Publications & Resources
January/February 2009
Focus: Funding & Liquidity
Managing Liquidity and Funding During a Recession
By
The Speed of Change
Everything moves faster these days. The FDIC website indicates that no
bank failures occurred in 2005 or 2006 and only 3 small banks failed in 2007. In
2008, there have been 16 bank failures through October 24th, many of them most
significant.
The loss of credit availability, coupled with illiquidity has caused the stock market to become a rollercoaster ride, with continuing downward pressures on stock values.
Just about every economist in the country has affirmed the fact that we are in or on the edge of a worldwide recession.
Historians will doubtlessly research the sequence of relevant events that led up to this point in time, and perhaps we will learn how to avoid them in the future. But for now we must learn to better operate and manage our financial institutions in an unstable and recessionary economy.
To accomplish this task, bankers must learn to carefully monitor current events, compile relevant information, alter strategic and tactical decisions and implement changes and solutions at lightening speed.
Federal Government Intervention Will Help
In October 2008 the Emergency Economic Stabilization Act (EESA) was
enacted. The first aspect of this new law was to establish the Troubled Asset
Relief Program (TARP). Thus putting the wheels in motion for the Treasury
Department to purchase and insure mortgage assets and purchase any other
financial instrument necessary to stabilize our financial markets including
buying equity securities in banks and bank holding companies. It is an historic
and far reaching piece of legislation that will quickly evolve into a long list
of programs to enable regional and community banks to restore their ability to
deal with troubled assets, and capital insufficiency.
The first implementation step was to inject $125 billion into nine money center banks in the form of preferred stock capital. The second phase is to inject another $125 billion into regional and community banks before the end of 2008.
The immediate objective is not to shore up troubled banks, but create the potential for larger well capitalized and managed banks to immediately increase lending to businesses and consumers. A second objective is to enable these enhanced capital ratio banks to target other banks to be acquired and stabilized.
The next phase of the plan is to create a procedure for the Treasury to purchase certain identified loans and assets to shore up weak bank balance sheets.
Overall, the plan is intended to avoid significant bank failures, and encourage lending and restore liquidity.
However, for the plan to work, each bank's liquidity must be properly managed during these recessionary times.
Liquidity is a Top Priority
In an economic recession, circumstances change very quickly. Banks must
detect even slight movements in their liquidity in order to implement treatment
actions.
Relying upon traditional periodic bank operating and balance sheet ratio analysis is insufficient. This data focuses upon bank conditions but ignores changing market conditions. It is historically based, and trend oriented. It is compiled and analyzed much too slowly to move quickly. Often problems surfaced by balance sheet ratios are well beyond available opportunities to reduce exposure.
The OCC Liquidity Handbook makes reference to five critical liquidity risk elements: (a) a well defined liquidity strategy; (b) a viable contingency funding plan; (c) tools and techniques to identify and measure liquidity risk; (d) strong internal controls; and (e) reliable and accurate management information systems and reporting processes.
Because of the increased reliance upon high volumes of non-core deposits, community banks need to track their Sources and Uses of funding, (inflows and outflows) daily if possible. Next they need a Funding Concentration report that identifies what factors or decisions could cause a sudden withdrawal of funds. These might include average deposit balance volatility, rollover dates, and interest rates. Lastly, a Current Funds Availability report is a necessary forward looking analysis tool that is especially important for community banks that operate at high loan to deposit ratios.
And finally, the bank's contingency funding plan should be updated and carefully documented. It is much more than merely making mention of the Federal Home Loan Bank resource, or a list of correspondent or other informal borrowing arrangements. It needs to be a dynamic plan that indicates on an “as if” basis the actual potential for availability in the event of rapidly changing scenarios that might negatively impact the bank.
Community banks should re-assess their funding information systems, and make liquidity management a key priority.
Richard
Sprayregen is partner with Squar, Milner, Peterson, Miranda & Williamson, LLP in
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