WASHINGTON (Reuters) - Regulators are concerned about heavy commercial real estate exposures and risky mortgage lending practices at U.S. banks, Federal Reserve Board Governor Susan Bies said on Thursday.
"There are certain rapidly growing business lines in banking operations that are placing pressures on risk-management systems," Bies told a financial services industry conference as she outlined guidance regulators have issued on commercial real estate and so-called nontraditional mortgage lending.
In discussing the guidance on exotic mortgage products, such as interest-only loans, Bies repeated that government regulators were concerned risk-management practices had not kept pace with the risks that these widely available loan products could present.
She also cautioned those risks could be "heightened by a downturn in the housing market."
Bies said that in the past such products were normally offered to higher-income borrowers only, but they now were being extended to low-income borrowers in the subprime market.
"These borrowers are more likely to experience an unmanageable payment shock at some point during the life of the loan, which means they may be more likely to default on the loan," she warned.
Bies also expressed worry that banks could face difficulties if abnormally low risk-spreads in capital markets increased. "When risk spreads return to more 'normal' levels, banks need to be prepared for the resulting impact on liquidity and pricing," she said.
Bies added that regulators had observed that lenders were increasingly combining nontraditional mortgage loans with weaker controls on credit exposure.
"The absence of traditional underwriting controls may have unforeseen effects on losses realized in these products," she said.
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Bies also warned on growing commercial real estate exposures, saying the Fed and other regulators were worried risk-management practices at some banks had not kept up with growth in this "highly volatile asset class."
"A bank with significant concentrations may need to both strengthen its control environment and hold capital well above regulatory minimums," Bies said. "In certain cases, it may be prudent for an institution to reduce its concentrations."
Bies said that was especially the case since lending in recent years had occurred "under fairly benign credit conditions and, naturally, those conditions are unlikely to continue indefinitely."
She also told the group "a primary concern" for regulators was the potential for banks to face legal and reputational damage if they failed to comply with the Bank Secrecy Act and other anti-money laundering controls.