On December 3, 2018, the National Risk Committee (“NRC”) of the Office of the Comptroller of the Currency (“OCC”) released its Semiannual Risk Perspective for Fall 2018. The report analyzes the condition of the federal banking system using data reported by national banks and federal savings associations as of June 30, 2018. The analysis covers five main areas: banks’ operating environment, bank performance, emerging risks, trends related to key risks, and supervisory actions. In addition to these usual areas, the Fall 2018 report included a special supplement discussing risks related to the easing of credit underwriting standards. A brief summary of each of these areas follows.

Operating environment. The OCC report begins with a discussion of the strength of the overall U.S. economy, as well as industry trends affecting banks. The industry trends highlighted include (1) a continuing shift away from banks and toward non-bank lenders, (2) the ongoing implementation of new accounting standards for recognizing current expected credit losses, (3) the ongoing adoption of a new reference rate for overnight funding, and (4) new technologies and innovation.

Bank performance. Against the broader economic and industry backdrop, the report indicates that the federal banking system exhibited strong performance in the first half of 2018—exceeding 10% return on equity for the first time since the Great Recession—driven by tax cuts and expanding net interest margins. In addition to banks’ financial performance, lagging indicators of systemic problems (such as delinquencies and nonaccruals, classified assets, and allowance for loan and lease losses) continued to decline.

Emerging risks. Despite banks’ strong performance, the report warns of several emerging areas of risk. In particular, the report notes that non-financial business debt is approaching a record high as a share of GDP, and as a result, it expresses concern that the strong investor appetite for corporate bonds and loans is compromising credit quality. Given these conditions, a downturn in the corporate bond and loan market could have a strong adverse impact on banks.

Trends in key risks. In line with previous guidance, the report cautions that banks should remain diligent with respect to cyber risks (and relatedly, reliance on third-party service providers), BSA/AML concerns, and regulatory compliance challenges. The report also suggests that rising interest rates and technological advancements may increase the level of competition for deposits, potentially affecting banks’ funding mix.

Supervisory actions. The report highlights a decline in the number of both MRAs and outstanding enforcement actions, reflecting an overall improvement in banks’ risk management practices, capitalization, and other factors. Despite this progress, some banks continue to experience compliance and operational issues, which are among the leading causes of enforcement actions.

The OCC report includes a supplemental discussion of credit underwriting standards at supervised banks. While indicating that the overwhelming majority of banks had strong or satisfactory credit policies, the report notes that market pressures are driving more liberal underwriting standards at many banks, pushing those banks toward the upper end of their risk tolerances. The report includes five examples of eased credit terms or policy exceptions that represent areas of concern.