Executive Briefing: Summarizing the FDIC and OCC 2021 Risk Review Reports

Highlighting What You Need To Know and How SRA Watchtower Can Help

Your job is already hectic enough trying to manage a business and probably haven’t had time to read the 100+ page FDIC Risk & OCC 2021 reports, right?  Well, we did the heavy lifting for you and created cliff notes below highlighting the #7 key risk profiles you should be most concerned about. Give it a quick read and contact us if you have any questions on how Strategic Risk Associates can help your business thrive this year. SRA Watchtower is a risk and performance management platform, turning resultant data into actionable intelligence to run your bank, schedule a demo today to learn more.

#1 Credit Risk:

Banks are exposed to an array of credit risks. In 2020, these risks intensified as the economic contraction unfolded. Banks remained relatively resilient partly because of government support extended to businesses and consumers most affected by the recession. The system-wide offering of proprietary relief and mandated programs coupled with unprecedented stimulus efforts may be deferring potential losses within the financial services industry. Institutions with elevated levels of credit exposure to affected sectors are potentially more vulnerable to market disruptions and could present risk management challenges. FDIC/OCC highlighted credit risks in agriculture, commercial real estate, consumer debt, energy, housing, leveraged lending and corporate debt, nonbank financial institution lending, and small business lending.

 

The pandemic’s progress and potential shifts in behavior and preferences may influence the outlook for CRE across property segments. Because changes in CRE tend to lag changes in the broader economy, it is possible that the worst effects of the pandemic have yet to be seen. In 2021, institutions holding CRE loans face significant possible challenges, including weakened cash flows for some properties and potentially higher interest rates and debt servicing costs for some CRE borrowers.

 

How Watchtower Can Help

SRA Watchtower allows institutions to track and monitor concentration risks to multiple lending segments and sectors relative to Total Assets, Total Loan Portfolio, and key credit portfolio sub-components in alignment with their risk appetite. SRA Consultants leverage their deep expertise to set benchmark thresholds that are embedded in comparison with a set of Peer banks that are appropriate for the bank. Institutions are also able to identify, measure, and weigh overall and sub-component loan growth to Total Loans, and key sub-component totals in order to assess relative growth in riskier and less risky segments of the portfolio.

 

SRA Consulting and SRA Watchtower enable usage of “forward-looking” risk indicators, which can be indicative of future performance and should be the focus of a sound credit MIS program to proactively identify and mitigate risk exposure instead of conventional “lagging” indicators of risk, in the sense that they provide after-the-fact evidence of a credit-quality issue.

SRA Watchtower enables participating institutions to establish a sound governance framework, assess data integrity, set up KRIs, define thresholds to help define the institution’s risk appetite and monitors the evolution of credit risk through quantitative (policy exceptions, risk segmentation, and migrations, criticized/classified assets, credit losses, provisions, etc.) as well as  qualitative attributes (credit policies, credit culture, quality of data and reporting, etc.).  Contact us to learn more.

 

#2 Interest Rate Risk and Net Interest Margin  

Banks are reporting record low NIMs driven by the low and flat yield curve coupled with growth in low-yielding assets funded by deposit inflows. Stimulus measures, limited investment options, reduced lending opportunities, and significant loan prepayments placed downward pressure on net interest margins (NIMs)- which reached a record low as asset yields declined more than funding costs. The ratio of loans to total assets also declined for community and noncommunity banks in 2020, as strong deposit inflows exceeded loan demand. Community banks face interest rate risk challenges in a low interest rate and tepid loan environment. The annual net interest margin (NIM) for the industry fell to 2.82 percent -the lowest annual NIM since year-end 1984. While financial market conditions have improved significantly, they remain sensitive to developments related to the pandemic. Non-maturity deposits rose 16.7 percent in 2020 from 2019 levels. Because depositors can withdraw these funds at will, bank expectations related to the stability of these deposits will be crucial to effective interest rate risk management. If withdrawn, bank management may have to turn to more costly funding sources, which would place additional pressure on net interest income. Significant volatility and shifts in interest rates may pose challenges to the banking sector.

 

How Watchtower Can Help

SRA Watchtower  allows institutions to track and monitor ALM, balance sheet, and interest rate risks in alignment with the portfolio composition, asset-liability duration mismatches, and comparison to peer benchmarks. Contact us to learn more.  

#3 Liquidity Risk

Sudden changes to depositor behavior could challenge community bank liquidity. While many community banks ended 2020 flush with liquidity, the permanence of new consumer and business deposits is unknown. The reduction in bank borrowings and other wholesale funding components correlates with increased deposits and enhanced on-balance sheet liquidity. However, the long-term liquidity position for community banks remains uncertain. Liquidity levels will depend on how long consumers and businesses hold funds in risk-free deposit accounts. Deposits that exit banks more quickly than anticipated could create higher liquidity risk for banks that are not adequately prepared.

