34 MARCH / APRIL 2019 DIRECTORS / SENIOR MANAGEMENT Regulatory Priorities Dale Sheller Senior Vice President, Financial Strategies Group The Baker Group dsheller@GoBaker.com The Baker Group is a Preferred Service Provider of the Indiana Bankers Association and an IBA Diamond Associate Member. If you’ve read any recent headlines on the banking industry, you’ve likely seen some combination of the following: record profitability, strong asset quality and expanding margins. There is plenty of great news out there; however, you will never get the “everything is perfect” rhetoric from the regulators … trust me, I used to be one. Even with a thriving industry, the regulators are always reluctant to get too comfortable, and they definitely don’t want bankers to get too comfortable. Here is my regulatory priority list for 2019: Credit risk. Yes, even with the low charge-off and past due numbers in the industry, credit risk remains a critical regulatory concern. Credit risk should always be on the list, as this is the most likely cause of bank failures. However, we saw zero bank failures in all of 2018. So why now the big concern with credit risk? In 2018, many banks experienced strong loan demand and, as of 3Q 2018, 72 percent of banks saw increases in their loan and lease balances from the previous quarter. Loan-to-deposit ratios have increased to pre-financial crisis levels. Additionally, the regulators have identified incremental easing in credit underwriting standards for several years. Recommendation – Ensure any underwriting and credit administration practices are strong, and exceptions to policy are properly identified, tracked and documented. Liquidity risk. In the eyes of the regulators, more loans equal less on-balance-sheet liquidity. Higher loan-to-deposit and loan-to-asset ratios have reduced on-balance-sheet liquidity for many banks. Additionally, reliance on wholesale funding has steadily increased. Recommendation – Conduct forward-looking cash flow liquidity analysis and run quarterly stress tests to that cash flow analysis. Ensure your liquidity stress testing process is intertwined with your contingency funding planning. As always, run a scenario where you are considered “less than well-capitalized” and consider the effects to your contingency liability sources. Interest rate risk. Interest rates have nowhere to go but up, right? We will see about that; however, the regulators have been in our ear about rising interest rates since they were last cut by the Fed in late 2008. There are two major concerns: 1. As rates have increased, some institutions have had to pay up more rapidly on their deposits in order to keep them. These increased liability costs have translated into a more challenging net interest margin picture for them. Others have been fortunate enough to “lag and drag” the Fed’s rate hikes, and have seen their margins expand. However, deposit competition has been heating up as of late, and the Fed is now well into its tightening phase. 2. Since the historic fall in rates, money has flown into non-maturity deposits (NMDs) at a rapid pace. These low-cost NMDs have benefited banks for years, but it is unknown whether depositors will now seek higher deposit rates at other institutions or shift into higher-yielding time deposits. Recommendation – Stress test your earnings at risk and capital at risk by changing underlying assumptions on your NMDs (repricing betas and time lags). Additionally, simulate a migration of your lower-cost NMDs into higher-cost time deposits and/or wholesale funding. Cybersecurity risk. I don’t see cybersecurity risk going away anytime soon, and I’m sure you don’t, either.
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