'An Extraordinary Thing': OCC's Curry Sees Operational Risk as Top Concern

WASHINGTON — Operational risk has replaced credit risk as the major safety and soundness challenge for national banks, Comptroller Thomas Curry said at a speech in Washington on Wednesday.

Curry said operational risk, or the risk of loss due to failures of people, processes, systems and external events, is "high and increasing" in light of the complexity of today's banking markets and the technology that supports it.

Although he did not mention it in his prepared remarks, Curry's comments come just after JPMorgan Chase & Co. announced it was taking a $2 billion loss on trades due to "egregious" errors in its risk management procedures, according to its chief executive, Jamie Dimon.

Curry said operational risk is currently at the top of the list of safety and soundness issues for the institutions the OCC supervises.

"This is an extraordinary thing," Curry said. "Some of our most seasoned supervisors, people with 30 or more years of experience in some cases, tell me that this is the first time they have seen operational risk eclipse credit risk as a safety and soundness challenge."

Curry said operational risks manifest in a number of ways, from inadequate systems and controls that led to servicing mortgage servicing errors, to flawed risk models that create inadequate risk management systems, to lack of controls over relationships with third-party vendors.

"No issues loom larger today than operational risk in all its dimensions, the manner in which all risks interact, and the importance of managing those risks in an integrated fashion across the entire enterprise," he said.

In particular, Curry said the OCC is finding a rising number of Bank Secrecy Act and anti-money laundering deficiencies in midsize and community banks, including ineffective account monitoring, inadequate tracking of high-risk customers and bulk cash transactions, and lapses in monitoring suspicious activity.

Because terrorists and other criminals are constantly altering their tactics, BSA/AML compliance is complex and efforts must be constantly reorganized, Curry said.

"Controls that may be entirely adequate today may prove inadequate for tomorrow's risks and threats," he said. "However, it is critical that banks and thrifts instill strong cultures and oversight processes. Management needs to focus on key controls and maintain knowledgeable and sufficient staff."

He also said banks must resist the temptation to "under-invest" in the systems and controls they need to prevent greater loss and risk.

"They should take their cues from the cases in which such breakdowns have occurred," he said.

The losses at JPMorgan have raised questions about whether the trading strategy amounted to hedging or speculation, and whether those trades were likely to be banned under the Volcker Rule.

An OCC spokesman said earlier this week that it was premature to conclude that the rule, which has not yet been finalized, would have prohibited the trades, and said the transactions are so complex that it would require careful analysis to determine whether they would qualify for exceptions under the proposed rule.

"The OCC and other regulators are gathering additional details regarding the transactions to determine the full regulatory implications of these activities and the proposed rules currently being considered," he said.

In a question-and-answer session after the speech, Curry declined to give further details on the agency's view.

Asked how regulators can draw a bright line between hedging and proprietary trading, and how they can identify situations where trades start out as hedging and migrate into proprietary trading, Curry said, "That's a very interesting hypothetical," eliciting chuckles from the audience. "And I'm sure it's one that our reviewers of the pending Volcker Rule proposal will look at with great detail."

"Right, Julie?" he added, turning to the agency's chief counsel, First Senior Deputy Comptroller Julie Williams, before quickly moving on to the next question.

Another audience member complained about banks and regulators not doing enough to articulate what qualifies as "responsible" hedging.

"I do think that on the rulemaking process with the Volcker Rule … how do you define hedging, that's something that we are working on in the regulatory community," Curry said.

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