Liquidity and liquidity risk management is essential for every FICU, regardless of size and complexity. All credit unions are required to have a policy and process in place to identify, measure, monitor, and control liquidity risk that is commensurate with its respective needs.
NCUA’s final rule on liquidity and contingency funding adopted in 2013 set different liquidity requirements depending on the credit unions asset size. All credit unions, regardless of size, must have a written liquidity policy that provides a board-approved framework for managing liquidity and a list of contingent liquidity sources that can be employed under adverse circumstances. As the credit union gets larger or more complex, then a contingency funding plan that sets out strategies for addressing liquidity shortfalls in emergencies must be developed. Finally, if the credit union has assets of $250 million or more, access to a backup federal liquidity source such as the Federal Reserve window or the Central Liquidity Facility (CLF) is required.
Over the last few years, we have watched as more credit unions move from balance sheet structures with:
- Lower loan-to-share ratios
- Shorter duration of assets
- Double-digit share growth
- Higher amounts of liquidity
- Balance sheets with higher loan-to-share ratios
- Increasing duration of assets
- Limited share growth
- Lower liquidity balances
When a balance sheet changes as described above, it is not enough to monitor liquidity using ratios or other simple measures that alert management when liquidity conditions and minimum cash-on-hand targets are becoming inadequate. The credit union must implement forecasting or modeling to measure, monitor, and manage liquidity more closely. Regulatory supervision and scrutiny of the credit unions policies, processes, and contingency funding options also increase.
The purpose and goal of liquidity management are to ensure the credit union has access to enough funds to maintain a “business as usual” posture and can always raise or borrow funds at a reasonable cost. Managing liquidity risk is critically important to the well-being of the credit union. Having well thought out and solid practices in place to monitor and forecast both current and potential liquidity events is fundamental to credit union operations. Management must understand liquidity and how their cash flow may quickly change to prepare for potential liquidity threats. In our experience, realistic and reasonable cash flow forecasting is a starting point, but additional stress scenarios should be evaluated to help prepare and anticipate unusual, or unexpected events.
We at MHSI have helped credit unions as regulators have asked for unusual or highly unlikely liquidity scenarios. When an unusual request is made, ask the regulator for their rationale. Understanding their thought process may clarify the logic behind their request. Sometimes, even a highly unlikely event should be considered to expand management’s thought processes and understand where a breaking point may be. Run the scenario at least once to evaluate the potential impact on liquidity. Forecasting the cash flow in these highly unusual scenarios may not be the best use of time every month or quarter but looking at it at least once may provide some value or insight. Being able to demonstrate to the regulatory agencies that you have considered alternative situations that will stress cash flows is good management practice. Some of the stress scenarios may include:
- Monitor loan growth above current levels or at levels that exceed investment maturities or cash availabilities
- Track Increased member withdrawals or anticipate various levels of deposit runoff.
- Identify large depositors and evaluate the impact if they withdraw their funds.
- Identify older members or seg groups and evaluate potential exposure due to some of these concentrations.
- Evaluate unfunded commitments for reasonableness and the impact of high utilization.
- Determine if the commitments could be retracted if necessary.
- Anticipate a change in loan payment behaviors as the interest rate environment changes.
- Run some or all these scenarios concurrently
Each credit union has a different balance sheet composition and different situations that may stress liquidity and ongoing operations. Prudent liquidity management may require customized approaches to achieve the credit unions financial objectives and effectively manage liquidity risk along the way.