CHICAGO Comptroller
of the Currency John C. Dugan said today that the supervisory process must
support a competitive banking industry that takes risks and innovates, while
also ensuring a safe and sound system that avoids excessive risks.
For example, proposed
regulatory guidance on nontraditional mortgage products is not intended
to ban innovative mortgage products, he said in a speech to the Conference on
Bank Structure and Competition, sponsored by the Federal Reserve Bank of
Chicago.
We believe that financial innovation is
vital to promote the national goal of homeownership, and we encourage it, he
added. What our proposed guidance seeks to do instead is
to ensure that all nontraditional mortgage products are properly underwritten
and disclosed. We believe this will
help promote sound and sane practices in the mortgage market and thus serve the
interests of the banking system and the general public.
Mr.
Dugan said supervision works best when it helps banks in the identification of
emerging and growing risks a process that encourages banks to develop
advanced tools and techniques to manage those risks, for their own account and
for their customers. Both the proposed real estate guidance and a separate
proposal on commercial real estate reflect that approach.
Neither is intended to restrict the availability of credit to
finance commercial real estate or home sales, Mr. Dugan said of the two
proposals. To the contrary, each is intended to address
concerns early, effectively, and without undue disruption. This, in turn, is intended to foster a
climate of stability in which credit remains available on reasonable terms to
support developers and homebuyers alike.
Mr. Dugan said the
business environment that banks operate in has seen much change since he last
addressed the Chicago Fed conference, as Deputy Assistant Treasury Secretary 15
years ago. Not very long ago, he said,
most business transactions were fundamentally local, but today even small
businesses have global ties.
Their involvement in
global markets has produced growing exposure to fluctuations in commodity
prices and foreign exchanges rates, Mr. Dugan said. And that, in turn, has increased reliance on more comprehensive
and integrated analysis of risk and the most sophisticated risk management
tools.
There have been two
types of responses to the new competitive environmentone from banks that seek
new opportunities in evolving markets, and another from those that choose to
specialize in markets where they have particular expertise and experience, he
said.
Banks in the
first group typically larger institutions have responded by diversifying
their revenue streams, developing new products and services, and enhancing the
features of existing offerings, Mr. Dugan said. They have embraced the world of multiple risks as a way of
cushioning themselves against excessive exposure to any one risk.
The members of the second group, often
midsize and community banks, have concluded that their competitive advantage
lies in superior knowledge, service and efficiency, and therefore narrowed
their focus to regional geographies and to specific products and services, he
said.
Larger banks the
diversifiers, as I have termed them have come to dominate the
national market for home mortgages, while smaller banks have increasingly
focused their attention on the localized market for commercial real estate
loans, Mr. Dugan said. These two very
different approaches to real estate lending have resulted in two very different
types of risk.
Commercial real estate
markets are inherently cyclical, which adds risk to lending in this field. Although loan quality has risen as risk
management techniques have improved, the concern today is growing concentrations
and how they are managed.
I should emphasize that, while
concentrations pose a known risk to safety and soundness, this risk can be
effectively addressed if properly recognized and actively managed, Mr. Dugan
said. Of course, banks with real
estate lending concentrations must also have adequate capital to address the
increased risk, as most of these smaller banks already do.
Although traditional
home mortgage lending has posed far less credit risk for banks than commercial
real estate lending, the increased use of interest-only and payment-option
mortgages as a tool to make mortgages more affordable has increased bank
exposure to both credit and reputation risk, he said.
But what happens if
rates rise, or house prices fall, or both occur? Mr. Dugan asked. A borrower could easily be stuck with a
mortgage that exceeds the value of his or her home, making it very difficult to
refinance or sell the home.
This could lead to
default and foreclosures, and expose the lender with a portfolio of such loans
to a much higher credit risk than would be the case with traditional mortgages,
with possible implications for their capital and earnings, he said.
Even if negative
economic factors become a reality, this cluster of concerns with nontraditional
mortgage products might not result in the failure of a single bank, Mr. Dugan
said. But in combination they
nevertheless have the potential to impair an institutions earnings and
capital; sully its reputation; impair its relationship with consumers; and
impede its ability to fulfill the publics future need for home loans.
Knowing when to
intervene in business of the banking system and to what degree will always
demand the exercise of subjective judgment, Mr. Dugan said. The OCC brings long and specialized
experience to this critical mission, and we will continue to work hard to strike
the right balance in our guidance on real estate lending.
Related Links:
Comptroller John C. Dugan
Speech Text
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The Office of the
Comptroller of the Currency was created by Congress to charter national banks,
to oversee a nationwide system of banking institutions, and to assure that
national banks are safe and sound, competitive and profitable, and capable of
serving in the best possible manner the banking needs of their customers.