The condition of the federal banking system is currently safe and sound, with strong financial performance. Federally chartered banks within the system enjoy a myriad of business opportunities and are capable of meeting the rapidly evolving needs of the consumers, businesses, and communities they serve.
This section highlights four factors contributing to the federal banking system's condition:
Figure: Federal Banking System at a Glance*
Influencing each of these factors are the trends regarding responsible innovation within the financial services industry and improving financial conditions in the United States. Technology and evolving consumer preferences are driving change at an unprecedented pace. Competition from nonbank companies offering traditional banking products is increasing. This competition is promoting financial inclusion and greater efficiency but also may challenge traditional banking models. In such a dynamic environment, the Office of the Comptroller of the Currency (OCC) wants banks, particularly community banks, to remain a vibrant and relevant part of the financial services landscape and wants consumers to continue to have fair access and fair treatment related to financial services.
Resiliency of the Federal Banking System
Today's 1 condition of the federal banking system shows that banks are resilient, well positioned to grow, and able to expand services to meet customer needs. Profitability at both community and large banks has recovered from the 2008 financial crisis with consistent loan growth, albeit at a slower pace in 2017.
Robust capital levels, which stand near historic highs, are key to banks' resiliency. Furthermore, banks, particularly large banks, have substantially increased the volume and quality of capital, and implemented additional risk management practices to strengthen the quality and reliability of both capital and liquidity planning. These practices, which include use of stress testing and more stable funding and monitoring of liquidity, have had a positive effect on the overall strength of capital and liquidity in the federal banking system.
Figure: Capital and Liquidity
The level and quality of bank capital improved this fiscal year, in part through the concerted effort of regulators and bankers. One key measure of the industry's capital health is commonly called tier 1 capital, which includes shareholders' equity and retained earnings. Tier 1 capital, which rose in 2017 to 13 percent of risk-weighted assets, measures how well banks can absorb losses and the resiliency of the banking system.
Stress tests help determine whether the industry can weather a crisis. Positive results reassure the public that the banking system is sound. Current capital levels suggest that, even under the most severe stress test scenarios of the largest bank holding companies, these banking companies would remain well capitalized and capable of lending in a recession, mitigating the severity and length of an economic downturn.
Liquidity is the ready access to funds on reasonable terms. The OCC examines banks' liquidity risk management to determine whether bank liquidity can meet banks' financial obligations and fulfill the banking needs of their communities.
The largest banks have improved their quantity and quality of liquidity. In 2017, the liquidity coverage ratio rule, which requires banks to hold sufficient highly liquid assets to meet short-term outflows in a stress situation, took effect. Liquid assets2 in the banking system continue to increase and have now achieved a 30-year high of 16 percent of total assets.
Regulatory relief efforts focused on reassessing capital requirements and freeing up balance sheet capacity could improve liquidity. Some of these efforts are discussed in section two of this report, "Reducing Regulatory Burden and Promoting Economic Opportunity."
Financial Performance of the Federal Banking System
Federal banking system profitability improved in 2017. Return on equity (ROE) stood at 9.9 percent in the first half of 20173, up from 9.1 percent a year earlier. Return on assets was 1.08 percent in the first half of 2017, up from 1.01 percent in 2016. For community banks with less than $1 billion in assets, ROE rose over the same period, bolstered by higher net interest margins and strong loan growth. System net income rose by $6.4 billion during the first half of calendar year 2017 compared with the same period in 2016, reflecting an expansion in the net interest margin. Rising net interest income more than offset increased noninterest expenses, while provisions for future loan losses remained nearly flat.
Pre-provision net revenues rose by $8.4 billion (8.5 percent) in the first half of 2017 compared with a year earlier. After years of low interest rates, rising rates made net interest income the primary earnings driver, growing by $12.5 billion, while noninterest income increased just $0.9 billion (1 percent). Noninterest expenses rose by $5.1 billion, reflecting higher staffing costs. Provisions edged down by $0.9 billion even though net charge-offs increased, resulting in little change to the allowance for loan and lease losses.
