Liquidity management and measurement has become a key point of regulatory emphasis. Make sure that all relevant parties within your institution are doing their part to ensure a sound liquidity process and the best possible result come exam time. Use this checklist to ensure your policies and procedures reflect the current guidance for liquidity.
Board Responsibilities
- Each year your Board must review and approve the Liquidity Policy.
- Liquidity risk limits must be defined.
- Risk limits should reflect the material liquidity concerns of your institution and the board’s tolerance for those risks. Consider all unique customer, industry and account concentrations and associated risks.
- Your liquidity policy must clearly define roles and responsibilities with respect to monitoring and measuring liquidity risks.
- The liquidity policy must spell out all roles, responsibilities and procedures to be followed in the event of a liquidity crisis.
- The board should review the results of liquidity measurement and modelling as part of their normal meeting agenda.
ALCO Responsibilities
- ALCO must monitor current and potential liquidity positions and deposit structure with an eye towards potentially volatile deposit balances and concentrations.
- ALCO must review liquidity ratios and cash flow forecasts for both normal and stress scenarios.
- ALCO should monitor deposit product pricing relative to local and national competitors.
- ALCO should create a process for measuring and monitoring liquidity, both static liquidity ratios and cash flow projections.
- Standard liquidity ratios that can used and are available in the UBPR include:
- Net Non-Core Funding Dependency
- Net Loans and Leases to Deposits
- Net Loans and Leases to Assets
- Short-Term Assets to Short-Term Liabilities
- Pledged Securities to Total Securities
- Brokered Deposits to Deposits
- Core Deposits to Total Assets
- Ensure you have adequate liquid assets and a diverse set of funding sources
- Cash flow projections should include both a “business as usual” as well as stress scenarios.
Management Responsibilities
- Maintain an up to date list of primary and secondary funding sources
- Primary Sources
- Unencumbered liquid assets at market or liquidation value.
- Cash flows from existing book of business.
- Secondary or Contingent Sources
- Identification of loans or securities that can be used to secure additional borrowings.
- Include operational requirements, timing and physical location considerations for collateral.
- Established borrowing lines and collateral requirements.
- Provide reporting to ALCO for oversight of liquidity position.
Liquidity monitoring should be a regular agenda item discussed at each meeting and include analysis.
- Periodic testing of borrowing lines
Analyst Responsibilities
- Prepare liquidity measurement and reporting.
- Seek management and ALCO direction on modelling assumptions.
- Dynamic liquidity modelling including liquidity contingency stress testing.
- Model multiple liquidity scenarios, including
- Normal – Business as usual
- Moderate – Short Term
- Severe – Longer Term
- Work with ALCO and Management to create story lines to accompany each scenario.
- Local economic conditions
- Negative press
- Cyber breach/embezzlement/fraud
- National economic conditions
- Loss of key local employer
- Natural disaster
- Considerations
- Changing cash flows on existing book of business (call options, loan refinancing, etc.).
- Time deposit balance renewals or withdrawal.
- Early redemption of time deposits.
- Non-maturity deposit runoff (amount and timing).
- Accelerated funding of existing loan commitments.
- Future loan and deposit originations.
- Purchase and sales of bond holdings.
- Seasonal/Cyclical patterns.
- Regulatory limitation on deposit pricing or use of brokered funding.
- Curtailment of existing borrowing lines or additional collateral requirements should be considered.
- Produce cash flow forecast
- 12 month forecast of monthly cash flows is normally sufficient, unless specific concerns merit additional detail.
- Produce both periodic and cumulative net cash flows for future periods (Sources – Uses = Net Cash Flow).
- Alternatively, a coverage ratio (Sources divided by Uses) can be produces. Ratios greater than one are considered adequate.
- Use of contingent sources to meet funding requirements should be clearly noted.
NXTsoft hosted an instructional webinar on stress-testing your liquidity. It discusses the key elements including intrinsic cash flows, forecasting liquidity, and creating stress scenarios. You can view the recorded session
on-line by following this link.
Bankers who want more information about the regulatory expectations for liquidity measurement and management should refer to the
FDIC – RMS Manual of Examination Policies – Liquidity and Funds Management which was used as a reference in the production of this article.
