Emerging Risks in Banking 2023

Determining the dominant risks to banks and credit unions over the past year has meant chasing a moving target.

While we don’t lack data about what keeps banking leaders and chief risk officers (CROs) up at night, events such as the collapse of SVB and Signature, continually rising interest rates, and persistent cybersecurity concerns have played a role in the shifting risk landscape.

What do the recent surveys tell us about risk management for FIs in 2023?

Community Bankers Worry About Staying Ahead of Regulatory Changes

At the beginning of 2023, the Conference of State Bank Supervisors revealed that community bankers remain concerned about government regulation. The only more pressing concern is inflation, the CSBS reported.

This is supported by the Bank Director 2023 Risk Survey, which found 28% of banks cited “evolving regulatory or compliance requirements” among their three most significant strategic challenges over the next 18 months. Those concerns are growing, with 21% of banks saying their concern over compliance risk has increased significantly, and another 49% said it increased somewhat.

The fact that more than a quarter of community bankers worry about their ability to keep up with regulatory change points to the need to maintain an updated library of regulations. Effective compliance risk management solutions identify regulatory changes for compliance officers, giving them more time to interpret how new regulations will impact their institution.

What’s top of mind? The implications of 1071 for small business lending looms large despite an injunction delaying implementation until the Supreme Court rules on the constitutionality of the Consumer Financial Protection Bureau’s (CFPB) funding mechanism. Fair lending laws are the source of increased regulatory scrutiny, with more cases being referred by regulators to the Justice Department. Meanwhile compliance with BSA/AML remains a challenge due to frequent changes as the Biden Administration issued an Executive Order related to sanctioned persons and bad actors exploiting digital currencies for illicit means and the collapse of the crypto trading platform FTX.

Related: FTX Fraud & Bankruptcy: What It Means for Your Financial Institution 

Growing Risk Management Concerns Surrounding Interest, Credit, and Liquidity

According to the Bank Director’s 2023 Risk Survey, financial institutions’ concern over interest rate risk (91%), credit risk (77%), and liquidity risk (71%) have all grown significantly.

Since the Federal Open Market Committee began elevating interest rates in March 2022, banks have focused on gradually raising deposit rates. With the specter of a recession hanging over the heads of bank and credit union leaders, they must be mindful of the interest rate paid to depositors and the credit risk of their loan portfolio.

The Bank Director Survey was conducted before the liquidity crises that brought down SVB and Signature, so we can assume that bankers' worry about liquidity risk has grown. Financial institutions concerned with a sudden run on their deposits should strengthen their contingency funding plan, especially because they will face more scrutiny from regulators going forward.

Regulators will likely require financial institutions to actively engage in asset-liability management (ALM) to avoid the fate of SVB and Signature. The OCC’s Semiannual Risk Perspective report draws attention to four key areas as emerging risks for financial institutions in the second half of 2023 – and likely through 2024. These include liquidity risk, credit risk, compliance risk and cybersecurity risk.

The emerging risks for banks in 2023 of liquidity, interest, and credit will depend on larger macroeconomic trends, but financial institutions can prepare themselves by adopting a comprehensive risk management solution.

While community banks and credit unions can’t control what the Fed does on interest rates, they can develop robust and thorough risk management practices that put them in a position to weather whatever storms may lie ahead.

Read also: Key Risk Indicators for Banks, Credit Unions and Other Financial Institutions

Credit Risk

While credit risk remains moderate, the Bank Director’s 2023 Risk Survey shows an increasing concern among banks and credit unions, with 71% of participants listing it as their primary concern at the end of 2022. 

Both the FDIC and OCC anticipate potential problems in specific segments of the commercial real estate market in 2023 and headed into 2024. While industrial properties, multifamily, and consumer lodging remain up, office fundamentals have weakened due to the rising trend in remote work. 

In Q1 of 2023, office rent prices nationally remained close to before the pandemic, contrasting with the rising rents in other real estate sectors. According to many informal reports, many owners of office properties have reduced rents by offering more generous terms to tenants, including complimentary rent periods and tenant-specific modifications to leases. 

Community banks hold 28% of commercial real estate loans on their balance sheets, which could be problematic if the office rental market continues to deteriorate.  

So far, longer-term leases have insulated community banks from the full impact of delinquencies in this real estate market sector, but this could soon change. 

Higher interest rates combined with decreasing household savings could also increase consumer credit risk in the second half of 2023 and on through 2024.  

According to the FDIC, the proportion of auto and credit card loans that were delinquent aligned with regular seasonal patterns throughout the end of 2022 and early 2023. Compared to 2019, credit unions and banks have yet to observe an uptick in consumer loan delinquencies. 

But if the labor market or economic conditions become less favorable toward the end of 2023 and into 2024, consumer loan performance may decline. There are worrisome signs that the quality of existing auto loans could worsen as auto prices continue to stabilize. 

Related: What Are Examiners Looking for in 2023

Continued Concerns with Cybersecurity Risk

FIs typically cite cybersecurity as their most significant concern in managing risk in any given year. While early 2023 presented unique challenges to financial institutions in the areas of interest risk and credit risk, cyber risk still dominates many of the surveys.

In the Bank Director survey, cybersecurity came in as the second highest risk concern for financial institutions at 83%, with only interest risk on top. These findings are confirmed by EY’s 2022 survey, which specifically surveyed CROs.

According to EY, cybersecurity risk was primary with 72% of CRO respondents citing it as their top priority in 2023. Credit risk ranked as their second-highest top priority for 59% of respondents, although the EY survey did add that if economic conditions worsened, credit risk could become a larger area of concern than cyber risk.

Related: Regulatory Compliance is Hot! Have You Been Listening?

Implementing a Successful Risk Management Program

Many financial institutions know they need to address risk management. The Bank Director survey found that 59% of respondents have set goals and objectives related to risk management processes and risk governance. Corporate governance processes are a priority for 41%.

Regulatory changes impact financial institutions regardless of their size. An FI with $500 million in assets must comply with the same regulations as a financial institution with trillions in total assets.

At the same time, when financial institutions cite satisfying examiners as a chief concern, as many do, they confuse compliance culture with risk management culture. The two are not the same. Failing to comply with regulations and laws is just one aspect of risk management.

With every financial institution subject to the same regulations and risks, community banks and credit unions face unique challenges in creating a robust risk management culture because they have fewer resources.

According to the Bank Director survey, 50% of financial institutions cite talent retention and staffing as one of their primary strategic concerns. Human capital is one of the pillars of building a successful risk management program.

Attracting and retaining capable individuals in management positions and securing buy-in from those at mid-senior and lower-level positions is an essential aspect of a sound risk management strategy.

Related: On-Demand Webinar - The Efficiency Formula: Harnessing Talent, Compliance, & Collaboration

Most financial institutions are focused on limiting losses and avoiding regulatory penalties and fines. This doesn’t mean your FI must adopt the latest and greatest technologies. But it does mean that you need a system that fully addresses risk management from the top down.

Adopting a cost-effective, comprehensive risk management solution helps solve the problem of talent retention because it involves all your employees in risk management. When new employees are onboarded, they can be quickly trained in your institution’s risk management culture.

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Financial institutions shouldn’t worry about having the newest technologies in risk and compliance. They should instead concern themselves with workable solutions addressing their institution’s total risk tolerance and exposure.