Half of Large Banks Have Bad Operational Risk Management

It’s shocking and sobering if you’re in CRE. Major federal bank regulatory Office of the Comptroller of the Currency made “confidential assessments” of 22 large banks it supervises, according to a Bloomberg report. Fully half lack an adequate grasp of and controls for many types of operational risk.

The lack of operational risk management in the largest banks is outside of bad loans or the potential for damaging market swings. The OCC looked at such threats as employee mistakes, legal problems, natural disasters, or tech weaknesses. These are things that can go wrong in how a bank undertakes day-to-day ordinary procedures, not with, for example, the quality of loans. And yet, the results could rebound indirectly on CRE.

That’s because, in a bank, virtually every type of risk comes down to holding capital in reserve. “Banks have to show regulators plans for managing such risks, and they have to hold capital against those threats, a requirement that’s long been debated because they’re harder to measure than credit or market risks,” Bloomberg wrote.

If banks have “insufficient” or “weak” management of operational risk, that means the institutions can’t see or control it enough. The less it’s possible to identify, anticipate, and counter risk, the greater the amount of capital reserves ultimately needed to offset the potential threat.

In a report from last month, the OCC noted that operational risk was elevated, whether from cyber threats, increasing digitalization, new and innovative product and service adoption, and payment and wire fraud. Banks that have poor control over operational risk should have to plan for even greater amounts of capital reserves.

That capital must come from somewhere. If there isn’t a sudden influx, it stands to reason that there will be less capital to cover other types of risk, like CRE lending. However, the OCC report also noted increased credit risk, particularly from commercial real estate, specifically office and some multifamily.

That isn’t surprising. The credit quality on office bank loans has continued to drop. The Federal Reserve most recently said that CRE overall continues to weaken. Even the largest banks are showing signs of pain from CRE lending.

The new question is whether operational weaknesses at major banks are likely to open new negative pressures on CRE lending by pulling reserve capital away.