Industry Q&A: Touching Base with the OCC

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Comptroller Thomas Curry reports the OCC’s recent perspectives and activities

The U.S. Office of the Comptroller of the Currency supervises nearly 2,000 national banks and federal savings associations, which include both largest Wall Street financial institutions and hundreds of Main Street community banks. With the OCC and other federal banking agencies issuing several new rules and regulations last year, including the Basel III capital standards, ICBA Independent Banker reached out to ask the agency’s perspective on recent topics and activities relevant to community banks.

U.S. Comptroller of the Currency Thomas Curry, who serves on the FDIC’s board of directors, filed answers to written questions that IB submitted to the OCC.

IB: You’ve served as Comptroller of the Currency for almost two years. What is your most important accomplishment so far, and what is your biggest new initiative?

Curry: The past two years have been extraordinary ones for the industry and for the Office of the Comptroller of the Currency. While accomplishments are better judged by others, I’d point to the significant rules and guidance regarding capital, deposit advance products, leveraged lending and proprietary trading that have been completed in that time span. This progress makes the entire system safer.

I’d also point to the work we’re doing to ensure the OCC is ready for the challenges of the next 150 years—from inviting international peers to assess our large and midsize bank supervision to initiating strategic initiatives to be more efficient and effective in all we do.

Operationalizing these new rules into our daily supervision and our commitment to continuous improvement will occupy a great deal of our time next year.

IB: Different industry data and surveys of community banks show that lending conditions, particularly loan demand, are gradually improving. What’s the OCC’s outlook for community banks for 2014?

Curry: The future is bright for well-managed community banks and thrifts. While we expect the financial conditions to improve further in 2014, banks still face pressure from sluggish growth, weak loan demand and declining investment yields. The greatest areas of concern for community banks involve strategic risk, as banks respond to changes in the economic environment, the adequacy of succession planning, the erosion of underwriting standards, the development of new products without the requisite management skills, increased interest rate risk and over-reliance on third-party vendors.

IB: The OCC has been out front warning national banks to review risks related to their relationships with third-party vendors. What are the key controls that some banks might be overlooking in this area of risk management?

Curry: Using third-party vendors can be effective and affordable, but over-reliance without rigorous controls can lead to operational, compliance and reputation risks. Our recent guidance clarifies expectations for banks to plan for identifying and managing the risks of third parties, to perform proper due diligence, to implement written contracts with clear roles and responsibilities, have proper oversight and accountability from the board of directors all the way to the individuals with direct contact with vendors, to maintain proper documentation, to monitor the vendors, and to conduct independent reviews of risk management processes.

IB: You have recently voiced concerns about the possibility of cybercriminals turning their attacks now mostly aimed at big banks toward community banks. What’s new that community banks should know about these threats? What IT security changes should community banks consider?

Curry: Staying ahead of cyberthreats demands all of our skill and will require all of us, regulators and bankers alike, to work together. I have stressed that cybersecurity is not just an IT problem. Cyberthreats pose risks across the bank and require management to set clear expectations and stress the importance of a security culture. Executives must be concerned with the growing sophistication and frequency of cyberattacks that can disrupt operations, cover up illicit activity to commit fraud or theft of intellectual property, and damage systems and information. Community bankers need to consider whether their businesses and their third-party providers are up to the task and consider how adding business processes, new technology and third-party arrangements could expose institutions to additional risk.

As chairman of the Federal Financial Institutions Examination Council, I called for the creation of The Cybersecurity and Critical Infrastructure Working Group to improve coordination and information sharing among regulators and to consider how to implement aspects of the President’s Executive Order on Cybersecurity and how to address recommendations of the Financial Stability Oversight Council. As the group develops, it will also look at gaps in federal and state examination policies related to cybersecurity.

IB: What other safety and soundness priorities does the OCC have looking forward into 2014?

Curry: Community banks and thrifts need to focus on strategic risk. Many banks are reevaluating business models and risk appetites, and some are cutting costs by reducing control functions and leaning on third parties to perform important functions. Others are “chasing” yield and layering risk in an environment of slow growth and unusual interest rates. In 2014, examiners will look at strategy planning and processes to approve new products to ensure banks have the proper controls and management in place for these risks.

IB: Capital is a significant issue for community banks. While the federal banking agencies addressed several primary concerns that community banks had with the proposed Basel III capital standards, the final rules will still put additional capital pressure, and therefore profitability pressure, on more community banks. What should community banks be doing now to prepare for the implementation of the rules in 2015? What will examiners be looking to see in community banks’ capital planning leading up to 2015?

Curry: The vast majority of community banks and thrifts already have capital that meets or exceeds the new minimum requirements. However, to help community banks with the transition, we are phasing in the bigger changes over five years, including the capital conservation buffer and required deductions from common equity Tier 1 capital.

Throughout this process, we have been committed to helping community bankers understand and act on the new requirements. The agencies published a guide to the new rule and a tool to help community banks understand and estimate the effects of the final rule.

IB: The Financial Accounting Standards Board has proposed a new, more complex “expected loss” model for community banks to calculate their estimate of expected losses on loans and security investments. ICBA and many community bankers are very concerned about how the proposal would burden their capital and earnings while complicating their reporting requirements. While the OCC estimates the accounting change would increase community bank loan loss reserves by 30 to 50 percent, your agency is supporting the proposal but advocating accommodations for community banks. What changes would you like FASB to make for community banks?

