In a speech at the RMA Annual Risk Management Conference in Boston, Curry stated that the topic of credit risk was muted as recently as 2012 because banks were still in a post-crisis state of recovery and were being extremely cautious with lending—some believe too cautious. Three years ago, however, the need to discuss credit risk was minimal because loan demand was soft, consumer confidence was down, and businesses were reluctant to make loans to only the most creditworthy borrowers.
In the last 18 months, however, banks have generally become profitable as economic conditions have improved, unemployment is down, and loan demand has increased, leading Curry to ask: “Where do we go from here? What will it take to ensure that banks remain solvent, stable, and secure in their role in the payments and credit system?”
Curry pointed out that the increased regulation of today is designed to prevent another financial crisis similar to the one in 2008; however, he said, things do not need to get to that point if the right decisions are made today in the financial system, particularly in the area of credit risk by banks.
While banks are prospering, however, they have created some credit risk concern by loaning to customers who almost certainly would not have qualified four or five years ago because of the risk they pose, Curry said.
“Many banks have made a conscious decision to increase their risk appetite and take on additional credit risk,” Curry said. “They are doing this in part because in times of economic growth banks feel confident that they can. But they are also targeting less creditworthy customers and offering easier terms and conditions because they feel that they must, in order to hold their own against the competition for loan growth, market share, and revenue.”
“We can ensure a safe and sound banking system and avoid crises if we take sensible and toughminded steps now to address the emerging risks I’ve discussed today.”—Thomas Curry
Credit risk is showing up now in banks in two classic forms, according to Curry: that of relaxed underwriting and increased loan concentrations. While banks with increased loan concentrations and eased underwriting standards always prosper for a time, there will eventually be a “day of reckoning,” Curry said. As a regulator, Curry said, his job is to raise awareness of the credit risk these conditions pose before things reach that point.
“At present, these concentrations flash yellow lights rather than red ones, and, as I’ve noted, credit quality has not suffered significantly as a result,” Curry said. “Our job as supervisors is to ensure that things stay that way.”
Curry said he would like to see banks take the initiative to address concentration risk on their own, without supervisory action, and stated that the OCC has provided tools to help them do so. He urged risk managers to carefully examine their respective banks’ loan loss allowance to see if it is appropriate for the level of risk their bank is taking on.
“We’ve been through a long period in which banks have been steadily reducing reserves,” Curry said. “Just over the last two years, the key ratio of the loan loss allowance to total loans dipped by more than 40 percent. Although banks have argued, with some justice—and please note the qualification—that improvements in loan quality justified those reserve releases, drawdowns of that magnitude are clearly disproportionate.”
Curry stated it was clear to him that the reserves needed to be raised in order to account for the increasing credit risk in the financial system today
“We can ensure a safe and sound banking system and avoid crises if we take sensible and toughminded steps now to address the emerging risks I’ve discussed today,” Curry said.