Another year in the books and another great year for the banking industry. Profits were strong, but there are always concerns on the horizon. Regulators who have been on the job for more than ten years haven’t forgotten the most recent financial crisis and the problems and bank failures that followed. Like many industries, the banking industry is cyclical: when the macro economy is doing well, banking does well. The reality is that recessions are an ordinary part of the business cycle, as nothing goes up forever nor does the economy drop indefinitely. Let’s be honest; the fact that we are currently in the longest economic expansion in U.S. history is reason for people to be on high alert, regulators included. During the “Third Quarter 2019 FDIC Quarterly Banking Profile” release, FDIC Chairman Jelena McWilliams stated, “…the banking industry reported positive results this quarter. With the sustained economic expansion, the FDIC urges banks to uphold careful underwriting standards and prudent risk management.” Some positive news sprinkled in with some caution.
Here’s my Regulatory Priority List for 2020.
- Credit Risk – The current state of credit quality is strong when measured using traditional asset quality metrics such as delinquencies, nonperforming loans, and charge-offs. So why the concern? After a long period of economic expansion, competition for loans and recent credit success may encourage the making riskier loans. Remember the old saying, “The worst loans are made in the best of times”? In short, regulators are concerned that banks are easing underwriting standards and credit administration practices to compete for loans.
- Concentration Risk – Concentration risk is generally seen as a subcategory of credit risk. Banks can have concentration exposure to various industries or loan types, but the one loan type consistently mentioned by regulators is commercial real estate. Commercial real estate concentrations may make certain institutions more vulnerable to cyclical commercial real estate markets. Regulatory guidance on commercial real estate states “Concentrations in CRE lending coupled with weak loan underwriting and depressed CRE markets have contributed to significant credit losses in the past.”
- Corporate Governance – Recently, I listened to a regulatory panel made up of executives from each of the federal regulatory agencies. Each one of them stressed at length the need for strong corporate governance. Strong corporate governance is the foundation for an institution’s safe-and-sound operations. Regulators can usually point to a breakdown in governance as one of the root causes when problems arise.
- Liquidity Risk – Liquidity risk—our old friend! I’ll keep this simple: there is less on-balance sheet liquidity due to strong loan growth, which has put liquidity and liquidity risk management on the minds of regulators. Review and update your contingency funding plans as you deem appropriate and continue to stress test your liquidity position. Remember this: always consider a low probability/high impact scenario. At a minimum, your stress testing needs to include a scenario where the bank goes under an enforcement action and/or has capital problems. This scenario would restrict your access to various wholesale funding sources, including your ability to pay interest rates above the national rate caps.
- Interest Rate Risk – Interest rate risk—our other dear old friend! Remember the years of waiting for the Fed to increase interest rates? We saw the last four rate increases of the Fed tightening cycle in 2018, and then we saw three quick rate cuts in the second half of 2019. The quick change in Fed policy was surprising to some. Until mid-2019, many were focused on the risk to their balance sheet of rates rising; now we also need to consider the prospect of further rate cuts by the Fed. Ensure your modeling assumptions in the down interest rate scenarios are sound, as some time may have passed since you reviewed them.
- Cybersecurity – This will be on the regulatory priority list for a long time, probably forever. Banks are focusing more resources and attention than ever on cybersecurity. The regulatory expectations of what a sound cybersecurity program looks like continues to increase.
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