The current operating environment of the U.S. banking system presents community banks with a high level of “strategic risk,” according to the most recent Semiannual Risk Perspective published in January by the Office of the Comptroller of the Currency (OCC) National Risk Committee (NRC).

Given this, the report urges banks to be especially vigilant in case the economy weakens or markets suddenly tighten.

Banks in Good Health …
The report, which is based on data as of June 30, 2017, paints a positive picture of the financial health of U.S. banks. For example, capital and liquidity have improved tremendously since the financial crisis and are near historic highs. Return on equity, net income, net interest income, and net interest margins all improved during the first half of 2017 compared to a year earlier.

And while bank loan growth slowed overall during the period measured, it remained stable for smaller banks, which the NRC defines as banks with total assets of less than $1 billion.

Based on this data, the report concludes that the banking sector remains “relatively stable” with strong asset quality and satisfactory underwriting policies and procedures. However, the volume of loans with eased terms or structures is increasing due to growing competition. Weaker underwriting heightens the risk of credit quality problems if and when economic conditions deteriorate, notes the report.

… But Ongoing Concerns Persist
The NRC voices ongoing concerns about strategic risk due to a number of factors. These include competitive pressure to boost lending, enhance efficiencies, embrace new technologies, and innovate products and services.

In particular, the credit environment continues to be influenced by aggressive competition (especially from non-bank lenders), heightened asset valuations, slowing loan growth, and tighter spreads. “These factors are driving incremental easing in underwriting practices and increasing concentrations in select loan portfolios,” states the report.

It specifically voices concerns about potential lender complacency due to the long economic recovery and expansion. “In this environment, lenders need to focus on maintaining sound credit standards within risk tolerances and understanding the potential credit risks that may be exposed under less-benign economic conditions,” the report states.

Operational and Compliance Risk
Banks also continue to face operational risk due to the increasing complexity of cybersecurity threats and the growing use of third-party service providers for some critical operations. And compliance risk remains elevated due to growing money laundering threats, challenges in complying with Bank Secrecy Act (BSA) requirements, and complexity in consumer compliance regulations.

In addition to the credit, operational, and compliance risks noted previously, the NRC monitors a variety of other risks that it believes bankers should be aware of, including the following:
• Weaknesses in the governance of product sales, delivery, and service may further increase operational risk.
• Increasing concentrations of commercial real estate (CRE) loans highlight the need for sound risk management processes, including concentration risk management.
• The potential for renewed price declines for grain crops, livestock, and dairy may compound the declining prices of the past few years, thus increasing agriculture borrowers’ debt and their ability to service this debt.
• New requirements under the amended regulation implementing the Military Lending Act (MLA)—as well as pending changes to the data collection and processing rules for the Home Mortgage Disclosure Act (HMDA)—may present further challenges to banks’ compliance change management processes.
• The current expected credit losses (CECL) standard—for which implementation begins in 2020—may pose operational and strategic risk to some banks when it comes to measuring and assessing the collectability of financial assets.

The NRC publishes the Semiannual Risk Perspective twice each year, using data gathered midyear and at year end. You can download the complete report by visiting https://www.occ.treas.gov and typing “Semiannual Risk Perspective” in the search box.