5 key risks – including credit hazards due to CRE, climate-related threats – outlined in FDIC report

Credit, market, crypto-asset, operational and climate-related financial risks are top hazards facing banks in the year ahead, according to the 2023 version of the federal bank deposit insurance agency’s annual risk review released Monday.

The Federal Deposit Insurance Corp. (FDIC) said that monitoring the five risks is “among the FDIC’s top priorities.” It noted climate-related financial risk will focus on the physical risk of severe weather and climate events to the banking system.

The FDIC’s annual Risk Review, the agency said, summarizes the agency’s assessment of risks related to conditions in the U.S. economy, financial markets, and the banking industry. The Review pays particular attention to risks affecting community banks, the agency said.

This year’s Review, the FDIC said, points out that the failure of three large banking institutions in March and May (Silicon Valley Bank [SVB] of Santa Clara, Calif., and Signature Bank of New York, N.Y., which both failed in March; and First Republic Bank of San Francisco, which failed in May) “highlighted certain risks to the banking sector.”

More specifically, regarding the five risks it highlighted, the report asserted:

  • Credit risks: Weaker economic conditions and higher interest rates may challenge bank loan portfolios, including credit card, commercial and industrial, residential real estate, and commercial real estate (CRE) loans. On the latter, the report notes that banks have “substantial exposure” to CRE lending as that comprises a quarter of all loans held by banks in the first quarter of the year. “With a structural decline in office demand and weak rent growth, some borrowers may have difficulty refinancing,” the report states. “Longer-term leases, which are prevalent in the office sector, helped to insulate office properties from reduced occupancy earlier in the pandemic, but more office leases are scheduled to expire over the next three years in some large markets. While aggregate banking industry CRE asset quality metrics remained favorable in first quarter 2023, challenges to loan performance include higher interest rates, difficulty refinancing particularly for loans secured by some office properties, and economic uncertainty.” The report also noted housing as a risk, stating that while asset quality metrics for residential mortgage loans remained favorable, “early signs of potential credit deterioration have emerged.”
  • Operational risks: The report contends that these, including cybersecurity hazards and threats related to illicit financial activity, remained elevated across the banking industry.
  • Market risks: Related to effects of higher interest rates, the report stated that deposit outflows along with “high levels of unrealized losses could pressure liquidity for some banks in 2023.” The report asserted that banks benefited from strong loan growth and higher net interest margins (NIMs) in 2022, “but higher funding costs reduced NIMs in early 2023.”
  • Crypto-asset risks: The report stated that these hazards “present novel and complex risks that are difficult to fully assess.” The report stated that the agency has been aware of rising interest in crypto-asset-related activities through its normal supervision process. “However, as this interest has accelerated, the FDIC determined that more information was needed to better understand the risks associated with these activities.”
  • Climate-related financial risks: The agency said it is expanding efforts to understand climate-related financial risk in a “thoughtful and measured manner that emphasizes a risk- based approach and collaboration with other supervisors and the industry.” It said it recognizes that risk management practices in this area are evolving and that it will “continue to encourage banks to consider climate-related financial risk in a manner that allows them to prudently meet the financial services needs of their communities.”

FDIC 2023 Risk Review