OCC Report Identifies Key Risks Facing Federal Banking System

The Office of the Comptroller of the Currency (OCC) has released its semiannual report analyzing the key issues facing the federal banking system.

The Semiannual Risk Perspective for Fall 2023 report identified credit, market, operational and compliance risks as the key risk themes.

It found credit risk is increasing due to higher interest rates, increasing risk in commercial real estate lending, prolonged inflation, declining corporate profitability, and the potential for slower economic growth.

It also found compliance risk remains elevated due to the intensified 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.

Donna Murphy, the OCC acting deputy comptroller for the Office of Financial Technology, released a statement on the agency’s supervision of banks’ expanding relationships with FinTechs, stating third-party risk management is “essential” to ensure the safety of consumers and maintaining bank safety and soundness.

It also highlighted AI in banking as an emerging risk, despite the potential benefits to widespread adoption of AI. It said AI presents significant challenges relating to compliance risk, credit risk, reputation risk, and operational risk.

The regulator also released guidance on ‘Buy Now, Pay Later’ (BNPL) lending, focusing on risk management.

BNPL loans are payable in four or fewer installments and carry no finance charges.

The guidance states banks should maintain underwriting, repayment terms, pricing, and safeguards that minimize adverse customer outcomes and should ensure that marketing materials and disclosures are clear and conspicuous.

Michael Hsu, acting comptroller of the OCC, said: “As the buy-now-pay-later market grows and we enter the holiday shopping season, the guidance confirms our expectation that OCC-supervised institutions offering these products do so in a responsible manner.”

The regulator issued a bulletin to assist banks in effectively managing BNPL risks, including that borrowers could overextend themselves or may not understand their repayment obligations.

The bulletin recommends banks establish policies and procedures for BNPL lending that address loan terms, underwriting criteria, methodologies to assess repayment capacity, fees, charge-offs, and credit loss allowance considerations.

It also recommends banks establish ongoing monitoring and reporting that capture the unique characteristics and risks of BNPL loans.

It highlights that traditional credit metrics, such as loans bucketed by delinquency over 30 days past due, tend to be lagging indicators that might not promptly identify trends and problems in BNPL.