Elevated corporate debt, cybersecurity threats and the risk from chasing yield in a low-interest rate environment could undermine banks' efforts to jumpstart earnings as the pandemic continues, the Office of the Comptroller of the Currency said Monday.
In a semiannual report on risks in the national banking system, the OCC noted that banks bounced back sharply from the pandemic in the first half of the year as credit conditions improved.
But some banks may be accumulating risk too quickly with lower-quality loans, looser underwriting and failure to conduct sufficient due diligence of products and services, an OCC official said on a conference call with reporters.
"Excessive risk eventually becomes kind of like the boiled frog syndrome. When it's too late, it's too late to do anything about it," the official said.
Acting Comptroller Michael Hsu urged banks to manage risks carefully as they seek earnings opportunities.
“Strategic actions taken by banks to offset earnings, the impacts of low yields and interest rate margin compression remain a risk,” Hsu said.
Meanwhile, nearly every conversation that OCC examiners have with a bank these days involves a discussion about cybersecurity risk, OCC officials said. Ransomware attacks have become increasingly sophisticated and bad actors more brazen, they said.
On the upside, credit risk has moderated due to the government’s injection of stimulus into the economy. At the start of the pandemic, OCC examiners thought banks would face massive losses that never really materialized.
But high liquidity is both a blessing and a curse for banks, OCC officials said. Banks were able to gradually release loan losses over the course of the past year, but that momentum has run out of steam.
“Banks are going to have to rely on traditional business practices, relying on net interest margin and income and other ways to generate income from the bank,” one OCC official said. Banks are “really finding it hard to park that money to gain any margin at all. So they need to deploy deposits somewhere [and] loan growth is fairly flat.”
Against this backdrop, the OCC is encouraging banks to guard against what it calls “complacency risk.” Banks are being advised to remain vigilant and avoid excessive risk-taking.
"The OCC encourages banks to guard against complacency to ensure financial resilience without compromising effective risk management systems that support sound business models and strategic and operating plans," the agency said in the report.
Another area of concern is corporate debt loads that were already high in 2019 and surged during the pandemic.
Corporate debt has continued to rise this year. The OCC is concerned that companies are accessing cheap debt to pay dividends and buy back stock rather than to invest in areas of the economy that would result in long-term productivity.
The presence of large amounts of debt in the economy as a whole, coupled with a greater share of debt held by high-risk borrowers, increases the risk of default in the event of an economic downturn or a rise in interest rates, the OCC said in the report.
“If you have a downturn where earnings may not be as good for some of these companies, that can pose a real challenge for them,” an OCC official said. “Because of the breadth and the depth of that debt, it can actually pose a systemic risk to the economy as well.”
The OCC is also closely watching the commercial real estate sector as companies start bringing employees back to work. It is unclear whether businesses and consumers’ habits have changed permanently and what a post-pandemic environment will look like specifically for office buildings and strip malls.
Hsu also said the OCC continues to work on developing supervisory principles on climate risk for large banks. The agency recently issued a request for academic and policy-focused research on climate risk in banking and finance due to the increased frequency and severity of extreme weather events.
“We are getting more and more into concrete things,” Hsu said. “There’s just a lot of flow of information now back and forth as to where those practices are and issues that inform our policy.”
