OCC Report Identifies Key Risks Facing Federal Banking System

Summary

The OCC reported that the overall strength of the federal banking system remains sound. The OCC expects banks to remain diligent and adhere to prudent risk management practices across all risk areas. Banks should continue to guard against complacency to ensure they maintain the ability to withstand potential future economic challenges.

The OCC highlighted credit, market, operational, and compliance risks, as the key risk themes in the report. Highlights from the report include:

• Credit risk is increasing due to higher interest rates, increasing risk in commercial real estate lending, prolonged inflation, declining corporate profitability, and potential for slower economic growth. Key performance indicators are beginning to show signs of borrower stress across asset classes.
• Rising deposit rates, broader market liquidity contraction, and increased reliance on wholesale funding started to impact net interest margins through the first half of 2023. Competition for deposits and higher interest rates are raising deposit rates. Deposit and liquid asset trends stabilized in the latter half of 2023, but these levels were supported by increased reliance on wholesale funding. Increases in interest rates are negatively impacting investment portfolio values.
• Operational risk is elevated. Cyber threats continue. Banks continue to leverage new technology to further digitalization efforts, offering innovative products and services to meet customer demands. Increasing digitalization efforts can also heighten risk of fraud and error, including fraud targeting peer-to-peer and other faster payment platforms.
• Compliance risk remains elevated. This is due to the heightened focus on ensuring equal access to credit and fair treatment of consumers, the expanded use of innovative technologies for product and service delivery, and expanded partnerships with third parties, such as financial technology firms, and increases in Bank Secrecy Act/Anti-Money Laundering risk.

The report highlights artificial intelligence (AI) in banking as an emerging risk. The potential for further benefits as AI gains more widespread adoption could be significant. Developments in the technology may reduce costs and increase efficiencies; improve products, services, and performance; strengthen risk management and controls; and expand access to credit and other banking services. Widespread adoption of AI, however, may also present significant challenges relating to compliance risk, credit risk, reputation risk, and operational risk.