The Federal Reserve will be keeping a close eye on banks to make sure they maintain enough capital and liquidity to weather a potential economic downturn.
In its
Overall, the report details a banking market that is, in many ways, returning to pre-pandemic norms. Deposits are falling, loan volumes are growing and aggregate earnings falling and Tier 1 capital ratios have returned to 2019 levels.
Still, as risk factors rise and market confidence begins to falter, the Fed notes that some large banks might not be adequately prepared for the worst. The report points out several areas of weakness in capital planning, including lackluster loss estimations and market stress scenarios, as well as errors in how some firms risk-weight assets when determining how much capital they must hold.
The Fed also found that most large banks struggle with issues of governance and control, specifically when it comes to managing operational resilience, information technology, third-party risks and compliance.
The findings of the report will set the tone for Fed's supervisory priorities next year.
For large banks, the Fed's supervisors will key in on how banks are prepared to deal with interest rate risks that accompany changing monetary policy. This extends to their funding practices, as well as their assessment of the credit risks related to other financial market participants and their own customers.
Large banks appear to have ample capital on hand, the report notes, citing the Fed's most recent
Most banks experienced greater losses in the 2022 scenario than in 2021, leading to their stress capital buffers being adjusted accordingly. To meet these higher requirements, some banks have slowed or paused share repurchases, the report notes.
Still, capital ratios have fallen this year, in part because of the large volume of Treasury securities added to bank balance sheets. Flush with deposits, banks favored these liquid assets over new loans because they offered a source of liquidity in a potentially unstable market. Now, as monetary policy tightens, the liquidity of the Treasury securities market has become a growing concern for Fed supervisors.
Treasury securities tend to depreciate as interest rates rise. This has led to mounting unrealized losses on bank balance sheets. As of June 30, the value of for-sale securities had fallen by $224 billion. These paper losses impact banks' book values and also
Overall, only about half of the large financial institutions monitored by the Fed were deemed to be meeting their supervisory expectations in a satisfactory fashion, according to the report. The share of banks deemed satisfactory has been gradually declining since 2019.
Outstanding supervisory findings — matters that banks must address — increased during the first half of 2022, bucking the general trend of decline seen since 2008, the report noted. Still, the total number of outstanding findings was still just a fraction of what it was even a few years ago.
Top issues among large banks included those related to operational risks like cybersecurity threats and data management, managing risks from third-party service providers and meeting compliance obligations. Among foreign banks, there were a higher number of banks failing to meet Bank Secrecy Act and anti-money- laundering requirements.
Along with dealing with these issues, supervisors will also be focused on the transition away from the London interbank offered rate next year. The benchmark is set to be fully phased out by June 30, 2023. The Fed's report noted that banks have made "substantial progress" in updating their contracts to reflect the change to the Secured Overnight Financing Rate as the benchmark of choice, but the volume of legacy Libor contracts remains high.
Among regional and community banks supervised by the Fed, the biggest concern is the concentration of commercial real estate loans on their balance sheets.
Banks with between $10 billion and $100 billion of assets are historically very active in the commercial real estate lending business. While this activity trailed off in the early part of the pandemic, it has ticked up in recent months, the Fed's report notes.
While this sector has performed well, with delinquency rates well below half a percent, the amount of loans between 30 and 89 days late has increased in each of the past two quarters, the report found. With remote work still prevalent among many white collar workers, the Fed said there is a high risk for stress in this market. As a result, its supervisors will track whether these banks have adequate risk management processes in place.
Other supervision priorities for regional and community banks include their ability to manage high-risk loans in a changing rate environment, their implementation of Current Expected Credit Loss standards and operational risks such as cybersecurity management and exposure to firms that deal in cryptocurrencies.
