The federal banking system remains sound but faces credit, market, operational and compliance risks, according to the Office of the Comptroller of the Currency (OCC).
An emerging risk faced by the system is the use of artificial intelligence (AI) in banking, per the release.
The report underscored the overall robustness of the banking system while urging banks to maintain diligent risk management practices, according to the release.
Credit risk is on the rise due to several factors, including higher interest rates, risks associated with commercial real estate lending, inflation, declining corporate profitability and the potential for slower economic growth, the release said. Key performance indicators are already indicating signs of borrower stress across different asset classes.
The report also highlighted the impact of increasing deposit rates and a broader contraction of market liquidity on net interest margins, per the release. Banks are facing intense competition for deposits and higher interest rates are leading to elevated deposit rates.
While deposit and liquid asset trends stabilized in the latter half of 2023, this stability was supported by an increased reliance on wholesale funding. Moreover, the rising interest rates are negatively affecting the value of investment portfolios.
Operational risk remains a significant concern, with cyber threats posing a constant challenge, according to the press release. Banks are leveraging new technology to enhance digitalization efforts and offer innovative products and services to meet customer demands. However, this increased digitalization also exposes banks to higher risks of fraud and error, including fraud targeting peer-to-peer and other faster payment platforms.
Compliance risk is another area of focus, driven by the emphasis on equal access to credit, fair treatment of consumers, and the expanded use of innovative technologies for product and service delivery, the release said. The OCC also highlighted the increased partnerships with third parties, such as financial technology firms, and the associated increased risk of money laundering risk.
The report also identified AI in banking as an emerging risk. While the adoption of AI offers significant benefits, such as cost reduction, efficiency improvement and expanded access to credit and banking services, widespread adoption may also present challenges related to compliance risk, credit risk, reputation risk and operational risk.
The release of this report comes a day after the OCC issued a guidance to national banks and federal savings associations, saying that those who offer buy now, pay later (BNPL) loans should minimize adverse consumer outcomes.