Conditions Have Improved, Banks Still Face Certain Indirect Risks

Retail Sales Consumer Price Index (CPI)

Conditions Have Improved, Banks Still Face Certain Indirect Risks

Total retail sales increased 0.2 percent in November compared with the previous month. Core retail sales, excluding autos, gas, and building materials, rose 0.6 percent, and retail sales excluding autos rose by 0.4 percent. Sales in most major categories increased between 0.6 percent and 0.8 percent with the exception of auto dealers and gasoline stations, which decreased 0.6 and 0.8 percent, respectively, compared with the previous month. On a year-over-year basis, growth in total retail sales was 1.4 percent in November.

Headline consumer prices rose 0.5 percent on a year-over-year basis in November, up from a 0.2 percent year-over-year increase in October. On a one-month annualized basis, headline consumer price inflation decreased from 2.4 percent in October to 0.3 percent in November. The deceleration was partially the result of the decrease in the energy commodities subindex (gasoline and fuel oil), which fell 25.0 percent on a one-month annualized basis in November. The core measure, which excludes food and energy, was up 2.0 percent year over year, the highest 12-month change since May 2014.

Nancy Condon: Welcome to another Economy Matters podcast. I'm Nancy Condon, executive editor of the Atlanta Fed's Economy Matters magazine. Today, we're joined by Mike Johnson, executive vice president of Supervision and Regulation at the Atlanta Fed. Mike will talk to us today about some of the key risks financial institutions are facing. Mike, thanks for joining us.

Mike Johnson: Thanks for having me, Nancy. It's always a pleasure to be here.

Condon: Mike, now that banking conditions are improving, what important risks do you see on your radar screen?

Johnson: So Nancy, that's a great question and one that we often get asked by the banking industry itself and the banks that we supervise. We try to incorporate much of the answer to that question in a lot of the outreach that we conduct. As you said, financial conditions have improved, so direct financial risks are less on our radar screen. Risks such as cybersecurity—top of the list, for sure. We're also seeing an increase in consumer compliance issues, primarily dealing with fair lending and UDAP. (UDAP stands for Unfair Deceptive Acts and Practices.)

But there are still some financial risks that we see as well. Interest rate risk is something that we have concerns about, given the current environment that we're in, as well as emerging risk in commercial real estate—not broad based, but within some commercial real estate product segments and specific markets. So those are the things that I would put at the top of our radar screen.

Condon: So, Mike, you mentioned cybersecurity. We're hearing in the media, with increasing frequency, about cyberthreats and data breaches. How big of a risk is this for the banking industry?

Johnson: I think it's a huge risk. It's at the top of our risk list, here at the Federal Reserve Bank of Atlanta. We also have a system risk process and cyberrisk is at the top of that list as well. It manifests itself in a number of ways. Obviously, as you pointed out, there are the data breaches. Before data breaches were as prevalent as they are today, the industry suffered from DDoS attacks—distributed denial of service attacks—that would take down websites. These are real and important risks. They have costs, not only to the institutions, but cost to the customers. They have reputational risk associated with them for the banking industry. I don't want to diminish those, but the real risk would be a potential cyberbreach that could result in a loss of confidence in a particular institution, or the financial payment system as a whole. Those are the things that I really worry about that keep me up at night. So, you can imagine a scenario where a hack may take down an ATM system, or something that's even larger than what we've experienced today.

We're doing a few things about that, of course. One is working through the Federal Financial Institution's Examination Council, or FFIEC. We've recently developed and issued publicly a cyber assessment tool that banks can utilize, to assess both their inherent risk and their technology infrastructure maturity as it relates to dealing with that. We're also developing an advanced CAT tool—cyber assessment tool—for larger institutions and institutions with a more complex environment, which that would be appropriate for.

We're looking at this risk with increasing intensity in our normal course of supervision and examinations that we conduct.

Condon: So these cyberassessment tools—are they becoming part of the normal supervision process?

Johnson: They're not mandated. We made them public in June of this year, and we're strongly encouraging all of our institutions to go through that type of risk assessment process. It's really the risk assessment process that's important, whether you use that tool or a tool that is similar in nature. We're definitely looking to ensure that our institutions go through that risk assessment process, have meaningful conversations with their board of directors, and take steps to mitigate that risk if they're uncomfortable with where they're at.

Condon: That's very reassuring, actually. What about rising interest rates? You mentioned that as a potential risk as well on the horizon.

Johnson: Let me be clear, I'm not a prognosticator [laughs]. I'm not here speaking for the FOMC, but rumor has it that a rise in interest rates is at least something that's on the discussion table. We do have some potential concerns with a "rising rate" environment. So I should say at the outset, though, that we're already at such a low base in interest rates that a modest increase and a modest increasing path over a medium- to long-term horizon I really don't think poses material risk for at least the vast majority of the banks that we supervise.

There are some caveats to that. Primarily: what if that scenario, which is probably the most likely scenario, doesn't play out? So a rapid rise in rates could be unexpected and cause a reduction in the value of certain assets on the banks' balance sheets. It could cause a hit to earnings that may be otherwise unanticipated.

The other thing that I would point out is to just remember that the Federal Reserve controls short-term rates, not necessarily long-term rates. So just because there's a slow, modest increase in short-term rates doesn't necessarily mean that long-term rates will behave in the same manner. So you could easily see a sharp increase or maybe even the reverse, a flattening, or inversion, of the yield curve. That unexpected behavior could have a significant impact on earnings, liquidity, and the deposit behavior as it relates to bank balance sheets. So those are a few things that we have on our radar screen.

Condon: Well, Mike, thanks again for speaking with us today. We're at the end of our Economy Matters podcast. Again, I'm Nancy Condon, executive editor ofEconomy Matters magazine and I've been speaking with Mike Johnson, executive vice president at the Atlanta Fed. I hope you'll join us next month when we discuss gross domestic product [GDP] and an Atlanta Fed tool that measures it. GDPNow, developed by an Atlanta Fed economist, has proved to take a very accurate snapshot of GDP. Hope to see you then.