System-wide net interest income grew 8.4 percent in the first half of 2017 compared with a year earlier, as net interest margins expanded at both large and small banks. System loan growth slowed to 2.6 percent, even though it remained stronger at community banks, rising by 7 percent for banks with assets less than $1 billion. Margins benefited from rising interest rates, but increasing competition for deposits could temper margin improvement going forward.
Figure: Bank Profitability
Noninterest expenses rose 3.6 percent system-wide in the first half of 2017 compared with a year earlier. Salary and benefits were the largest contributors, increasing 5 percent ($3.3 billion), while premises costs rose 4.4 percent ($0.7 billion).
The ROE for community banks rose nearly 50 basis points over the past year to 10.8 percent, though their median ROE remains under 8 percent. In the first half of 2017, net interest margins at community banks benefited from rising interest rates and the strong loan growth. Smaller banks have not been as successful as their larger peers, however, in keeping down noninterest expenses.
Overall loan performance in the federal banking system has improved annually since 2010, though improvement stalled in several loan categories in 2016 and 2017. In the first half of 2017, charge-off rates were stable compared with 2016. Credit quality improvement in commercial and industrial (C&I) and commercial real estate (CRE) loans paused. Some borrowers in energy-dependent areas already strained by oil price volatility may face additional stress from repercussions of Hurricane Harvey. Nonetheless, loss rates for all major loan categories remain below their 25-year averages.
Figure: Credit Quality
To strengthen their balance sheets, many banks increased capital over the past several years, mostly by retaining more earnings. Equity to assets rose from 10.1 percent in 2007 to 11.1 percent as of mid-2017 for the system and from 11.1 percent to 12 percent for community banks. The result is a stronger banking system than before the 2008 financial crisis.
Risk Perspective of the Federal Banking System
Because banking is essentially a business of managing risk, banks' risk identification, assessment, monitoring, and management affect the condition of the federal banking system. The OCC's supervision focuses on evaluating a bank's ability to identify, measure, monitor, and control risks. The OCC's current assessment of key risk issues—credit, operational, compliance, and strategic—remained relatively unchanged from 2016.
Competitive pressure and strong credit risk appetites drove some banks to ease underwriting standards and increase credit risk for some loan portfolios for the fourth consecutive year. Examiners reported this incremental easing in underwriting standards across a variety of commercial and retail loan products during this period. That easing, however, slowed in the first half of 2017. In commercial lending, some banks made concessions on pricing, loan covenants, and guarantor requirements. In retail lending, lenders eased loan-to-value, loan-size, and debt-to-income requirements.
Credit risk in the portfolio of large syndicated bank loans declined slightly but remains elevated. Like in 2016, the high level of credit risk in certain sectors of the shared national credit portfolio stems primarily from distressed borrowers in the oil and gas sector and other industry sector borrowers exhibiting excessive leverage. Strong CRE loan growth has resulted in increasing concentrations in the community and midsize bank portfolios. Credit risk management practices at most large banks improved in 2017.
Operational risk rose as banks sought new business opportunities, adapted business models, and used technology to transform operating processes. Banks also confronted sophisticated cyber threats posing high risks to the increasingly interconnected financial services marketplace. Banks enhanced cyber defenses by augmenting staff, providing more training, increasing awareness, improving processes, and investing more in cyber-related technologies. Other factors contributing to operational risk include the number, nature, and complexity of third-party relationships, and control breakdowns in the governance of product sales, delivery, and service.
Compliance risk remained elevated as banks worked to manage evolving money laundering risks, subject to resource constraints. Banks also faced change management challenges as they worked to implement changes to policies and procedures to comply with new and revised consumer protection rules, including
- rules under the Truth in Lending Act (TILA) and the Real Estate Settlement Procedures Act (RESPA).
