The Federal Reserve and Federal Deposit Insurance Corporation released their response and breakdown of the recent bank failures — and at the top of the list is mismanagement of basic interest rate and liquidity risk.
Credit unions need to have adequate liquidity to meet day-to-day operational expenses, loan demand, and potential unexpected cash outflows — including declines in deposits. The ability of your credit union to effectively manage liquidity can have significant implications on profitability, stability, and reputation.
Here are six practices credit unions can adopt to help develop a comprehensive liquidity management strategy that accounts for various scenarios.
1. Adjust accordingly.
Assess your credit union’s approach to liquidity and interest rate management in light of current and evolving economic conditions in the marketplace, the industry, and the community. Periodically test your contingency funding plan or monitor your asset-liability management process monthly instead of quarterly to help increase the effectiveness of your approach.
2. Perform stress testing.
Stress testing involves analyzing your credit union’s liquidity position under various hypothetical scenarios, such as a sudden increase or decrease in interest rates, a significant increase or decline in deposits, or one-time unexpected losses. This testing might help identify potential liquidity gaps and allow you to develop strategies to address them before they become a problem.
For example, the Federal Reserve stated, “Social media enabled depositors to instantly spread concerns about a bank run, and technology enabled immediate withdrawals of funding.”
Has your credit union considered the viral nature of social media or the ability to move funds almost instantaneously in your stress testing scenarios? Do you have someone or a team evaluating social media daily to see what your members or community might be saying about you?
3. Diversify your funding sources.
Credit unions need to diversify their sources to reduce reliance on any one type of funding.
For example, relying heavily on short-term deposits or one line of credit could create vulnerability to liquidity shocks if depositors suddenly withdraw their funds. By diversifying funding sources, a credit union can help mitigate this risk and maintain access to funding even if one source dries up.
Consider pledging additional investments, mortgages, or consumer loans to secure additional lines of credit, and evaluate the need for non-member or brokered deposits or subordinated debt.
4. Monitor and plan for liquidity risk.
As interest rates continue to rise, depositors are looking for higher-yielding accounts, including new competition from fintechs, online financial institutions, and other companies that previously didn’t offer such products. The need to pay higher interest rates to attract and maintain deposits and remain competitive puts pressure on your overall liquidity position.
Considering current economic conditions and potential changes, regularly review your liquidity position to help identify potential problems. This might include monitoring your daily cash position along with membership deposit activity. In addition, review cash flow projections at least monthly to properly prepare for future decisions.
5. Manage asset and liability maturity.
A credit union that heavily relies on long-term loans (e.g., mortgages) or investments might face liquidity problems if it needs cash quickly to meet unexpected demands — these types of assets in a rising rate environment have slower prepayment speeds. Balancing and possibly re-balancing the maturity of assets and liabilities can help maintain sufficient cash to meet current and future obligations.
6. Maintain sufficient liquidity buffers.
Liquidity buffers can include cash reserves, unpledged high-quality liquid assets, and committed credit lines. These buffers can help your credit union weather unexpected liquidity shocks and provide flexibility to take advantage of new lending opportunities. Additionally, consider the need to evaluate and potentially reduce some of your members’ unused loan commitments.
Given the almost systemic impact on liquidity in the industry, you should test contingent funding sources. One institution’s recent testing revealed availability had been completely removed from three backup lines of credit and one other line had its availability reduced by half.
For more information on liquidity management, contact Bryan Mogensen at bryan.mogensen@CLAconnect.com or 602-604-3551.
The information contained herein is general in nature and is not intended, and should not be construed, as legal, accounting, investment, or tax advice or opinion provided by CliftonLarsonAllen LLP (CLA) to the reader. For more information, visit CLAconnect.com.
CLA exists to create opportunities for our clients, our people, and our communities through our industry-focused wealth advisory, digital, audit, tax, consulting, and outsourcing services. CLA (CliftonLarsonAllen LLP) is an independent network member of CLA Global. See CLAglobal.com/disclaimer. Investment advisory services are offered through CliftonLarsonAllen Wealth Advisors, LLC, an SEC-registered investment advisor.
