The RegulatoryLandscape

In today’s economic environment, the regulatory landscape may once again be at the forefront in Arkansas bankers’ minds. I appreciate that overall, Arkansas bankers always have the regulatory landscape top of mind, but I am hearing more commentary (I could say “concerns”) lately about how recent changes may impact the landscape of our financial institutions. It is fair to say that the banking industry is subject to robust regulatory oversight and engagement, both at the state and federal levels. However, when the economy is strong, consumer confidence is good, and businesses are operating at a high level, the banking industry’s performance is reflective of these conditions.

The recent changes in the economy, which include rapid interest rate increases and an elevated level of inflation, have begun to place pressure on certain financial metrics within the banking industry. Banks have experienced a lengthy period of asset growth and strong financial performance. This includes favorable earnings coupled with capital formation and appropriate levels of liquidity. As a result, we have witnessed a period of sound asset quality, overall positive supervisory findings, and exceptional regulatory ratings. However, we are beginning to witness a different trend in bank performance and the need for additional regulatory oversight because of the negative impact on the economy and changes in bank performance.

Through the first quarter of 2023, earnings pressures continue to increase, which indicates a heightened concern about prospects in the coming months for the industry. As such, an analysis of earnings during upcoming supervisory events may be elevated for some financial institutions, particularly those experiencing a decline in financial performance. In addition, concentration risk can be significant and impactful to some institutions, and this is a concern that I have expressed in previous correspondence. continue to evaluate changes within primary and secondary funding sources and bank management’s response to those changes. Lastly, areas such as consumer compliance, cybersecurity preparedness, Bank Secrecy Act compliance and third party or vendor risk will remain priorities during future examinations.

One area of concentration risk is commercial real estate (CRE) which is one of the most common types of concentration risk within Arkansas financial institutions. Although we are not identifying deterioration within asset markets or asset classes at this point, there will be continued regulatory focus on institutions that maintain above average CRE levels or report rapid growth in a particular asset class. On the opposite side of the balance sheet, funding concentrations or reliance on non-core or wholesale funding sources, or a notable shift in funding elements will remain a concentrated area of focus for regulatory oversight. It is especially important that financial institutions fully assess liquidity needs, available funding sources and contingency funding plans, and employ risk-focused actions and appropriate testing.

Regulators are identifying, and banks are reporting, declining trends of on-balance sheet liquidity. As a result, examiners will

Although this list appears long, I am confident that overall our Arkansas banks will work to ensure that these and other risks receive the appropriate amount of attention and oversight. One of the key responses that board members and management can take now is to internally identify and prioritize known weaknesses, variances to budgeted data versus actual performance, and any areas of diminished operations.

Being prepared to engage in robust discussions with your examiners so they can gain insight and understand changes in your financial conditions will be impactful to a regulatory evaluation. Examiner outreach and enhanced communications may occur more frequently and outside of the typical examination cycle as changes occur. As always, the Arkansas State Bank Department is available and willing to engage with you and your staff for opportunities to share dialogue and engagement on all regulatory matters.