- new requirements under the amended regulation implementing the Military Lending Act (MLA).
- changes to the data collection and processing rules for the Home Mortgage Disclosure Act (HMDA).
Strategic risk is elevated for banks of all sizes as they adopt innovative products, services, and processes in response to the evolving consumer demands and the entrance of new competitors, such as out-of-market banks and fintech companies. The rapidly changing financial industry calls for management at all banks to consider incorporating innovation and new technology in bank strategic planning.
Value of Federal Charters to the Condition of the Federal Banking System
A national bank or federal savings association (FSA) charter is a flexible, dynamic license to provide a broad array of financial products and services. The OCC supervision that comes with a federal charter enhances the federal banking system's resiliency, balances its risk, and promotes its strong economic performance. Bank owners, directors, and management can have confidence in the federal charter for many reasons:
- Provides consistent bank-level supervision across examination cycles.
- Aids banks by empowering frontline supervisory decision makers.
- Provides banks with local examiners who understand varied business models and local market conditions, which provides increasing value as a bank grows.
- Provides banks with access to the OCC's expertise in policy, compliance, supervision, legal, licensing, accounting, economics, information technology, and security issues.
- Offers benefits of federal preemption, allowing banks to operate nationwide under a uniform set of laws and regulations.
- Supports responsible innovation and fosters collaboration.
Nationwide Operation and Federal Preemption
Banks have broad statutory authority as stated in 12 USC 24 and 12 USC 1464 to engage in banking activities. Preemption allows banks to apply these authorities and operate nationwide under a uniform set of regulations and a single, prudential supervisor that monitors the condition of the federal banking system and keeps it safe and sound. Without federal preemption through a federal charter, certain activities are limited or more complicated and expensive to conduct on a national scale.
Nationwide Supervision With a Local Perspective
The OCC, by implementing consistent national standards for federally chartered banks and FSAs, enhances the condition of the federal banking system and, therefore, the value of a federal charter. Through this work, the OCC ensures that banks establish and maintain their corporate structure and operations in accordance with principles of safety and soundness and in compliance with applicable laws and regulations.
Federally chartered banks receive consistent, bank-level supervision across examination cycles by examiners who leverage agency experts with knowledge of specific banking issues, laws, economics, accounting, innovation, information technology, and data security. OCC examiners, located in banks and OCC offices across the United States and in London, conduct on-site examinations in scheduled cycles and maintain a continuous presence in the nation's largest banks. Bankers regularly interact with OCC examiners and other district staff who are familiar with the needs of local markets and communities.
Figure: Examiners in the OCC Workforce
Examiners analyze banks' ability to identify, measure, monitor, and control risk, such as with banks' loan and investment portfolios, capital adequacy, earnings, liquidity, and sensitivity to market conditions. They assess corporate governance and the bank's compliance with consumer protection, and Bank Secrecy Act and anti-money laundering (BSA/AML) laws and regulations. Examiners also review internal controls, internal and external audits, and information technology systems, including with respect to cybersecurity.
Foreign Banking Organization Supervision
The International Banking Act allows foreign banks to establish federal branches or federal agencies supervised by the OCC. Under this act, federal branches and agencies generally have the same rights and responsibilities as national banks operating at the same locations and are generally subject to the same laws, regulations, policies, and procedures that apply to national banks, though there are differences between a federal branch or agency and a full-service bank. As with national banks and FSAs, the OCC tailors its supervisory strategies for an institution's unique risk profile. The OCC also maintains ongoing communication with home country supervisors for supervisory monitoring purposes and to understand home country conditions.
1Unless otherwise noted, all references to 2017 in this report refer to the fiscal year ending September 30, 2017.
2Liquidity assets are defined as cash, net Fed funds, and U.S. Treasury securities.
3Data for only the first half of calendar year 2017 were available by publication deadline. This section of the Annual Report presents consolidated data for national banks and FSAs.