Read Between the Lines

Each month Bank Insights reviews news from regulators and others to give perspective on regulatory challenges.

OCC to Focus on Strategic Planning, Interest Rate Risk

Expect your OCC examiner to pay attention to the adequacy of your bank’s strategic, capital and succession planning procedures, according to the OCC’s Spring issue of its Semiannual Risk Perspective. Examiners will want to make sure that strategic initiatives take into account these risks. (One way to do this is to make sure your bank incorporates capital stress testing into its strategic planning.)

Examiners also want to make sure your bank has effective interest-rate risk measurement processes. Examiners will monitor portfolios for changes in risk appetite, and they want assurance that management not only can assess the bank’s vulnerability to interest rate changes, but also has tools to monitor and control the risk. “A key focal point” will be a bank’s ability to identify and quantity IRR in both assets and liabilities under varying model scenarios.

Other areas of focus for community banks will include corporate governance, stress testing (for Dodd-Frank banks), operational risk and cyber threats. The report notes that a recent review of asset-based lending found evidence of “gradual loosening credit policies,” so the OCC will also pay increased attention to underwriting standards.

The report notes that community banks have high strategic risk as they adapt their business models to the changing economic environment, and the sector’s earnings outlook is uneven due to weak loan demand and declining investment yields.

Higher CAMELS Scores Returning

More than 85 percent of the 491 community banks in the OCC’s Central District are rated a 1 or 2 on their CAMELS composite, a level not seen since 2009, the OCC reports. In Ohio, more than 92 percent of banks had a 1 or 2, up from 78 percent in 2009. The OCC says that banks in Chicago and Minneapolis saw the greatest decline in problem banks. “Community banks and thrifts supervised by our Chicago team had been in survival mode for several years,” noted Nathan Perry, Assistant Deputy Comptroller in
Schaumburg, Ill. He attributed the improvement to better risk management practices and a healthier economy.

FDIC Adds Community Bank Data

The FDIC has added a new section to its quarterly banking profile to report “insight into the condition and performance” of the community banking sector.  Although net income at community banks of $4.4 billion was down 1.5 percent from the previous year, the percentage decline was less than the 7.6 percent decline in earnings reported by the entire banking industry.

Fed’s Tarullo Questions Small Bank Regs

Policymakers should take a look at exempting community banks from the Volcker Rule and the incentive compensation requirements in Dodd-Frank, Fed Governor Daniel K. Tarullo said at the Federal Reserve Bank of Chicago Bank Structure Conference in May. (A month later, FDIC vice-chair Hoenig say it was time to end community bank carve-outs. See p.1)

Tarullo noted that banking regulators have tried to “avoid unnecessary regulatory costs for community banks, such as fashioning simpler compliance requirements and identifying which provisions of new regulations are of relevance to smaller banks.” But he conceded that there is a risk of “supervisory trickle down,” where “supervisors informally, and perhaps not wholly intentionally, create compliance expectations for smaller banks that resemble expectations created for larger institutions.”

Risks in Internal Audit Outsourcing

Although community banks have often turned to third parties for internal audit functions, there are risks that boards need to mitigate, according to an article in the Fed’s Community Banking Connections. The article advises boards and management teams to make sure that the outsourcing arrangement meets regulatory expectations.