Comptroller of the Currency Thomas Curry spoke to a conference of the American Institute of Certified Public Accountants (AICPA) on Sept. 16 at a suburban hotel near Washington. Sydney Sarmong, the Institute's technical manager, introduced Curry as the regulator of 2,000 national banks and federal savings associations, as well as 50 foreign agencies and branches, together accounting for two-thirds of the banking assets in the United States.

Curry also serves as chairman of the Federal Financial Institutions Examination Council (FFIEC), which coordinates principles, standards and report forms for the federal financial regulators. She added that the Institute and the Office of the Comptroller of the Currency (OCC) have a very strong and collaborative relationship and reminded the audience that the Federal Deposit Insurance Corporation Improvement Act of 1991 requires certification of bank compliance with standards for internal controls.

Curry built his speech around a process his agency adopted last year called the National Risk Perspective, designed to identify threats to the safety and soundness of financial institutions. He discussed three principal risks and then proceeded to discuss one regulatory issue, concerning bank provisions for loan losses, at length.

The three areas of particular concern are:

1. Strategic risk. This is the potential for adverse consequences resulting from poor business decisions or poor implementation of those decisions. This risk has been rising due to decisions by small banks to venture into new lines of business with the potential to generate higher profits but also bigger losses than from traditional activities. Curry declared that the OCC intends to make certain banks are not reaching beyond their technical competence, risk tolerance and capital adequacy.

2. Operational risk. This category consists of failures in the performance of systems and personnel. Many banks cut back their spending on these elements in response to the 2008 crisis episode, and this makes it harder for them to respond to new and emerging challenges, such as cyber security and increased regulation. Curry stated that the OCC will continue to drive home to the industry the importance of being vigilant and will continue to take appropriate supervisory action when it finds that bank systems and controls are wanting.

3. Economic environment. This items represents acknowledgement that the prevailing circumstance of sustainable but slow growth can lead banks to reach for yield by taking on higher interest-rate and credit risk in an effort to maximize returns. Therefore, it is particularly important for banks to maintain appropriate loan loss reserves (LLRs).

Curry proceeded to discuss this issue in considerable detail, recalling that last year the OCC had called attention to a declining trend of LLRs in relation to charge offs. The agency questioned the methodologies banks were using and whether the pace of this trend was sustainable.

However, he allowed that such a trend is to be expected in an improving economy and that releases of LLRs contribute to higher profits, additions to capital and enhanced safety and soundness. Then he zagged back to his original message and warned that this practice can become habit forming, and the OCC has observed "a growing disconnect between the pace and magnitude of LLR releases and underlying credit trends."

He expressed "particular concern" regarding significant reserve releases continuing despite reports from examiners that credit risk is on the rise due to relaxation of credit standards and increased layering of risk. He referred to an outreach effort by the agency on home equity lines of credit at last year's conference that was coupled with meetings to highlight increased repayment risk as interest-only arrangements put in place for 10 years move toward expiration.

Results from the last quarter of last year and the first quarter of this year indicated that the outreach had gotten the industry's attention, but Curry wondered whether those figures might have been an anomaly in the longer-term downward trend of LLRs declining faster than charge offs despite the loosening of underwriting standards.

Curry then zagged in the direction of reassuring the audience by hastening to make clear that he was "not talking about an imminent crisis." However, he called for banks "to take steps to be transparent about the current impairment of the loan portfolio." For its part, the OCC reaffirms its commitment "to support vigorous, open, and constant communication with key industry players" such as the AICPA.

Curry went on to say that in the interest of strong, unified risk management that the OCC expects to see from banks, the agency supports the pending Financial Accounting Standards Board (FASB) proposal on impairment measurement.

However, the OCC is waiting for FASB to work out questions as to how the standard would apply to debt securities. The objective is to enable banks to establish LLRs based on reasonable, supported forecasts of charge offs, in order to get ahead of the building of risk in the industry.

Finally, Curry recognized the industry's "trepidation" concerning the prospect of increases in allowances of as much as 200 to 300 percent, which would have a negative impact on capital levels. He indicated that perhaps this could be contained in the 30 to 50 percent range and assured the audience that he "doesn't want anyone to think the OCC is not sensitive to the cost and inconvenience."

He then pointed out that there would also be long-term benefits to the industry that are worth making a sacrifice today. He promised to support sufficient transition time and to continue the agency's effort to address the "deferred maintenance in banking regulation." He pointed out that the "vast majority" of the OCC's resources are devoted to community banks, and he touted the action the regulators have taken to insulate the banks from the effects of new Basel capital requirements.

The overall impression is that this is a regulator who has identified serious risks to the safety and soundness of the financial system and wants to cajole the industry to take them seriously, but he is ambivalent as to how vigorous he will be in pressing change on a balking constituency. He seems to be hoping that the economy will perform well enough to afford plenty of time to make adjustments that are long overdue.