OCC Comptroller Hsu Warns of "Tail Risks" from Russia's Invasion of Ukraine

OCC Comptroller Michael Hsu cautioned that "tail risk" ("low probability, high impact risk events") have increased as a result of Russia’s invasion of Ukraine. He also described tail risk factors associated with the trading of crypto-related derivatives.

In a speech at the American Bankers Association Risk Conference, Mr. Hsu explained that "tail risks, by their nature, are not well-informed by statistics and data," and that "identifying and managing tail risks requires judgment and imagination more than math and computing power."

He highlighted that tail risks have become "embedded in the business-as-usual risk management toolkit" including "geopolitical risk, cyber risk, inflation and rate risk, asset price risk, and recession risk[.]" He said that these risks, generally, have been treated as independent of one another, but that Russia’s invasion of Ukraine has increased the "likelihoods for each tail risk" which could be "linked and could materialize simultaneously." For example, he stated the invasion has created a higher "geopolitical risk of broader conflict in Europe" that could significantly impact financial markets. He added that the invasion heightens cyber risk and inflation risk given Russia’s cyber warfare capabilities and the impacts of higher fuel prices. Those heightened inflation expectations might increase the possibility of rate hikes. He warned that a combination of all these tail risks could lead to a broad market sell off and "trigger a recession."

With respect to trading crypto-derivatives, Mr. Hsu directed banks to consider various factors associated with tail-risks including, among others: (i) that crypto-derivatives have "limited or unreliable" price histories; (ii) that netting of positions may understate risk; and (iii) the heightened potential for "wrong-way risk" – where borrowers who post crypto to invest in crypto may lose value in their collateral while simultaneously suffering losses in their crypto-derivatives trading.

Mr. Hsu cautioned that tail risks may or may not materialize and that stress testing requirements help to ensure that banks are "well-positioned from a capital perspective to withstand a range of shocks." He stressed that risk managers, bank leaders and bank boards of directors must exercise "risk management vigilance."