As a result, community banks shifted their  focus to CRE lending. 2). The regulators, for  example, issued guidance to banks on managing CRE concentration risks,  conducted training on CRE treatment, and conducted internal reviews to  better ensure examiner compliance with CRE guidance. Even with the  training and reviews, a number of bank officials we interviewed stated that  regulators have applied guidance rigidly since the financial crisis and have  been too harsh in classifying loans and improperly applying the 2006 CRE  guidance, among other issues. In addition to the 2009 CRE loan workout guidance, the  regulators issued statements on lending to creditworthy borrowers and  creditworthy small business borrowers to encourage prudent lending  among banks and balanced supervision among examiners. Some  of these reviews identified inconsistencies or other needed improvements  related to examiner treatment of CRE loans. Based on this  information, regulatory officials from FDIC, the Federal Reserve, and OCC  believe that the 2009 CRE loan workout guidance has been helpful. Regulators Have Incorporated Lessons Learned from the Financial Crisis into Supervision, Which May Explain Some Bank Officials’ Experiences of Increased Scrutiny

Regulators have been incorporating into their regulatory processes a  number of lessons learned from the financial crisis, including findings  from the agencies’ IGs. Regulatory Officials’ Differing Views on the Adequacy of the 2006 CRE Concentration Guidance Could Lead to Inconsistent Treatment of CRE Loans

Senior officials and field examiners have differing views on whether the  2006 CRE guidance is sufficient in addressing CRE concentration risks. However, increases in capital requirements can raise the cost of  providing loans, which would lead to higher interest rates for borrowers,  tighter credit terms, or reduced lending. Although limited research exists on the impact of CRE loan  concentrations on a bank’s ability to lend, an existing study shows that  high CRE concentrations can limit loan growth during economic  downturns. Many factors can affect a bank’s decision to  lend, including regulatory requirements. Although  isolating the impact of bank supervision is difficult, the recent severe cycle  of credit upswings followed by the downturn serves as a useful reminder  of the supervisory balance needed to help ensure the safety and soundness  of the banking system and support economic recovery. Recommendations for Executive Action

To improve supervision of CRE-related risks, we recommend that the  Chairman of the Federal Deposit Insurance Corporation, the Chairman of  the Board of Governors of the Federal Reserve System, and the  Comptroller of the Currency:    Enhance and either re-issue or supplement interagency CRE concentration  guidance—based on agreed-upon standards by FDIC, the Federal Reserve,  and OCC—to provide greater clarity and more examples to help banks  comply with CRE concentration and risk-management requirements and  help examiners ensure consistency in their application of the guidance,  especially related to reductions in CRE concentrations and calculation of  CRE concentrations. As  noted in our report, the federal banking regulators all have numerous  controls to help ensure examination consistency, such as training and  internal reviews that FDIC highlights in its letter. As our report notes, additional capital provides an important  cushion against losses, though this comes at a cost. We conducted similar analyses for commercial banks with assets  more than $1 billion. To determine how the banking regulators responded to trends in the CRE  market, we interviewed regulatory and bank officials and reviewed reports  of examination (ROE) from a sample of banks. To obtain information  on how examiner practices may affect lending, we interviewed bankers,  examiners, and regulatory officials.
Why GAO Did This Study

Since the onset of the financial crisis in 2008, commercial real estate (CRE) loan delinquencies have more than doubled. The federal banking regulators have issued statements and guidance encouraging banks to continue lending to creditworthy borrowers and explaining how banks can work with troubled borrowers. However, some banks have stated that examiners' treatment of CRE loans has hampered their ability to lend. This report examines, among other issues, (1) how the Federal Deposit Insurance Corporation (FDIC), Board of Governors of the Federal Reserve System (Federal Reserve), and the Office of the Comptroller of the Currency (OCC) responded to trends in CRE markets and the controls they have for helping ensure consistent application of guidance and (2) the relationships between bank supervision practices and lending. GAO reviewed agency guidance, examination review procedures, reports of examination, and relevant literature and interviewed agency officials, examiners, bank officials, and academics..

What GAO Found

Aware of the potential risks of growing CRE concentrations at community banks, federal banking regulators issued guidance on loan concentrations and risk management in 2006 and augmented it with guidance and statements on meeting credit needs and conducting CRE loan workouts from 2008 to 2010. The regulators also conducted training on CRE treatment for examiners and internal reviews to help ensure compliance with CRE guidance. Nevertheless, a number of banks reported that examiners have been applying guidance more stringently since the financial crisis and believe that they have been too harsh in treatment of CRE loans. Regulators have incorporated lessons learned from the crisis into their supervision approach, which may help explain banks' experiences of increased scrutiny. GAO found that examiners generally provided support for exam findings on loan workouts, but identified some inconsistencies in applying the 2006 CRE concentration guidance-- which is similar to what some of the regulators uncovered in their internal reviews. Moreover, regulatory officials had varying views on the adequacy of the 2006 guidance, and some examiners and bankers noted that the guidance lacked clarity on how to comply with it. As a result, examiners and bankers may not have a common understanding about CRE concentration risks. Although many factors influence banks' lending decisions, research shows that the capital banks hold is a key factor. Capital provides an important cushion against losses, but if a bank needs to increase it, the cost of raising capital can raise the cost of providing loans. High CRE concentrations also can limit a bank's ability to lend because the bank may need to raise capital to mitigate the concentration risk during a downturn. Economic research on the effect of regulators' examination practices on banks' lending decisions is limited, but shows that examiners' increased scrutiny during credit downturns can have a small impact on overall lending. Although isolating these impacts is difficult, the recent severe cycle of credit upswings followed by the downturn provides a useful reminder of the balance needed in bank supervision to help ensure the banking system can support economic recovery. Federal banking regulators should enhance or supplement the 2006 CRE concentration guidance and take steps to better ensure that such guidance is consistently applied. The Federal Reserve and OCC agreed with the recommendations. FDIC said that it had implemented strategies to supplement the 2006 guidance.