How Watchtower Can Help

SRA Watchtower allows institutions to track the strength of funding sources, liquidity ratios, wholesale funding reliance, the concentration of deposits, structural mismatches, contingency funding plans, the robustness of liquidity reporting, etc. Set up of risk appetite guardrails and systematic monitoring of liquidity risk KRIs will help mitigate the liquidity risks that FDIC highlights in the 2021 risk review. Contact us to learn more.

 

#4 Economic Risks

Weak labor market conditions pose risks to banks through potential asset quality deterioration. In addition to debt servicing issues, unemployment or uncertainty about employment also reduces demand for new loans, limiting the prospects for new loans in the medium term. Individual states and regions have faced uneven economic conditions owing to the spread of COVID-19 and the nature of public health orders. The economic recovery has been uneven across sectors, in a pattern that is atypical of recessions. States with a higher share of industries most affected by the pandemic, such as leisure and hospitality, experienced larger increases in unemployment. The speed of states’ labor market recovery in the third and fourth quarters depended partly on when public health orders and other pandemic safeguards were lifted.

How Watchtower Can Help

Exogenous risk offering within SRA Watchtower enables rigorous monitoring of geographic and sectoral risk at a granular level. SRA Exogenous risk assesses consolidated economic trends for 390 metropolitan statistical areas utilizing historical trends since 1991 and forecast over the next 5 years. Exogenous risk offering also evaluates sectoral risk for more than 100 industries (including CRE property types) by evaluating their resilience, volatility, and economic prospects. Contact us to learn more.  

#5 Operational Risks

Operational risk remains elevated. A flexible, risk-focused approach to operational resilience, underpinned by scenario analyses, surveillance and reporting, and management of third-party risk is important for banks. When mandatory stay-at-home orders were put in place at the onset of the pandemic, banks had to quickly adapt to provide and maintain an acceptable level of customer service while limiting branch access. Banks pivoted to remote access to banking services through online and mobile applications, and many banks shifted employees to remote work to ensure their safety. On the other hand, Cyber actors continue to focus on exploiting vulnerabilities identified in bank systems and third-party providers of information technology services. Banks should remain diligent in detecting and protecting against cyber threats, ransomware attacks, and fraudulent unemployment or economic impact payments.

How Watchtower Can Help

SRA Watchtower has an extensive library of KRIs encompassing operational/IT risks. SRA consultants help determine appropriate guardrails for attributes ranging from transaction processing risk, customer information risk, third party risk, quality of information controls, business continuity plan quality, etc. in alignment with the interagency paper Sound Practices to Strengthen Operation Resilience issued by OCC, Federal Deposit Insurance Corporation, and Federal Reserve Board in 2020. Contact us to learn more.

#6 Compliance Risks

Compliance risk is elevated as banks’ expedited efforts to implement assistance programs continue to challenge change management, product, and service risk management practices. These programs include the Coronavirus Aid, Relief, and Economic Security (CARES) Act’s Paycheck Protection Program (PPP) and federal, state, and bank-initiated forbearance and deferred payment programs. These programs feature increased compliance responsibilities, high transaction volumes, and new fraud typologies, at a time when banks continue to respond to a changing operating environment. Consistent with interagency statements, prudent bank managers should closely monitor the performance of all credit portfolios and adjust operational processes for compliance with laws and regulations. Specific areas of challenge may include responsibilities associated with underwriting and opening new accounts, monitoring customer activity, processing transactions, loan modifications, servicing loans, communicating with customers, complying with consumer protection law, and treating customers fairly, complying with consumer protection laws, and meeting BSA and Office of Foreign Assets Control (OFAC) compliance obligations as well as regulatory and policy actions by the Consumer Financial Protection Bureau (CFPB).

How Watchtower Can Help

SRA Watchtower has an extensive library of KRIs that evaluate compliance management program holistically in the context of complexity and mix of products and services offered by the financial institution. SRA consultants help determine appropriate guardrails for attributes ranging from transaction processing risk, customer information risk, third party risk, quality of information controls, business continuity plan quality, UDAAP, fair lending compliance, BSA/AML/OFAC compliance. It also aids in the assessment of compliance culture, quality of internal audit program, and quality of compliance controls and monitoring.  Contact us to learn more.

#7 Strategic Risks

The adoption of new innovative technologies to facilitate financial services can offer many benefits to both banks and their customers, but appropriate due diligence, change management and risk management is essential to successful implementation. Risk and control environments need to keep pace to address innovation and emerging trends. Unwarranted risk may occur if risk is not fully understood or effective controls are not fully developed.  

How Watchtower Can Help

SRA Watchtower allows broad assessment of strategic risks including due diligence of new products and services. SRA Watchtower allows the institutions to quantify and report on effectiveness of Board and management succession strategies. Contact us to learn more.

Sources:

2021 FDIC Risk Report

2021 May OCC Report

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