Twice a year, once in the spring, and then again at the end of the year, the Board of Governors of the Federal Reserve System (Federal Reserve) publishes a report on banking conditions in the United States. Typically, the Spring Report summarizes the Federal Reserve’s supervisory and regulatory position for the next twelve months and is released to coincide with the testimony of the Federal Reserve Vice Chairman for Oversight to Congress. As such, the report serves as a good barometer for the Federal Reserve’s perspective on three key areas: (1) banking system conditions, (2) regulatory developments, and (3) the supervisory environment. On April 30, the Federal Reserve released its Spring report on supervision and regulation 2021. Below is a brief summary of the parts of the Federal Reserve’s Spring 2021 report that are of particular importance to regional and community bankers.
Banking system conditions
The pandemic continues to present challenges for families and businesses nationwide, regardless of geography or economic sector. But, as we regain our balance at the end of the first year of COVID-19, it’s clear that regional and community banking organizations have played a vital role in supporting customers and the economy at large. In large part, this is due to the financial literacy and operational resilience of the US banking system. Several factors identified by the Federal Reserve reflect the key strengths of our banking system in the second quarter of 2021:
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Capital and liquidity positions remain strong, with capital ratios well above regulatory minimums and significant deposit growth providing a buffer to absorb losses and support lending continuation.
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The rapid investment and deployment of technology has helped regional and community banks continue to engage with customers in a remote digital environment.
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Profitability – measured by return on equity (ROE) and return on average assets (ROAA) – has rebounded to pre-COVID-19 levels.
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The bank’s participation in the Small Business Administration‘s Paycheck Protection Program (PPP) has been instrumental in sustaining main street businesses.
Despite these strengths, however, the Federal Reserve is careful not to declare the economic recovery over. Several unresolved issues worry the Federal Reserve, including:
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Overall bank lending activity remains weak, with reduced demand and tighter lending standards, especially in smaller banks (despite the success of the PPP).
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The net interest margin declined sharply in the first three quarters of 2020 and recovered only slightly at the end of 2020.
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Borrower default rates have increased slightly, and loan modification activity continues – particularly in residential and commercial real estate – despite the flexibility offered by banking regulators.
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The increased reliance on technology has resulted in a corresponding increase in cybersecurity vulnerability, which affects all banks, regardless of asset size or technical sophistication.
Regulatory developments
In the first year of the pandemic, the Federal Reserve issued 60 rule notices and proposed or final statements on policy actions to support economic recovery. The Federal Reserve has also worked to improve regulatory transparency and efficiency and cooperation with other financial regulators, particularly in its approach to emerging risks related to operational resilience and oversight of new technologies (such as than artificial intelligence or AI).
Since the onset of the pandemic in early 2020, many regional and community bank balance sheets have grown unexpectedly, which – if left unchecked – would subject these banks to new and unknown regulatory requirements. To support operational resilience during this period, the Federal Reserve, along with the Federal Deposit Insurance Corporation and the Office of the Comptroller of the Currency, granted temporary regulatory relief to deal with the consequences of unanticipated asset growth, giving banks time to reduce their assets. or prepare for new regulatory and reporting standards.
At the same time, the banking industry continues to explore AI in a number of technology-intensive areas, including fraud monitoring, customer service, and loan underwriting. In response, the Federal Reserve and its sister financial regulators have engaged with supervised financial institutions to gather information on the risk management of AI applications in financial services, including the potential for lack of transparency in business models. ‘AI, the use of data in AI applications, cybersecurity risks, and fair lending considerations. Over the next several months, the Federal Reserve intends to use this information to determine whether further clarity regarding supervisors’ expectations regarding the use of technology is warranted.
The monitoring environment
Since the Federal Reserve’s supervisory approach and priorities differ depending on the size of a supervised bank, the report distinguishes between large financial institutions, on the one hand, and regional and community banks, on the one hand. somewhere else. Typically, community banking organizations (CBOs) have total assets of less than $ 10 billion, while regional banking organizations (RBOs) have total assets of between $ 10 billion and $ 100 billion, and large financial institutions have total assets of $ 100 billion or more. With this framework in mind, the Federal Reserve highlighted the following for the 2021 supervisory environment with respect to CBOs and RBOs:
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Although CBOs and RBOs have stable operational and credit conditions, they still face uncertainties about the future performance of loans to industries and businesses most affected by the pandemic.
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The number of CBOs and RBOs reporting losses has declined over the past twelve months and, at the same time, CBOs and RBOs are reporting generally stable or increasing levels of liquidity and less reliance on non-funding. essential.
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The importance of sound risk management of third-party risk exposure is expected to increase as CBOs and RBOs increasingly rely on third-party technology service providers to serve clients in an increasingly digital environment. more distant.
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Since many CBOs and RBOs forecast flat or minimal lending growth in 2021 (with obvious credit risks among borrowers affected by the pandemic, such as commercial real estate), banks should expect that the Federal Reserve is closely monitoring lending concentrations.
In addition, the Federal Reserve sets out the following categories of supervisory priorities for CBOs and RBOs over the next twelve months:
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Globally: (1) capital and liquidity resilience and (2) risk identification and management practices.
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Credit risk: (1) loan modifications; (2) high-risk loan portfolios (commercial real estate loan portfolios and loans to borrowers in areas sensitive to COVID-19); (3) underwriting practices and asset growth; and (4) reserve practices and levels.
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Capital city: (1) planning, projections, needs and vulnerabilities; (2) capital shares; and (3) evaluation of earnings.
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Operational risk: (1) business and operational continuity and (2) information technology and cybersecurity.
The COVID-19 pandemic has changed many aspects of the way banks, businesses and consumers work and use financial products and services. The economic recovery is not over, but conditions are improving – mainly because the pandemic has asserted the values and priorities that underpin the US banking system. As the Spring 2021 report makes clear, the Federal Reserve will continue to support and closely monitor risk exposures, credit performance and transactions as the banking industry passes through this unique and demanding period.
