The Federal Deposit Insurance Corporation (FDIC) published its 2022 Risk Review, which offers a comprehensive summary of emerging risks in the U.S. banking system as observed in 2021. The 2022 Risk Review expands coverage of risks from prior reports by examining operational risks, from cyber threats and illicit activity, and climate-related financial risks faced by banking organizations. Monitoring these risks is among the top priorities of FDIC.
The 2022 report provides a retrospective summary of conditions in the U.S. economy, financial markets, and banking sector; it also presents key credit and market risks to banks as of year-end 2021. The report focuses on the effects of these risks on community banks, as FDIC is the primary federal regulator for the majority of community banks in the U.S. banking system. The report notes that the overall banking environment improved while financial market conditions were generally supportive of the banking industry in 2021. Below is a summary of the assessment of key banking sector risks:
- Credit Risks. The banking industry reported record high commercial real estate (CRE) loans in fourth quarter 2021 and community banks remain heavily involved in lending to this industry. While CRE asset quality remained strong, expiration of pandemic-related financial assistance and shifts in the market demand for CRE properties may affect future performance. However, consumer loans remain sensitive to pandemic developments and could be a source of risk for the banking industry. In general, banks remain vulnerable to potential distress in the corporate debt markets, particularly if interest rates rise and challenge the financial conditions of highly leveraged corporations. Bank lending to nonbank financial institutions reached a record high in 2021. Nonbank lending activity is concentrated in the largest banks; community banks have limited exposure. While the risks of bank lending to nonbank financial institutions is relatively moderate, lending to nonbank institutions exposes banks to broader risks from the financial system. Small business loans remained a large share of the community bank loan portfolio, though aggregate small business loan growth declined in 2021 when the e Paycheck Protection Program ended in the second half of the year.
- Market Risks. Market risks remain moderate overall. Low interest rates continue to challenge net interest margins and banking sector profitability. Liquidity levels in the banking industry remained strong and were supported by historically high levels of deposits and bank reserves. To earn return in a low loan demand and low interest rate environment, banks lengthened the maturity of their securities portfolios. The risk of higher interest rates poses challenges to banks that invested heavily in long-term securities when rates were relatively low and will pressure funding costs for all banks.
- Operational Risks. Operational risks, including cybersecurity risks and risks related to illicit financial activity, remain elevated for the banking sector. The number of ransomware attacks in the banking industry increased in 2021 and banks continued to discover vulnerabilities to their software and computer networks. The number and sophistication of cyber attacks also increased with remote work and greater use of digital banking tools. Moreover, threats from illicit activities, including money laundering, continue to pose risk management challenges to banks.
- Climate-Related Financial Risks. The effects of climate change present emerging risks to the banking industry. In 2021, severe climate-related events resulted in USD 145 billion in damages, the third most-costly year since 1980. Two hurricanes, several wildfires, and a serious drought affected many local communities and the banks that operate there. Severe climate-related events can disrupt local economic conditions and present risk across the banking industry, regardless of an institution’s size, complexity, or business model. The report notes that identifying and assessing climate-related financial risks to the banking industry and the financial system is a top priority for FDIC. Thus, FDIC and other US regulators addressed such issues in various statements published from time to time. In March 2022, FDIC approved a proposed Statement of Principles for Climate-Related Financial Risk Management for Large Financial Institutions, as an initial step to promote a consistent understanding of effective management of climate-related financial risks across the banking industry.
Keywords: Americas, US, Banking, ESG, Climate Change Risk, Lending, Credit Risk, Market Risk, Operational Risk, Community Banks, Physical Risk, Transition Risk, SME Lending, FDIC
Hasan leads Moody’s Analytics ESG methodology development. He is expert on carbon transition, nature related risks and is a guest lecturer at ESSEC Business school on sustainable finance.
Dr. Denton provides industry leadership in the quantification of sustainability issues, climate risk, trade credit and emerging lending risks. His deep foundations in market and credit risk provide critical perspectives on how climate/sustainability risks can be measured, communicated and used to drive commercial opportunities, policy, strategy, and compliance. He supports corporate clients and financial institutions in leveraging Moody’s tools and capabilities to improve decision-making and compliance capabilities, with particular focus on the energy, agriculture and physical commodities industries.
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