Treliant Takeaway…FDIC 2023 Risk Review

FDIC Risk Review 2023

• Source: fdic.gov

Takeaway:

The FDIC’s 2023 Risk Review highlights key developments across five categories in Section 1: (i) credit risk, (ii) market risk, (iii) operational risk, (iv) crypto-asset risk (new), and (v) climate-related financial risk. While the first three categories are fairly traditional, the crypto-asset and climate-related risks continue evolving, including the regulatory frameworks. Treliant is actively working engagements across these areas of focus and our risk management professionals the skills and resources to support risk assessment, program development, and regulatory remediation across large, regional, and community based financial institutions.

Highlights:

The FDIC notes the resilience of the banking industry despite a weakening economy, higher interest rates, and inflation and market stresses. While most banks have withstood these challenges, the industry is under continuing pressures that have impacted bank liquidity, net interest margins (NIM), and investment security valuations. Stronger banks will take a forward looking, proactive approach to managing risk through the cycle, not just in times of crisis. The FDIC Risk Review provides a useful framework for banks to conduct internal risk analysis against the primary areas of risk focus. Key risk categories are highlighted below.

(i) Credit Risk

Sectors in the FDIC focus include agriculture lending (risking rates & production costs), commercial real estate (office), consumer lending (credit card & auto), energy, housing (affordability), leveraged lending (slowing economy), nonbank FI lending, and small business lending.

(ii) Market Risk

The emerging market risks are related primarily to the impacts of rising interest rates. Liquidity and deposits were closely connected with deposit competition and pricing accelerating across certain segments. The unrealized losses in securities portfolios have also triggered potential credit liquidity pressures for certain banks. Liquidity risk will remain elevated while interest rates remain at higher levels.

The other key market risk related areas were NIM and interest rate risk. NIMs were expanding with rising rates in early cycle, but increased funding costs have caught up and is pressuring NIM levels. The combination of deprecation in investment portfolios and lower growth in NIMs has been most pronounced at financial institutions with longer team asset portfolios.

(iii) Operational Risk

Cybersecurity risks continue to be elevated, particularly with recent geopolitical events, and industry software infrastructure remain vulnerable to ransomware attacks and threats against third-party vendors. Money laundering and terrorist financing also remain high focus areas with banks expected to have robust due diligence and controls in place.

(iv) Crypto-asset Risk

This area was the only new risk addition for 2023, which emerged from the crypto stresses that started in late 2022. The FDIC, along with its fellow regulators, is closely scrutinizing all financial institutions engaged in crypto activities. The agencies have each issued clarifying guidance on crypto risk management expectations and continue to have robust conversations with banking organizations.  Clearly, there is more regulatory communications to come in this space.

(v) Climate-related Financial Risk

The FDIC specifically noted physical risks and transitions risks as two primary areas of climate-related financial risks.  The past year has produced multiple severe hurricanes, extensive wildfires, and a prolonged drought out West. The FDIC acknowledges that risk management in this space is evolving and encourages a risk-based approach while continuing to meet the financial service needs of the community.

Section 2 of the FDIC report provided an overview of the economy, financial markets and the banking industry. At a high level, the economy remained resilient, labor markets are strong, inflationary pressures continue to impact businesses and consumers, and monetary policy has significantly tightened. Financial markets were more mixed with equity market volatility increasing, bank valuations declining, and bond markets stabilizing further into 2023. The banking industry was resilient in Q1 2023 even with the stresses in the regional bank space. Earnings and capital largely remained strong, although NIMs are facing pressures and investment portfolios exhibit depreciation from rising rates. Asset quality softened somewhat, but remained strong through Q1, however, the industry faces downside risks.

Sections 3 through 7 provide further details across the five key risk categories highlighted in Section 1. The FDIC commentary is very useful for a financial institution’s internal risk assessment activities and to benchmark against risks noted across the industry.

What Does This Mean for Financial Institutions?

The FDIC Risk Review confirms that the risk themes we have seen across our client base and in our discussions with industry leaders and regulators hold true. As noted earlier, institutions focused on maintaining strong risk management practices can use these important regulatory insights to remain proactive in assessing risk and implementing proper controls and mitigations. The banking industry remains in transition from the long, low-rate world of the past 20 years into the dramatically higher rate environment of 2022 and 2023. The impacts of the change in rates will be felt for many quarters ahead, which presents a cautious environment for banks.

Regulators have proposed certain capital and liquidity regulatory changes, among others, that could significantly impact certain segments of the market including large and regional banks. It is imperative for these institutions to be well prepared for these changes as the regulatory pressure will be felt even before final guidance is issued.

Treliant has the expertise and resources to assist firms in assessing key risks across all lines of business and helps financial institutions develop strategic and risk management plans to meet current challenges and future expectations.