WASHINGTON — The long economic expansion that has taken hold since the crisis may be driving tougher competition between banks, which could lead to looser underwriting standards for certain loans, the Office of the Comptroller of the Currency said Thursday.

The OCC's Semiannual Risk Perspective report said that although the quality of underlying assets is strong and overall underwriting practices are “acceptable,” the agency is concerned that the growing economy could lead to looser underwriting standards, driven by competition and faith in continued economic expansion.

“The credit environment continues to be influenced by strong competition, tighter spreads, and slowing loan growth,” the report said. “These factors are driving incremental easing in underwriting practices and increasing concentrations in select loan portfolios — leading to heightened risk if the economy weakens or markets tighten quickly.

Joseph Otting, chief executive officer of OneWest Bank.
"Incremental easing in underwriting and increasing concentration in select portfolios is occurring because bankers are still seeking yield among strong competition, tighter spreads and slower loan growth,” said Comptroller Joseph Otting. Bloomberg News

“In addition, the long economic recovery and expansion may collectively increase lender complacency,” the report continued. “In this environment, lenders need to focus on maintaining sound credit standards within risk tolerances and understanding the potential credit risks that may be exposed under less benign economic conditions.”

Comptroller of the Currency Joseph Otting said that in the low-growth environment that the U.S. has been in, banks have had to reach for yield to stay competitive. As the economy heats up, those firms should be more restrained, he said, and be sure to maintain underwriting standards.

"Incremental easing in underwriting and increasing concentration in select portfolios is occurring because bankers are still seeking yield among strong competition, tighter spreads and slower loan growth,” Otting said.

A senior OCC official said that complacency with the strength of the macroeconomic environment is a major source of concern, and one that requires vigilance not only from bankers but from supervisors as well.

“Given the benign environment that we’ve been operating in and the improvement in the economy we’ve been seeing for the past seven years, complacency is clearly at the top of our mind,” the official said. “Complacency of the bankers, but complacency of the examiners also.”

The report noted that the economic outlook for 2018 remains positive, with the consensus forecasts for real GDP growth expected between 2% and 2.5% for 2017 and 2018 — consistent with the Federal Reserve’s reported expectations as observed by its regional banks. The report also said that growth in business spending on equipment has doubled to about 9% in the third quarter of 2017.

Several factors highlighted in the report are the same as risks identified in previous reports — namely concentrations of lending activity in commercial real estate and operational risks posed by cybersecurity threats.

With respect to CRE lending, the OCC said that deeper concentrations in CRE lending for some banks highlights the need for “sound risk management processes and the effectiveness in managing concentration risk for some banks.” The report said that CRE is driving growth particularly among small banks with $1 billion to $10 billion in assets, and that is in part because those banks are facing declines in consumer and residential mortgage loans.

The report said that the severity of cybersecurity threats is also increasing, specifically “phishing” scams that are the “primary” means of breaching bank cybersecurity systems. The OCC also said that an increasing concentration of critical operations within a handful of third-party service providers could “create concentrated points of failure resulting in systemic risk to the financial services sector.” Those risks could be mitigated with “appropriate due diligence and ongoing oversight” by the banks themselves and by regulators, the report said.

The OCC also said that compliance risks also warrant attention, particularly risks associated with “new or amended consumer protection regulations” and regulatory changes associated with anti-money-laundering laws.

The report said that changes to the Consumer Financial Protection Bureau’s Home Mortgage Disclosure Act reporting requirements — and any future changes that have not yet been decided — could make it harder for banks to comply with the law.

The OCC added that AML compliance risk “remains an area of emphasis” and that banks continue to keep pace with ever-changing threats and compliance requirements. The agency said it expects the banks it supervises to comply with the Treasury Department’s Financial Crimes Enforcement Network’s Beneficial Ownership/Customer Due Diligence rule when it goes into effect in May.

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