From the Asset-Liability Management Trenches: A Focus on Liquidity 2024

7/18/2024 - By Terry Treadwell, CPA

Since the 2023 collapse of Silicon Valley Bank, we have observed heightened examiner scrutiny of the liquidity practices with our financial institution clients. While liquidity policies, contingency funding plans (CFP), and related reporting differ significantly among clients, we are observing “better practice” similarities and consistencies. We suggest considering the following liquidity management practices:

Board and ALCO Oversight

The importance of having appropriate liquidity risk measurement and reporting systems and processes has been elevated. Boards are reviewing policy-defined liquidity ratios monthly for compliance and trends, and we now find Board and ALCO reviewing expected cash flow forecasts more frequently (often monthly, especially if there are heightened concerns) as well as the results of liquidity stress testing (most quarterly, some monthly).

Strategies, Policies, Procedures, and Risk Tolerances

Liquidity policies are more specifically defining the liquidity reporting and the related ratio calculations for the ALCO and Board review. Primary and total liquidity calculations are typically defined, although useful liquidity-related ratio definitions tend to vary. Large deposit concentration metrics such as uninsured and/or non-core ratios are getting much more attention, with more focus on definitions and monitoring, and specific policy limits more often incorporated into policy as a separate section. Written procedures for daily liquidity-related tracking and monitoring activities are also becoming common practice, along with wholesale funding component limits and an overall wholesale limit defined in policy.

Liquidity Risk Measurement, Monitoring, and Reporting

Liquidity ratio reporting incorporates comparisons for all policy-defined ratios. Dynamic cash flow forecast reporting incorporates key liquidity ratio forecasted positions (some using an integrated ALM model as the basis for forecasting). Large deposit concentration reporting is described and, where significant, daily tracking incorporates the monitoring of large depositors and levels of uninsured deposits. Wholesale funding resource availability and usage are also reported. Internal controls are in place to review the reporting accuracy prior to distribution to the ALCO or Board (there has been a heightened awareness by examiners especially where Excel spreadsheets are used for the preparation of key reports).

The Contingency Funding Plan (CFP)

Typically identifies the following: a liquidity crisis management team including individual responsibilities in the event of a crisis; specific identification of the indicators that may trigger liquidity events and the necessary steps to mitigate a funding shortage; investment pledging practices (may be in a separate investment policy); cash flow forecasting and liquidity stress testing requirements; specific CFP reporting requirements to the ALCO and Board; and specific requirements for testing lines of credit.

More on Indicators

These vary widely but generally are comprised of a combination of quantified indicators, such as liquidity ratios, borrowing capacity, funding concentration, levels of sources and uses of cash flow, or net loss/capital at risk, and qualified indicators, such as reductions in funding availability, regulatory restrictions, and credit downgrades. Indicators are often incorporated into the trigger-tracking and cash flow forecast reporting and may utilize the capabilities within the ALM model.

More on Liquidity Stress Testing

Starting with a base case expected cash flow scenario, the liquidity stress scenarios utilize a variety of increasingly stressful concurrent stressors ranging from lower impact/shorter term events to significant impact/longer-term bank viability events, with the worst case scenario often including “break the bank” assumptions. These stressor combinations may include continued funding of unfunded loan commitments, sudden and significant declines in deposit balances, reductions in uncollateralized borrowings lines availability, loss in securities and FHLB collateral values, credit losses in loans, reductions in brokered deposit availability, and/or reductions in the volumes of new loan production or new deposit inflows. A “worst case” deposit runoff scenario normally includes a sudden loss of a substantial percentage of deposits considered non-core and/or uninsured. Reporting the results of stress testing includes the forecasted impacts on key liquidity monitoring ratios (primary liquidity and total liquidity ratios). Mitigation strategies to restore the liquidity to normal levels are also reported. Some better practice clients also utilize their CFP team and other members of Management to review the liquidity stress test reporting to help determine the best order of mitigation steps to restore to normal liquidity levels.

Questions? If you have any questions about liquidity or asset-liability management, contact a member of our Financial Institutions practice.

About the Author | Terry Treadwell, CPA

Terry is a senior consultant in the Financial Institutions practice at Saltmarsh, Cleaveland & Gund. She has more than 25 years of experience serving financial institutions, including 10 years as the senior vice president of finance for a Florida-based savings bank. Terry began her career with an international public accounting firm and also served as a bank consulting associate for Stogniew & Associates, she provided internal audit services to community banks. Terry’s primary areas of concentration are asset/liability management including interest rate risk modeling, strategic balance sheet planning and liquidity management.