🇮🇹❤️🇺🇸 SEC’s New Focus: What Banks Need to Know About Commercial Real Estate and AI

Eric Gerding, the head of the Division of Corporation Finance at the U.S. Securities and Exchange Commission (SEC), shared some critical updates. He emphasized the need for banks to be transparent about their commercial real estate (CRE) exposure and the use of artificial intelligence (AI) in their operations. Let’s dive into what this means for banks and how they can stay ahead of the curve.

Director Gerding pointed out that banks with heavy CRE investments face numerous risks. The SEC wants to see detailed disclosures on various aspects, such as loan portfolio characteristics, risk concentrations, and loan-to-value ratios. This level of transparency helps investors understand the risks banks are dealing with and the strategies they use to manage these risks.

The Office of the Comptroller of the Currency (OCC) highlighted in its Spring 2024 report that some CRE sectors are under pressure due to rising costs and limited rent increases. Elevated interest rates are also putting a strain on borrowers. Despite slowing CRE loan growth, high concentrations in CRE exposure remain a significant risk.

The Federal Deposit Insurance Corporation (FDIC) echoed these concerns. Their advisory on managing CRE concentrations pointed out that the CRE market has been hit hard by the COVID-19 pandemic, fluctuating interest rates, and the prolonged inverted yield curve. Higher vacancy rates, refinancing challenges, and the impact of rising interest rates on property values were significant issues.

Investors and analysts have been particularly worried about how these factors have affected banks’ earnings. Smaller banks, which have a higher concentration of CRE loans, are seen as more vulnerable. Fitch Ratings has warned that these banks might see higher rates of nonperforming loans and provisions for credit losses.

Director Gerding stressed the need for banks to provide more detailed information in their disclosures. This transparency helps investors understand the risks and the measures banks are taking to mitigate them.

Navigating AI in Banking

As banks increasingly integrate AI into their operations, they face new operational and regulatory risks. Director Gerding emphasized that these risks might require disclosure under existing SEC rules. AI applications, like customer chatbots, fraud detection, and credit scoring, bring potential issues such as bias, privacy concerns, and third-party risks.

The OCC has identified several AI-related risks, including the lack of explainability, reliance on large data volumes, potential discrimination, and cybersecurity concerns. The SEC will be closely examining how banks describe AI opportunities and risks, focusing on current and proposed uses and their impact on business and financial results.

Practical Steps for Banks

Enhance Transparency

Clearly outline CRE and AI risks in your disclosures. Provide detailed information on loan portfolios, risk management practices, and AI applications.

Stay Updated

Keep abreast of evolving regulations and guidance from the SEC, OCC, and FDIC. Regularly update your disclosure practices to comply with new requirements.

Leverage Technology

Use AI to improve operational efficiency but ensure robust risk management practices. Address potential biases in AI systems and safeguard customer data.

Engage with Stakeholders

Maintain open communication with investors and analysts. Address their concerns proactively and provide detailed explanations of risks and mitigation strategies.

Trends and Recommendations

The regulatory focus on CRE and AI disclosures is growing. Banks should:

• Increase CRE Disclosure Detail: More granular information about loan portfolios and risk management will help satisfy regulatory expectations and investor demands.
• Proactively Address AI Risks: Be transparent about AI usage, associated risks, and mitigation measures. This compliance will build trust with stakeholders.