Punch One
As you are probably aware, the Proposed Inter-agency Guidance on Liquidity and Funds Management was released on July 6. We’ve been told that the final version is likely to be released late first quarter or early second quarter 2010 with only minor changes. The guidance document raises the bar on liquidity risk measurement and management by a considerable amount. For the most part it tells you what to do, but not how to do it. Every liquidity policy we’ve reviewed in the last six months falls short of meeting the requirements of these standards. And field pressure is growing. We’ve not talked to a single institution in the last few months that didn’t receive significant criticism on a recent safety and soundness exam for their liquidity management. Criticisms have focused on the institution’s current liquidity and on the policy and measurement system.
Punch Two
In late December the Basel Committee released their “International framework for liquidity risk measurement, standards and monitoring.” It is a “consultative document” which means it is out for comment until April 16. While it is aimed at the international marketplace, its components are likely to be incorporated in a follow up to the guidance document by the five major US bank and credit union regulatory agencies in late 2010. Note that standards defined are minimum standards. Regulatory agencies are given the latitude to add additional requirements and standards. The Basel document defines two new ratios for measuring and monitoring liquidity risk – the Liquidity Coverage Ratio, and the Net Stable Funding Ratio. Both focus on adequate coverage of cash flow mismatches during liquidity stress events with adequate levels of highly liquid marketable securities. It defines ‘highly liquid marketable securities’ and specifies measurement horizons, measurement frequency, funding classification guidelines, and minimum runoff assumptions in stress environments for liquidity stress situations like falling below PCA Well Capitalized minimums. This is much more of a “How To” document than the guidance document.
Farin / ABA Connection
In November we signed a contract with the American Bankers Association to rewrite the ABA Liquidity and Funds Management Toolbox. The toolbox was last released in 2001, and was written by Alex Sheshunoff. The revised toolbox will be delivered to ABA members at no cost. But the intellectual capital behind the toolbox is available for Farin and Associates to use in working with all of its customers. The revised toolbox will have an Introduction and the following 5 books.
- Developing an effective capital plan – This is an important step as we are likely to see a significant revision of capital standards this year. Everyone will need to put together a capital plan.
- Building an effective plan to grow and maintain core funding – Core funding is the most valuable, most stable, and most favored source of funding for a financial institution. This book will lay out the basic approach to developing an effective core funding plan.
- Managing the use of non-core and near-core funding – Regulatory pressure is building on financial institutions to reduce reliance on non-core funding and diversify the non-core sources. We define near-core as funding raised as part of a core funding strategy that does not meet the regulatory definition of core – large CDs, CDARs, etc. This book will focus on tradeoffs between sources and lay out what needs to be in your policy.
- Developing an effective asset-based liquidity strategy – Pressure is building to increase levels of highly liquid marketable securities. We plan to lean heavily on the Basel document in helping you determine what level is appropriate. We will also review the earning assets most likely to be found on your balance sheet discussing how they fit into an asset-based liquidity strategy.
- Developing an effective Asset/Liability & Liquidity policy and program – Pressure is also building to upgrade interest rate risk measurement techniques. We feel your approach should be dynamic for both liquidity and interest rate risk measurement. We need to focus our measurement systems on risk/risk and risk/return tradeoffs. Policies and systems will be the focus of Book 5.
We are designing the revised ABA Toolbox to address the issues raised in the guidance document as well as the Basel document. Release is expected in summer of 2010 with a re-release anticipated once the Basel guidelines have been incorporated into the guidance document.
Farin Foresight Development
Upon the release of the next version of Foresight, we will begin development of a very significant upgrade to Foresight’s liquidity measurement and reporting capabilities. It is our objective to hit both the framework laid out in the Toolbox and the Basel reporting and measurement guidelines on the head.
Getting Yourself Ready
Many of you recall the increasingly higher hurdles put in your path by regulators in the area of interest rate risk over the last decade or so. We expect the same will happen in the liquidity risk area. You may have sailed through your last liquidity exam only to find that the same balance sheet structure, measurement system, and reporting system is heavily criticized in the next exam. Two-thirds of the financial institution failures in this financial crisis have been liquidity related. The regulators are attacking this area of industry weakness aggressively. In thinking through upgrades in balance sheet structure, policy and measurement systems, it will be to your advantage to look down the road a few years and build a liquidity system that will meet the test of time.
We Can Help – Evaluation of Your Policy
If you would like us to review your liquidity policy and provide a written report on your measurement system, balance sheet structure, and policy deficiencies, we will be happy to do so. Our analysis and comments will be based on the standards laid out in the guidance document. You can use this report in targeting upgrades to your program. The fee for this review is $995.
We Can Help – Upgrading Your Program
Both the guidance document and the Basel document rely heavily on stress tests performed as part of a Contingency Funding Plan to determine liquidity adequacy. There are no general guidelines on such matters as an appropriate level of asset-based liquidity. Such issues need to be addressed on an institution by institution basis.
If you would like us to perform stress tests and work with you on developing CFPs, upgraded measurement systems, and set standards for asset-based liquidity, we will be happy to do so. As part of that project we will also work with you on any policy upgrades we feel to be important. Fees will be somewhat dependent on the amount of work required but are likely to be in the $5,000 to $10,000 range.
Initially, our analysis will be performed using a spreadsheet that we are developing for delivery with the ABA Liquidity Toolkit. For those of you that are Farin Foresight users, we will switch you over to Foresight once the upgrades to its liquidity features are complete. If you would like more information, contact Chris Acker at cacker@farin.com or at 800-236-3724 ext. 4212.
