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OCC Says U.S. Banks Are Taking Risks Chasing Returns

June 18 (Bloomberg) -- As U.S. banks take more risks hunting higher returns, regulators are keeping a close watch on the safety of new strategies and products, according to an Office of the Comptroller of the Currency report.

To maintain record profits, banks may take excessive risks in the sluggish economy, also facing the chance that an increase in the unusually low interest rates could make them vulnerable to capital erosion, the OCC said in its twice-yearly report on industry hazards. It also noted growth in other dangers to banks, such as computer hackers and increasingly sophisticated money laundering.

“Large banks are grappling with the need for fundamental changes to their business models as a result of weakening revenue growth, including shifts in trading, securitization, and consumer fee income,” according to the OCC’s Semiannual Risk Perspective. “OCC supervisory staff will focus on strategic business and new product planning to determine whether adequate consideration of safe and sound business practices is evident.”

The agency is taking lessons from the banks’ mortgage-servicing faults during the 2008 credit crisis, according to the report, and staff will look at high-volume, rapid-growth revenue activities to find potential weaknesses.

As investors chase more yield, the agency has also seen greater demand for high-yield products such as collateralized loan obligations, and the OCC said the surge will produce “greater quantities of weakly underwritten loans.”

Loan Growth

“Against a backdrop of sluggish economic growth and interest rates that remain near historical lows, loan growth is at half its average pace over the last 25 years,” the OCC said in the report. Strong commercial and industrial lending may slow in the next few years as businesses reduce the growth of their inventories, the report said, which would probably intensify current “aggressive competitive conditions” and weaken underwriting.

Revenue from trading dropped 31 percent from 2011 to 2012, the report said, partially crediting “well-publicized losses” at JPMorgan Chase & Co. along with tightening credit spreads. It predicted net interest margins will show little improvement “in the near term,” and many banks will increase their exposure to interest-rate risk by investing extra cash in longer-maturity securities.

Banks’ money-laundering compliance efforts could be squeezed by cost-cutting to sustain profits, Deputy Comptroller for Credit and Market Risk Darrin Benhart told reporters today. This comes as product innovations are opening new Bank Secrecy Act threats, he said.

“We’ve increased our emphasis on that,” Benhart said. “Banks really need to dedicate the resources.”

Big U.S. banks such as JPMorgan and Citigroup Inc. have been hit with recent enforcement actions for lapses in their money-laundering safeguards. M&T Bank Corp. agreed to improve its compliance in a deal with regulators announced today.

To contact the reporter on this story: Jesse Hamilton in Washington at jhamilton33@bloomberg.net.

To contact the editor responsible for this story: Maura Reynolds at mreynolds34@bloomberg.net.

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