FDIC Risk Review: Takeaways for Smaller Institutions

Managers at smaller financial institutions sometimes feel left behind in the risk discussions and guidance from regulatory agencies. But there’s plenty of material relevant to community banks and other smaller institutions in the FDIC’s 2023 Risk Review, published in August.

Credit Risk

The Credit Risk section includes an abundance of material regarding community banks and smaller institutions, starting with the agribusiness material. The FDIC shares that “community banks hold 69 percent ($127 billion) of total agriculture loans.” Regarding risk in this area, we learn that “total agricultural loan past-due and net charge-off ratios remained low, with similar improvements in past-due ratios compared to a year earlier.”

The material regarding commercial real estate (CRE) describes the risk environment for smaller institutions: they may be more inclined to write commercial real estate loans and have a greater percentage of those loans in their portfolio, creating concentration risk. The review states that “community banks hold 28 percent ($865 billion) of the CRE loans on bank balance sheets, a share that remains outsized compared to their holdings of 15 percent of total loans.”

CRE loan performance can be subject to the whims of the real estate market, which is extremely sensitive to interest rate fluctuations. We learn that “higher interest rates and the prospect for weaker economic conditions may stress bank CRE portfolios and constrain loan growth.”

The only material in the Credit Risk section that does not address community banks or smaller institutions is the segment on leveraged lending. Although not mentioned in the publication, smaller banks that venture into some of the more esoteric loan products, like leveraged lending, may not always have the same level of expertise in this area as larger institutions.

Market Risk

The Liquidity & Deposits material in the Market Risk section appears to be written specifically for community banks. The term “community bank” is used 61 times in the section, and the FDIC includes multiple statistics and metrics on liquidity, deposits, and investment mix for community banks. Perhaps the most significant finding is that “about 96 percent of community banks report some degree of unrealized losses in their securities portfolio, with 36 percent of community banks reporting unrealized losses higher than 25 percent of tier 1 capital.”

Climate-Related Risks

In this section, the FDIC acknowledges that smaller institutions may become impacted by fewer options for insurance coverage for severe weather events, and although there may be government support, it might not cover all expenses. Thus, smaller institutions could be challenged to mitigate climate-related financial risk. The FDIC found that “of the 353 institutions affected by the severe weather and climate events in 2022, 309 (87.5 percent) were headquarters of community banks and 1,596 (21 percent) were community bank branches.”

Other Risk Categories to Watch

There is no mention of community banks or smaller institutions in the Operational Risk section; however, we know that operational risks — specifically ransomware attacks — are a significant threat to smaller institutions and have been on the rise in recent years. A ransomware event can shut an entire institution down instantly and render it unable to serve customers/members. Smaller institutions might have fewer resources to dedicate to cybersecurity for ransomware prevention or to recover from a ransomware event.

There is also no mention of community banks or smaller institutions in the Crypto-Asset Risk section, but the risk can be summarized in terms of the institution’s expertise in the area and whether it lends to crypto-asset companies.