OCC Report Highlights Key Risks in Federal Banking System

Summary

The OCC reported that the strength of the federal banking system remains sound. Consumer sentiment, geopolitical risk, sustained higher interest rates, and downward movement in some macroeconomic indicators have increased economic uncertainty. The OCC also affirmed that the adoption of new technologies, products, and services and/or engagement with financial technology companies to deliver banking products and services can offer benefits to banks and customers.

The OCC highlighted credit, market, operational, and compliance risks, as the key risk themes in the report. Highlights from the report include:

• Commercial credit risk is increasing, driven by growing geopolitical risk, sustained higher interest rates, growing caution among businesses and their customers, and other macroeconomic uncertainty. Pockets of risk remain for some commercial real estate property types and vary by geographic market and product type. Refinance risk remains high for loans underwritten during a period of lower interest rates.
• Retail credit risk remains stable despite economic uncertainty. Most consumer borrower segments continue to withstand elevated prices, interest rates, and growing debt levels, supported in part by growth in wages exceeding aggregate inflation since 2019. However, wage growth is decelerating, and economic uncertainty is driving adverse changes in consumer sentiment.
• Regarding market risk, net interest margins in OCC-supervised institutions improved in the latter half of 2024 as effective federal funds rate (EFFR) cuts enabled banks to lower funding costs. Robust interest rate risk scenario analysis and sensitivity testing are critical due to uncertainty surrounding inflation and future EFFR movement. Asset-based liquidity was stable in 2024, but unrealized investment portfolio losses remain a focus. Deposits were also stable, but deposit competition warrants continued monitoring.
• Operational risk is elevated. Banks continue to seek opportunities to gain efficiencies and respond to an evolving and increasingly complex operating environment. Failure to upgrade systems and digitize may result in loss of market share to competitors offering faster and cheaper payment alternatives. Criminals continue to exploit traditional payment methods. Fraud schemes commonly target checks, wire transfers, peer-to-peer payment platforms, and insiders. Evolving cyber threats by sophisticated malicious actors continue to target banks and their key service providers, emphasizing the importance of operational resilience. Recent disruptions across many sectors, including the financial sector, highlight the importance of sound third-party risk management.
• Compliance risk remains elevated due in part to Bank Secrecy Act/anti-money laundering and consumer compliance risks associated with elevated fraud levels; account access concerns, and evolving business models.