On April 12, 2017, the Office of the Comptroller of the Currency (the “OCC”) issued a Retail Lending booklet (“Booklet”) as part of the Comptroller’s Handbook.  The OCC’s Booklet outlines a framework for evaluating retail credit risk management activities and discusses the risks associated with retail lending.  The Booklet supplements the core assessment sections of the “Large Bank Supervision,” “Community Bank Supervision,” and “Federal Branches and Agency Supervision” booklets of the Comptroller’s Handbook, and sets forth examination procedures for the supervision of national banks and federal savings associations.

Key Takeaways from the Booklet:

What types of products and services does retail lending cover?

The OCC defines retail lending broadly; it includes consumer loans, credit cards, auto loans, student loans, and loans to individuals secured by their personal residences, including first mortgage, home equity, and home improvement loans.

What are the risks associated with retail lending?

The Booklet describes eight categories of risk for bank supervision purposes: credit, interest rate, liquidity, price, operational, compliance, strategic, and reputational risk.  However, for the purposes of retail lending, the OCC focuses on the significant credit, interest rate, operational, liquidity, compliance, strategic, and reputation risks most common to retail lending.

Specifically, the risks are described as follows:

  • Credit risk is the risk arising from an obligor’s failure to meet the terms of any contract with the bank or otherwise perform as agreed. Credit risk is the primary exposure for most retail lending products.
  • Interest rate risk is the risk arising from movements in interest rates. Interest rate risk arises from differences in the timing of rate changes and the timing of cash flows, from changing rate relationships among yield curves, from changing rate relationships across maturities, and from interest-related embedded options in bank products. The “Interest Rate Risk” booklet of the Comptroller’s Handbook provides additional guidance on interest rate risk management.
  • Operational risk is the risk arising from inadequate or failed internal processes or systems, inappropriate accounting, human errors or misconduct, or adverse external events. Operational risk in retail lending is often elevated with higher volumes of loans, larger numbers of transactions processed, and more extensive use of automation and technology.
  • Liquidity risk is the risk arising from an inability to meet obligations when they come due. Liquidity risk includes the inability to access funding sources or manage fluctuations in funding levels.
  • Compliance risk is the risk arising from violations of laws or regulations, or from nonconformance with prescribed practices, internal policies and procedures, or ethical standards. Because of the number of consumer protection laws and regulations, banks engaged in retail lending are highly vulnerable to compliance risk.
  • Strategic risk is the risk arising from adverse business decisions, poor implementation of business decisions, or lack of responsiveness to changes in the banking industry and operating environment.
  • Reputation risk is the risk arising from negative public opinion. This risk may impair the bank’s competitiveness by affecting its ability to establish new relationships or services or continue servicing existing relationships. Inadequate policies and procedures, operational breakdowns, or general weaknesses in any aspect of the bank’s retail lending activities can harm its reputation.

The OCC notes that a product or service may expose the bank to multiple risks, and cautions examiners to be aware of this interdependence and assess the effect in a consistent and inclusive manner.

What are the elements of a sound risk management framework?

The basic elements of a well-managed retail credit portfolio include:

  • Structured oversight by the board and senior management;
  • Clear and consistent policies and operating procedures;
  • A well-established risk appetite;
  • Structured risk assessments;
  • Well-defined processes for policy exceptions;
  • Effective monitoring reports; and
  • Well-designed strategies, business plans, and product testing

The OCC expects risk management for retail lending activities to correspond to the bank’s size, complexity, and risk profile, and instructs examiners to assess risk management practices in the context of inherent product and portfolio risk.

What is a sound approach to credit approvals?

The elements necessary for a sound approach to credit approvals include the following:

  • Careful Choice of Products and Target Markets
    • Retail lending policies should identify the types of loans the bank is willing to accept (e.g., personal loans, auto loans, credit cards, etc.)
    • Target markets include geographic areas, borrowers’ credit profiles, and methods used to find new customers (e.g., mailing lists, credit bureaus, or brokers)
    • Appropriate product tests and pilot programs should be employed
  • Establishing Underwriting Criteria
    • The following three key factors generally determine creditworthiness for retail borrowers:
      • A reliable source of recurring income
      • A history of responsible performance
      • Sufficient income or assets to repay the subject debt and all other current and prospective debt
    • Loan Pricing Considerations
    • Managing Loan Acquisition Sources
    • Establishing Credit Approval Processes

How does the OCC define prudent credit administration?

Credit administration refers to activities occurring once a credit decision is made. The OCC emphasizes the following key risk management aspects of a well-run credit administration function: (1) efficient operations; (2) accurate and timely information; (3) prudent controls; and  (4) a comprehensive compliance program.

Additionally, the Booklet sets forth general guidance for: (1) managing retail accounts; (2) collecting delinquent accounts; and (3) monitoring portfolio quality, among other factors, in describing the best practices in credit administration.