This article is part of a series titled “Supervise the financial institutions of our country.
Banking conditions in the United States remained generally strong in the second half of 2021, with strong capital and liquidity, in addition to improving asset quality. This is the conclusion of the Board of Governors of the Federal Reserve, which recently published its latest Supervisory and Regulatory Report (PDF). The semi-annual report covers conditions in the banking system, as well as regulatory and prudential developments for institutions under the Fed’s umbrella.
While the banking sector currently appears to be on solid ground, supervisors are monitoring banks for traditional risks, such as management, liquidity and cybersecurity. Recent events, such as the COVID-19 pandemic and the Russian invasion of Ukraine, have created risks for some banks, leading to particular attention from supervisors. They also focus on new risks associated with the increasing use of technology by financial institutions of all sizes.
An eye on the risks
As the report notes, the actual and potential risks associated with Russia’s invasion of Ukraine are generally limited to the largest international institutions operating in the country. There are few direct financial exposures to either country, and those that do exist are considered limited and manageable. Indirect exposure through spillovers such as commodity markets is also limited to date, and supervisors believe that strong capital and liquidity levels are sufficient for banks to weather increased volatility and the potential losses. Banks have partnered with Western governments to implement sanctions, at home and abroad, and have adopted heightened cybersecurity alert levels.
The growing role of technology, particularly artificial intelligence, data analytics and cloud computing, in financial services and banking operations is a greater concern in surveillance. Banks are developing new technology-based products and services to improve back-office operations. These developments offer benefits to banks and their customers, but also generate risks.
An additional factor in technology risk is the reliance of many banks, especially smaller ones, on a few third-party service providers to maintain “operational resilience” – the ability to continue operating despite vulnerabilities such as cyberattacks and outages. To help supervised institutions keep up with technological and regulatory expectations, the Board of Governors has launched a innovation page on its website which offers resources and information. The Board is also updating its oversight programs for third-party service providers and reviewing financial technology (fintech) used by Fed-supervised banks.
Oversight by numbers
Although the Fed exercises supervisory authority over several very large banks and all bank holding companies in the country, the vast majority of banks under its umbrella are community banks – banks with assets of less than $10 billion. . Of the 705 member state banks (SMEs) the Fed supervised at the end of 2021, nearly 95% (665 banks) met this community banking threshold and were part of the community banking organization portfolio ( CBO) from the Fed. The second largest group, made up of 27 SMEs, is part of the Regional Banking Organizations (RBO) portfolio; banks in this group have total assets of $10 billion to $100 billion.
At the St. Louis Fed, all of our supervised banks fall under the CBO or RBO portfolio. Currently, we have direct responsibility for the supervision of 119 SMEs in the two portfolios, which represents almost a fifth of the banks supervised in the System. Six banks are part of our RBO group and the other 113 are part of the CBO group. In terms of assets under watch, RBO banks total $197.8 billion, or 69% of the total. The combined assets of CBO banks total $89.3 billion.
By the end of 2021, all RBOs and more than 99% of CBOs systemwide had capital ratios above “well capitalized” minimums, and nearly 97% of them received watch ratings “satisfactory” or “strong”.
A look into the future
While capital levels are generally good and problem loans are minimal, reviewers noted that credit risks could increase among RBOs and CBOs due to exposures to economic sectors hit hard by the pandemic, such as the commercial real estate. Smaller banking organizations are particularly sensitive to developments in commercial real estate since this sector tends to represent a significant portion of their loan portfolios. And while overall liquidity risk is currently low due to economic uncertainty and weak loan demand, that could change as funds are rolled out and stimulus programs continue to wind down.
In addition to these traditional concerns, reviewers will remain focused on IT risks and cybersecurity. The lack of robust infrastructure and reliance on third-party providers makes smaller banks more vulnerable to these risks. Difficulties in hiring and retaining qualified information technology and cybersecurity personnel could put additional pressures on these institutions.
There is an application for that
Finally, while much of the reviewers’ work was successfully conducted offsite due to the pandemic, some onsite reviews resumed this year. But we will continue to use technology to make the monitoring process as efficient and effective as possible. We are encouraged by the positive feedback generated by Central monitoring, a cloud-based application that enables the secure exchange of information between examiners and SMBs and holding companies with assets of less than $100 billion. The new app can also be used for communication between Fed reviewers and their state counterparts, reducing duplicative requests for information from supervised institutions.
1 Other member state banks belong to one of two major financial institution supervisory portfolios: one for US companies with assets of over $100 billion (the Coordinating Committee for the Supervision of Large institutions) and the other for foreign banking organizations with combined U.S. assets of $100 billion or more (Large and Foreign Banking Organizations portfolio).
2 A bank is “well capitalized” if it significantly exceeds the minimum level required for each relevant capital measure.