Curry: FASB’s proposed expected loss model makes good sense and is preferable to the existing regime because it would allow banks to take provisions for emerging risks rather than waiting for the loss to be incurred. During the financial crisis, it became clear that the incurred loss model had too often led to large loan-loss provisions at the worst time—in the midst of a credit downturn when earnings and lending capacity were stressed.

The new standard offers other advantages. Allowances would be more transparent and consistent with business results. The treatment of different financial assets would be simpler, which can help facilitate better loan pricing and pre-purchase assessments of investments. Ultimately, I believe bankers could increase reserves more effectively as they see risk building.

We’ve urged FASB to provide additional guidance and time for smaller institutions and to modify disclosure requirements.

IB: The regulatory enforcement process involving fair lending, including evaluations using the “disparate impact” statistical approach, continues to be a worry for community banks. What can community banks supervised by the OCC expect from the agency in terms of its fair lending enforcement in 2014?

Curry: I know bankers are committed to fair lending, and so is the OCC. We are working to implement updated procedures in 2014 for our fair lending risk assessments in institutions with less than $10 billion in assets, with an eye toward ensuring that we review risk factors specific to each credit product. We use these fair lending risk assessments to focus our examinations.

IB: As you know, cumulative, disproportionate regulatory burdens are one of the greatest challenges for community banks now. ICBA has offered Congress several legislative proposals to address the problem, including measures to expand tiered regulation that gives community banks relief from regulation aimed at larger banks. Can more be done on the regulatory level?

Curry: Burden comes in two forms—through rulemakings and the supervisory process. In developing new rules, we have paid a lot of attention to the impact on community banks and thrifts. We are working to improve how we explain and organize our rulemakings so bankers can easily understand whether and how a rule applies to their institution. Where possible, we are providing tools and guides just for community bankers.

In our supervision, the OCC tailors its supervision to the size and complexity of each institution according to the unique risks facing each institution. We have developed different supervisory approaches for large, midsize and community banks. And, we publish our Semiannual Risk Perspective to highlight the risks that have our focus and to give community banks a snapshot of the major risks they face.

IB: Many community bankers have been upset by what they considered a hostile and unfair examination environment that emerged in the aftermath of the financial crisis. The outcry that ICBA heard has toned down, but it hasn’t gone away completely. What has changed in the examination environment?

Curry: The recent banking cycle has challenged bankers and regulators. We have stressed the importance of open, candid communication and have assigned an examiner, designated as a portfolio manager, to each institution to facilitate that communication and to provide perspective on trends and outstanding issues from the previous exams. This approach gives banks a place to go with questions outside of the exam process.

Another key to a healthy supervisory process is the deployment of knowledgeable, well-trained and experienced examiners who add value to the process. Our examiners are able to look beyond standard performance indicators to assess the quality of risk management systems with the goal of identifying deficiencies early on, when they are most easy to fix. Proactive, forward-thinking supervision ultimately contributes to a bank’s safety and soundness.

IB: The OCC has been supervising federal savings institutions and mutual institutions for more than two years now. What changes has the agency made to supervise these institutions, and what has it learned?

Curry: Since the integration of the OCC and Office Thrift Supervision, we have gained an appreciation for the qualities that make federal savings associations and mutually-owned institutions unique. It is also clear that there are more similarities than differences in the supervision of banks and thrifts, such as the need for effective risk management systems tailored to each institution. In addition, we have fully integrated our supervision staff and our rigorous training program to ensure examiners leading exams have the knowledge of all types of charters.

IB: You’ve highlighted the importance of minority-owned community banks. What has the OCC learned about the regulatory needs of these particular institutions?

Curry: Minority-owned institutions remain a catalyst of economic activity in the communities they serve. To help ensure these institutions have access to the capital needed to perform this function, we revised our Policy Statement on Minority National Banks and Federal Savings Associations. The revision allows minority-owned institutions to accept equity investment capital from nonminority investors without jeopardizing their minority-owned status.

We’ve taken other steps to support the needs of these institutions. We established a Minority Depository Institutions Advisory Committee to bring together representatives from minority-owned institutions across the nation for regular conversations with senior OCC leaders. We also provide resources and assistance through our Community Affairs and External Outreach and Minority Affairs departments, and publish material on OCC.gov and Banknet that offers insight into small-business lending, New Markets tax credits and more.

IB: As the comptroller of currency, you regularly meet many community bankers throughout the country. What are some key insights taken from these encounters? What positive trends do you see?

Curry: Meeting with bankers from across the country is one of the most important things I do. These meetings provide insight into what Main Street bankers face every day. I have heard loud and clear about the challenges bankers have with new rules, the complex regulatory environment and the realities of the economy. We work every day to minimize the impact of these concerns while supporting a safe and sound federal banking system.

I’m helped in this process by the presence of our examiners in towns and cities across the country, near the banks and thrifts they supervise. Many community bankers have told me how knowledgeable and professional they find OCC staff, and I couldn’t agree more. I’m proud to lead an agency of dedicated professionals who believe so deeply in our mission and in the importance of community banks and thrifts.