBO supervisory priorities include:

  • Credit risk (concentrations of credit, commercial real estate [CRE] and construction and land development, and underwriting practices),
  • Operational risk (merger and acquisition risks, IT, and cybersecurity), and
  • Other risks (sales practices and incentive compensation and BSA/AML).

CBOs, the Fed observes, are in “robust financial condition,” with high capital levels and low-to-moderate liquidity risks. But like RBOs, CBOs have experienced “a slight uptick” in liquidity risks. Supervisors continue to focus on three areas of emerging risk: 1) management of concentrations of credit — specifically, CRE, agriculture, and oil and gas, 2) the impact of rising interest rates, and 3) increased liquidity risk.

CBO supervisory priorities for 2019 include:

  • Credit risk (concentrations of credit, CRE and construction and land development, and agriculture),
  • Operational risk (IT and cybersecurity), and
  • Other risks (BSA/AML and liquidity risk).

According to the report, the Fed also has made it a priority to modernize and increase the efficiency of the examination process to reduce the burden on community banks. A key part of this effort is the Bank Exams Tailored to Risk program. Under that program, each bank is classified into a low-, moderate- or high-risk tier. The classification provides examiners with a starting point for determining the scope of work, including the extent of transaction testing and other examination procedures. Examiners have the discretion to consider qualitative factors and apply their own judgment in confirming or adjusting the risk tiers.

A valuable tool

The Fed’s inaugural Supervision and Regulation Report examines trends going back to the financial crisis. Future reports will focus on developments since the previous report. Taken together, these reports provide banks with a valuable tool for keeping their fingers on the pulse of the banking industry and identifying emerging risks.

© 2019