In an effort to squeeze out profits in a low-interest rate environment, banks are under increasing pressure to lower underwriting standards, offer new, potentially dangerous products and ignore operational risk, a federal banking regulator warned this week.
The Office of the Comptroller of the Currency, in its first Semiannual Risk Review, offered a rare distillation of what agency officials see as the greatest safety and soundness threats facing national banks.
Though the agency noted that the industry overall appears to be slowly improving, the report focused squarely on potential pitfalls, particularly as banks attempt to make up for lost profitability.
"This is probably the biggest emerging risk area that we try to emphasize," said Darrin Benhart, deputy comptroller for credit and market risk at the OCC, in a conference call with reporters. "Banks are looking for ways to have higher earnings. How do you get that? Oftentimes you have to go out on the risk curve."
Chief among problem areas are how small and midsize banks are handling historically low interest rates, which have squeezed margins and—combined with continued weak loan growth—forced institutions to look elsewhere for profit opportunities.
"The low interest rate environment continues to make banks vulnerable to rate shocks. Small banks, in particular, are increasingly adding to investment portfolio positions and increasing duration to obtain higher yields," the report said.
While the problem of boosting earnings is widespread, OCC officials said, it’s most severe at smaller banks, which are far less diversified than their larger counterparts.
"The fact is the large banks have a much more diverse revenue stream," Marty Pfinsgraff, deputy comptroller for credit and market risk at the OCC, said on the conference call. "The megabanks are benefiting from some extent to some of the problems in Europe by picking up various businesses. The problem is probably more acute for those institutions that have less diverse revenue streams and less ability to find more diverse sources of revenue."
Large banks, meanwhile, face ongoing problems because of "legal, operational and reputational costs stemming from" mortgage underwriting and servicing deficiencies, the report said.
"They face fundamental changes in their business models that are dampening revenue growth, including shifts in the role of trading, securitization and consumer fee income," the report said. "Operational risk is heightened during this period of transition."
Comptroller of the Currency Thomas Curry warned banks in May about heightened operational risks, saying that for the first time they have eclipsed credit risks as the top safety and soundness concern.
"Operational risk is a key concern as banks try to economize on systems and processes to enhance income and operating economies," the report said. "This risk may be amplified by the use of third-party products or distribution systems."
