OCC Reports on Risks Banks Are Facing

In a report released by the ""OCC"":http://www.occ.treas.gov/ Thursday, the banking industry's levels of capital and allowance for loan losses were described as ""robust and of higher quality,"" but banks of all sizes are still facing specific risks as they adjust to aftershocks following the financial crises.

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The main risks the OCC said banks are facing include the ""effects of a weak housing market, revenue challenges related to slow economic growth and market volatility, and the potential that banks may take excessive risks in an effort to improve profitability.""

With home prices remaining well below their peaks and delinquencies and foreclosures remaining well above the norm, the housing market is still weak despite improvements. The report stated the large overhang of foreclosures suggests many areas will see further home price declines and any slowing in economic recovery could effect real estate values, a key component of the banking industry.

Net interest margins at smaller banks have also seen little improvement. The continuation of record-low interest rates is preventing banks from realizing benefits from lower funding costs. With a fairly flat outlook for interest rates and loan growth for 2012, net interest margins are expected to improve little in the near future, according to the report.

Also, the decline in non-interest income has affected both large and small banks, with impact more strongly felt by larger banks. Non-interest income includes income derived from various fees such as transaction fees, insufficient funds fees, and annual fees.

The OCC said the declines in non-interest income can be attributed to lower securitization and servicing revenues, and lower gains on the sale of loans. Regulation limiting consumer fees and more reluctance from customers to pay for banking services have also led to declines in non-interest income.

For community and mid-size banks, the OCC said, ""[m]argins are under pressure in the low interest-rate environment due to growth in deposits and weak loan demand."" This is leading smaller banks to increase the length of their investment portfolio and purchase more complex products, which leads to further exposure to interest rate risk.

For large banks, one challenge the OCC highlighted is their ability to identify weaknesses when processing foreclosures and servicing loans in large volume due to legal costs and financial penalties they face.