As we noted in late March Regulators are focusing on Liquidity, or more appropriately stated, they are sharply focusing on stressed liquidity and the adequacy of Contingency Funding Policies. The presence of an acceptable policy is not an option, regardless of the present liquidity on the balance sheet. In the past few weeks we have received request from bankers to help shape an acceptable policy “ASAP” in response to examinations.
Liquidity is always a more pressing issue in a highly loaned bank with little on balance sheet liquidity. Also, even in a bank with fewer loans coupled with a “long” investment portfolio with significant interest rate risk liquidity might be a concern. But, in recent weeks, a couple of banks with loan to deposit ratios of less than 55%; at least 45% on balance sheet liquidity; portfolios with less than 3.5 years duration; and above all else excellent asset quality, were scrambling to create an adequate policy.
The point of citing these examples is to drive home the point that every bank, regardless of its current risk or liquidity profile, should spend the time to create a good contingency funding policy. The policy should include an inclusive list of various scenarios that might lead to liquidity “stress” or a varying degree of “crises”. Then, it should systematically list the steps that could be taken to meet the emergency.
Keep in mind, there are three “stress events” related to the loss of deposits that should be covered. The first is a “Severe Stress Event” that reduces deposits by 20% while reducing borrowings and lasts one year. The second is a “Moderate Stress event” that reduces deposits by 10% and ability to borrow and last three months. The third is a “Mild Stress Event” that merely reduces deposits by 5% and lasts for a couple of weeks.
At one point it seemed that the “Severe Stress Event” was most scrutinized and at the end of the day if the Cumulative Net Surplus in the 181-365 days period was NEGATIVE or marginally positive, it was time to trot out the Contingency Funding Policy! But now, even if your numbers are solidly positive in the last time bucket, it is still imperative that the policy be updated, accurate, reasonable, comprehensive, and most importantly, an effective tool to provide the liquidity needed.Every AMG report contains all three Liquidity Stress Tests, and, we have sample Contingency Funding Polices and the experience to help meet current expectations. Call AMG at 800.226.1923 if you need help with any of these issues.