Banks should be preparing for the risk of losing more deposits than usual as interest rates climb, the Office of the Comptroller of the Currency said May 24.
The OCC added that factor as a "key risk issue" that banks should look out for in its semiannual risk perspective report, noting uncertainty around how customers will respond as interest rates keep rising. OCC officials told reporters that some of the top staff at banks are younger and have therefore not experienced a period of rising rates, one reason why the agency decided to add a section on the issue in its report.
The current cycle has been unusual in that banks did not have to raise deposit costs substantially when the Federal Reserve started increasing interest rates in 2015, the agency said. But with the Fed now several rate hikes into its tightening cycle, banks are increasingly seeing deposit costs grow.
"Deposits acquired during a period of historically low rates could expose banks to interest rate and liquidity risks that are more severe than projected by banks' models," the agency said. "Accordingly, it is important for bank management to perform sensitivity analyses of deposit assumptions across a range of scenarios and identify the potential impact on earnings and liquidity."
There are several factors that "may result in deposit behavior that deviates from historical norms," the OCC said in the report. For one, institutions have a significantly larger proportion of nonmaturity deposits on their balance sheets, making it easier for customers to take that money elsewhere. At the same time, the agency said, regulatory requirements such as the liquidity coverage ratio, or LCR, are prompting banks to compete for retail deposits, while nonbanks and financial technology companies are also increasingly getting into the mix.
Banks may "experience unexpected adverse shifts" in their liquidity and costs that may dent their earnings, the agency said. A flattening yield curve may also "complicate the margin outlook for banks" if spreads narrow more than expected, the OCC's report said.
OCC head Joseph Otting, fresh out of a White House signing ceremony on a bill revising parts of Dodd-Frank, told reporters that banks' liquidity and capital levels are "near historic highs," though he said banks are easing underwriting practices as the economy improves.
"We must be diligent when times are good because the worst loans are made in the best of times," he said.
Another risk is the increased dependence, particularly from smaller banks, on third-party providers for technology offerings, Otting said. Banks should ensure they have adequate cybersecurity protections in place, as well as appropriate anti-money laundering systems as technology continues to evolve, he said.
