Banking on the Future: OCC’s Roadmap through Risks and Regulations

The Office of the Comptroller of the Currency (OCC) has recently
presented its Semiannual
Risk Perspective for Fall 2023
, delving into the critical challenges facing
the federal banking system. The report identifies credit, market, operational,
and compliance risks as the predominant themes shaping the banking landscape.

Unpacking Key Risk Themes: Credit, Market, Operational, and Compliance
Risks

The OCC report underlines the escalating credit risk attributed to higher
interest rates, increasing vulnerability in commercial real estate lending,
prolonged inflation, declining corporate profitability, and potential economic
growth deceleration. Simultaneously, compliance risk remains elevated due to a
heightened focus on ensuring equal access to credit, fair treatment of
consumers, innovative technology adoption, and expanded partnerships with third
parties.

AI’s Emerging Role and Risks in Banking

Despite the potential benefits of widespread AI adoption in banking, the
OCC identifies it as an emerging risk.

The report underscores the challenges associated with AI, spanning
compliance risk, credit risk, reputation risk, and operational risk. While AI
holds promise for efficiency and innovation, careful management is essential to
mitigate its inherent risks.

Guidance on ‘Buy Now, Pay Later’ Lending

In addition to risk identification, the OCC has issued guidance on ‘Buy
Now, Pay Later’ (BNPL) lending, a sector gaining prominence. The guidance
emphasizes risk management in BNPL loans, payable in four or fewer installments
without finance charges.

The OCC’s acting comptroller, Michael Hsu, also highlighted the importance of
responsible practices in the BNPL market, particularly as the holiday shopping
season unfolds
. The guidance directs banks to uphold clear underwriting,
repayment terms, pricing, and safeguards, ensuring transparency in marketing
materials and disclosures.

Third-Party Risk Management: A Core Consideration

Donna Murphy, the OCC’s acting deputy comptroller for the Office of
Financial Technology, stressed the “essential” nature of third-party
risk management. This emphasis comes in the backdrop of increasing
collaborations between banks and fintech companies. Murphy’s statement before
the House Subcommittee on Digital Assets, Financial Technology, and Inclusion
reiterates the potential benefits of third-party partnerships but underscores
the necessity for robust risk management to protect consumers and maintain
overall bank safety and soundness.

AI and Machine Learning Landscape in Banking

Addressing the House Subcommittee, Murphy also discussed the growing
integration of AI and machine learning in the banking sector. While
acknowledging the significant potential benefits, Murphy highlighted the OCC’s
continued focus on managing and controlling the risks associated with AI use in
banking
. Potential risks include poorly designed mathematical models, faulty
data, changes in model assumptions, inadequate validation, testing, and limited
human oversight.

Looking Forward

As banks navigate the dynamic landscape of evolving risks, compliance
challenges, and technological integrations, finding a balance between
innovation and risk management becomes imperative. The OCC’s comprehensive
report and guidance aim to equip banks with the insights needed to navigate
these complexities successfully.

The Office of the Comptroller of the Currency (OCC) has recently
presented its Semiannual
Risk Perspective for Fall 2023
, delving into the critical challenges facing
the federal banking system. The report identifies credit, market, operational,
and compliance risks as the predominant themes shaping the banking landscape.

Unpacking Key Risk Themes: Credit, Market, Operational, and Compliance
Risks

The OCC report underlines the escalating credit risk attributed to higher
interest rates, increasing vulnerability in commercial real estate lending,
prolonged inflation, declining corporate profitability, and potential economic
growth deceleration. Simultaneously, compliance risk remains elevated due to a
heightened focus on ensuring equal access to credit, fair treatment of
consumers, innovative technology adoption, and expanded partnerships with third
parties.

AI’s Emerging Role and Risks in Banking

Despite the potential benefits of widespread AI adoption in banking, the
OCC identifies it as an emerging risk.

The report underscores the challenges associated with AI, spanning
compliance risk, credit risk, reputation risk, and operational risk. While AI
holds promise for efficiency and innovation, careful management is essential to
mitigate its inherent risks.

Guidance on ‘Buy Now, Pay Later’ Lending

In addition to risk identification, the OCC has issued guidance on ‘Buy
Now, Pay Later’ (BNPL) lending, a sector gaining prominence. The guidance
emphasizes risk management in BNPL loans, payable in four or fewer installments
without finance charges.

The OCC’s acting comptroller, Michael Hsu, also highlighted the importance of
responsible practices in the BNPL market, particularly as the holiday shopping
season unfolds
. The guidance directs banks to uphold clear underwriting,
repayment terms, pricing, and safeguards, ensuring transparency in marketing
materials and disclosures.

Third-Party Risk Management: A Core Consideration

Donna Murphy, the OCC’s acting deputy comptroller for the Office of
Financial Technology, stressed the “essential” nature of third-party
risk management. This emphasis comes in the backdrop of increasing
collaborations between banks and fintech companies. Murphy’s statement before
the House Subcommittee on Digital Assets, Financial Technology, and Inclusion
reiterates the potential benefits of third-party partnerships but underscores
the necessity for robust risk management to protect consumers and maintain
overall bank safety and soundness.

AI and Machine Learning Landscape in Banking

Addressing the House Subcommittee, Murphy also discussed the growing
integration of AI and machine learning in the banking sector. While
acknowledging the significant potential benefits, Murphy highlighted the OCC’s
continued focus on managing and controlling the risks associated with AI use in
banking
. Potential risks include poorly designed mathematical models, faulty
data, changes in model assumptions, inadequate validation, testing, and limited
human oversight.

Looking Forward

As banks navigate the dynamic landscape of evolving risks, compliance
challenges, and technological integrations, finding a balance between
innovation and risk management becomes imperative. The OCC’s comprehensive
report and guidance aim to equip banks with the insights needed to navigate
these complexities successfully.