red warning flag on a stormy beach

U.S. federal banking regulator the Office of the Comptroller of the Currency (OCC) is warning local governments about the impact of Covid-19-related lockdowns on the banking system.

In a letter to U.S. state governors and mayors, the acting comptroller of the currency, Brian Brooks, expressed concerns about the effects of local efforts to combat the pandemic on banks and, ultimately, the U.S. banking system.

“The nation’s mayors and governors should be aware of a set of risks to the nation’s banking system created by continued state and local lockdown orders,” the letter said.

“Certain aspects of these local orders potentially threaten the stability and orderly functioning of the financial system.”

In particular, the letter warned about the impact of prolonged, locally mandated business closures in certain cities and states.

“Requiring businesses to remain closed decreases businesses’ ability to service their debt, thus increasing default risk in the banking system,” the letter said.

Additionally, extended closures raise the risk of vandalism and burglary, reducing the value of the collateral securing commercial real estate and exposing banks to higher loss risks, the OCC said. This, in turn, exacerbates the threat of a deeper economic downturn, the OCC said, and raises “safety and soundness” risks for smaller banks.

“We now have anecdotal reports of banks that are experiencing small-business loan delinquency rates in the mid-double-digits on loan books that reflected strong cash flow expectations and pristine credit quality at the time of origination, prior to local lockdown orders,” the OCC said.

The letter also warned about requirements to wear face masks, saying this increases the likelihood of bank robberies.

“While that may have been a prudent decision when the extent of the health risk was still unknown, recent reports of face-covering-related robberies at bank branches and other establishments make clear that broadly applicable face mask requirements are not safe or sustainable on a permanent basis,” the OCC said.

Uncertainty about the scope of lockdowns also makes it tougher for both banks and regulators to forecast delinquencies and losses, and to assess the risk to the overall banking system.

“Failure to understand, forecast, and reserve for risks based on sound data deprives banks of a key financial risk management tool at a time when their safety and soundness depends on it,” the OCC said.