PHILADELPHIA, May 16 - Two senior bank regulators believe that the financial services industry's optimism about the economy is causing a build up of embedded risk in bank portfolios, a situation that they believe should be of concern to the industry.
The warning was expressed during a recent audioconference of RMA, the international association of lending, credit and risk management professionals, by Wayne Rushton, senior deputy controller for bank supervision, the Office of the Comptroller of the Currency (OCC), and Jim Sexton, director of supervision for the FDIC.
They believe that a number of factors are contributing to the risk build up, including a loosening of underwriting standards, earnings pressure and high levels of consumer debt. "From 1995 to 1998, about 80 of the largest financial services companies showed sustained slippage in virtually every category of underwriting standard," observed Rushton. "In the OCC's 1999 survey, the trend was reversed in some portfolios, but that gives little comfort to regulators.
"We believe that the effects of those three or four years of slippage probably have left embedded risk. It's not going to manifest itself until the economy turns down and then some of those borrowers are probably going to hit the wall pretty quickly," he said.
Although regulators are pleased with banks' increased profitability, they are concerned that increased competition and earnings pressure are causing banks to, as Sexton refers to it, "push the envelope on underwriting."
"As banks lend to riskier lines of business, many do not adjust their capital levels to compensate for the riskiness in these lines, particularly in subprime lending," said Sexton.
Rushton and Sexton reviewed OCC and FDIC plans to address these issues. The OCC has set new standards for its examiners at large and small banks to address loan quality. He also said the agency is working through the Basel Committee on some broader long-term capital revisions. The FDIC is pushing a new capital regimen that would impose higher capital requirements for subprime lending. "If that risk is not accounted for in capital, the risk will fall on the FDIC," said Sexton.
Other regulatory agencies have not supported the FDIC's push to double capital requirements for subprime lending, according to Sexton, but have urged examiners to deal with the issue on a case by case basis rather than increase capital across the board.
RMA has taken the position that while it believes that additional risk and thereby more capital may be necessary for subprime lending, it opposes any special treatment for one sector of the loan portfolio without addressing risk-weighted capital needs for the entire balance sheet.
RMA is the only financial services trade association that specializes in promoting prudent and effective credit risk management practices across the entire banking and lending spectrum for institutions of all sizes. Its membership consists of more than 3,000 financial service providers. These institutions are represented in the association by more than 18,000 commercial loan and credit personnel in 50 states, Puerto Rico, Canada and numerous foreign cities, including Hong Kong, Singapore and London.
For more information, call Pam Martin, Director of Regulatory Relations and Communications, at 215-446-4092 or e-mail mailto:pmartin@rmahq.org