Ludwig Sees Credit Risk As Rates Press Banks

NEW YORK - A top federal banking regulator said Thursday that banks are making riskier loans and charging less for them at the same time they are facing greater threats from interest rate changes.

Comptroller of the Currency Eugene A. Ludwig said in an interview that there is a "big pressure to reach for risk" as banks' record incomes are pressured by increases in interest rates.

"The shape of the yield curve is changing before our eyes, so there is going to be less profitability support" from the spread between interest rates banks pay for deposits and the amount they charge borrowers, Mr. Ludwig said.

The comptroller said in the interview that his agency will press banks to keep credit quality high. In a speech to the New York State Bankers Association later in the day, he announced that the OCC would also issue guidance this month on minimum standards that banks should employ to measure, monitor, and control interest rate risk.

Mr. Ludwig stressed that credit quality has not yet slid to unacceptable levels. But it is at the top of the business cycle when banks should be more cautious about taking too much credit risk, he said.

Banking trade groups agree that banks are moving more aggressively into the loan area. "The federal interest rate policy does push bankers out of bond investments into looking for loans," said Kenneth Guenther, executive vice president of the Independent Bankers Association of America.

The OCC became concerned after it surveyed several hundred syndicated loans as a barometer of credit pricing and terms.

"In that business, there has been a slippage in prices and a slippage of terms," Mr. Ludwig said. The agency has anecdotal evidence that the decline has spread beyond commercial loans to consumer loans, he said.

"Pricing has slipped most in the double-A credits, but we have seen slippage recently in the double- or triple-B" rated credits, Mr. Ludwig said.

As a result, the agency has formed a task group to design a "best practices" guide to credit risk by October. "This is meant to be largely informational," Mr. Ludwig said, and will not impose strict requirements on banks.

Separately, Mr. Ludwig told the New York bankers that, "In light of banks' increasingly complex asset portfolios and the increasing volatility of interest rates, the need for banks to be able to measure and control their exposure to interest rate swings has clearly increased."

Mr. Ludwig said he is particularly concerned that banks may not be monitoring how interest rates affect their medium and long-term debt.

"Some banks now hold medium and long-term instruments that are highly sensitive to changes in interest rates," such as adjustable rate mortgages, Mr. Ludwig said.

In addition to the new guidance setting out minimum standards banks should use to manage such rate risk, the agency may issue further instructions, particularly to smaller banks, on key assumptions and rate risk management techniques, he said.

Changes in the business cycle, such as interest rate increases, "will cause banks to have a tendency to reach by way of changing credit standards and slimming down pricing," Mr. Ludwig said. "That is part of the cyclical nature of the economy."

Mr. Guenther said the comptroller's remarks "must mean that the banking industry has not paid sufficient heed" to similar warnings late last year from Mr. Ludwig and Federal Reserve Board Chairman Alan Greenspan.

"The bankers will read it the same way that I am reading it, that this is going to be an ongoing effort by Comptroller Ludwig," Mr. Guenther said.

"The signal is being passed that bankers watch out," Mr. Guenther said. When regulators examine banks, "This is what they are going to be looking at," he said.

Asked if he thought interest rate risk could lead to a systemic problem, Mr. Ludwig replied, "I don't see a systemic problem now, but we sure don't want to see one. That's why we're focusing on this now."

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