Interest rate increases taking toll on bank investment portfolios, stands as key risk ahead

Rising interest rates have adversely affected bank investment portfolios, making the increases among the top risk issues facing the industry, according to a report issued by the national bank regulator Thursday.

The Office of the Comptroller of the Currency (OCC) in its Semiannual Risk Perspective for Fall 2022, said in addition to interest rate risk, operational, compliance and credit risks were also at the top of the list of gambles perhaps facing banks.

The agency pointed out that rising long-term rates have caused significant depreciation in investment portfolio market values. “Through the nine months ending Sept. 30, 2022, banks with more than $10 billion in total assets reported approximately 7% depreciation in available-for-sale portfolios and approximately 14% depreciation in held-to-maturity portfolios,” the OCC said. Banks with less than $10 billion in total assets, the OCC stated, reported approximate available-for-sale portfolio depreciation of 11% and approximate held-to-maturity portfolio depreciation of 12%.

The OCC asserted that the pressure on banks’ portfolios is not likely to end any time soon. It also pointed out that investment portfolio depreciation affects banks’ access to “timely and cost-effective” wholesale sources of funding through reduced fair market values for collateral pledging or to meet margin requirements.

“Investment portfolio values and banks’ access are likely to remain under pressure as the Federal Reserve ramps up quantitative tightening measures (balance-sheet runoff) and continues to raise short-term interest rates to fight inflation,” the agency said. “Banks with assets less than $50 billion are projecting, on average, about a 4% decline in portfolio values for every 100-basis-point rate increase.”

In any event, the agency also noted, banks in aggregate remain well capitalized and with ample liquidity and sound credit quality. However, it added that macroeconomic headwinds (such as interest rate risk) are a concern.

The OCC also outlined other key issues as:

  • Operational risk is elevated. Cyber threats continue to evolve, with threat actors continuing to target the financial services industry with ransomware and other attacks.
  • Compliance risk remains elevated as banks continue to operate in an increasingly complex environment that includes significant regulatory changes.
  • The quantity of credit risk in commercial and retail loan portfolios is moderate. Loan portfolio performance has been resilient, but signs of potential weakening in some segments warrant careful monitoring.

Not as part of key risks, the report also highlights the agency’s initiative on climate-related financial risks to the federal banking system and the OCC’s “careful and cautious” approach to crypto assets, the agency said.

OCC Semiannual Risk Perspective for Fall 2022