Warning that good economic times won't last forever, Comptroller of the Currency Eugene A. Ludwig on Thursday ordered examiners to spend more time reviewing the credit practices of national banks.
"We are asking OCC examiners to highlight their concerns in this area during their regular discussions with bank management and to work with management to ensure that weakening in this area does not occur," Mr. Ludwig told the New York State Bankers Association.
The comptroller sent an advisory letter to examiners and chief executive officers, outlining a new, more intensive approach to reviewing credit risk.
Examiners now will assess credit culture, risk-tolerance limits, risk- management models, syndicated loan programs, stress-testing techniques, and compensation policies during a single review. Previously, these items were spread out among different exams.
Mr. Ludwig said he issued the advisory because some banks have begun cutting back on risk management in the belief that the economy will expand indefinitely.
"The continuing expansion causes us to forget that cycles are an inherent part of a free market economy," he said. "This expansion, like all others, will without question end with a down cycle."
Though not forecasting a recession any time soon, Mr. Ludwig said banks must be prepared.
"The role of the regulator is to take action before potential problems become real problems that trigger in response the type of credit crunch we saw in the 1980s," Mr. Ludwig said.
Several bankers said they already monitor credit quality and welcome the OCC's oversight.
"This is just good risk-management advice," said Erland E. Kailbourne, chairman and chief executive of Fleet Bank New York. "It is incumbent upon management to keep its eye on the ball as we do business every day."
"This is already part of our culture and processes," said James B. Joyce, senior vice president at the Bank of New York. "We don't consider it burdensome for them to look at these controls."
"He is just saying be careful," said Stephen C. Ames, executive vice president at Marine Midland Bank, Buffalo. "No one would argue with that."
In the advisory letter, Mr. Ludwig combines directives for examiners with advice for bankers.
Examiners will check if employees throughout the institution understand how much risk the bank is willing to accept and if the bank's compensation system is in line with this credit culture. For example, banks that want to avoid risky assets should reward lenders for the quality-and not the volume-of their loans.
Examiners also will look at whether bankers determine ahead of time the maximum amount of risk they will tolerate in each portfolio, and they will review the adequacy of computer systems used to monitor investments.
The OCC urged bankers to segment their loan portfolios by loan type, industry, geography, structure, and collateral. This would allow banks to better monitor their exposure to sudden fluctuations in interest rates or securities prices.
Bankers also should review the credit quality of syndicated loans before they buy a participation, the OCC said. This will ensure that the bank knows ahead of time when it is buying a risky asset. They also should document each time the bank makes an exception to its underwriting policies. This will help banks set aside sufficient loan-loss reserves, the agency said.
The OCC also said banks should stress-test their portfolios of loans and securities to see what would happen if interest rates change, the country enters a recession, prices rise substantially, or political turmoil disrupts the economy.