Publications & Resources

March/April 2010
New Look for the Community Bank

 

Create a Contingency Funding Plan that Prepares the Bank for the Road Ahead

By Shawn O’Brien

If you surveyed most community banks, you’d find that the majority of their contingency funding plans are based on generic templates. While a plan of this nature may satisfy an examiner checklist, it falls short of addressing an individual bank’s potential risks and the stress situations that may occur within and outside of their local market.

Simply identifying your funding sources and including basic actions used to be enough; but when the bottom fell out of the market, the game changed. As the name implies, your bank’s survival could someday depend upon its customized contingency funding plan. And, it is not a “one and done” deal. Your plan must be dynamic—always reflecting what could happen today if one of your funding sources was no longer available. The key is to model upfront how various scenarios could impact the bank’s funding. Build a customized contingency plan that prepares for potential risks and then monitor this plan regularly; it will be a valuable tool for the bank in managing liquidity and risk moving forward. In hindsight, a more dynamic contingency funding plan would have assisted many banks to better prepare for the recent financial crisis.

Here’s how you can get started.

The crucial elements
Begin by conducting a pre-modeling analysis. Obtain input from your ALCO or ALM team and reach consensus on what the major risks are for your bank in the following three areas: local market; balance sheet; and regulatory. For example, identify concentrations in your customer base and balance sheet that could present substantial risks. Examine other potential vulnerabilities, such as correspondent bank relationships and any unfunded loan commitments which could be called on to fund. Consider potential disruptions that could cause significant deposit outflow with local customers, possibly a plant closing or widespread layoffs at a local corporation could impact the bank.

Model risk scenarios. Once you’ve identified potential scenarios, you must model them and assess the extent of the risk. As mentioned above, a vulnerability could be that your institution depends too heavily upon a single correspondent bank relationship; were a correspondent to go out of business, you would quickly find yourself with a liquidity issue. In this scenario, you should address questions like: how quickly could the correspondent relationship be replaced; who would process your cash letter; and where would the bank borrow overnight. Examiners are now requiring this level of analysis to ensure that your bank has considered and modeled all of the risk scenarios that could cause the institution to access its contingency funding sources.

Know your funding sources & their constraints. You must detail all of your sources in the contingency funding plan. Demonstrate your understanding of those sources and how they will be impacted in a liquidity event. For each source, indicate the funding strategy, required documents, behavior, constraints, limits and potential exposure. Again, this is one way that your plan can serve as a tool for preparing the bank. For example, if a Federal Reserve line of credit is among your intended sources, begin the process of establishing that line immediately, if you haven’t already; it can take four to nine months to obtain approval. The bottom line is that even though you can never be overly diversified in funding, you must understand each source and how stress events may impact them.

Analyze your capital. Many banks may make the mistake of not analyzing capital as a component of their contingency funding plan. In fact, if you don’t already have a capital plan in place, it may be too late to start now. Understand the impact of capital on your bank’s liquidity; if you have a capital event, you will likely have a liquidity event happening simultaneously. Stress your capital to determine how much of a cushion you have before becoming adequately capitalized.

Create a dynamic action plan. The key here is that a contingency funding plan isn’t designed to solve a problem; it’s a tool you can use to consistently monitor the bank’s position. Therefore, you must determine who will be responsible for assessing liquidity events and their impact, and specifically document what actions will be taken in the event of a trigger.

Liquidity must be an ongoing conversation
The market climate has definitely impacted the frequency with which your bank should be monitoring its liquidity position. You must know the bank’s liquidity position at all times.

It’s been expected that liquidity be a regular topic of discussion among senior management, but examiners now also want to see directors actively involved in their banks’ liquidity policies. More than ever, your board is expected to understand the bank’s primary and contingency funding sources, what options are available and play a role in ensuring that all sources have been fully activated and tested – so that liquidity needs can be met in the event of unforeseen circumstances.

Using the plan as a strategic tool
Yes, a generic contingency funding plan will meet examiners requirements, but there is a lot more it can do for you. Putting a customized plan in place can help you better manage the institution and its funding and protect the bank moving ahead. Furthermore, it enables you to uncover potential issues early and provides examiners with confidence that your institution is in control. The banking world has changed – a dynamic and proactive contingency funding plan is now an essential resource for ongoing liquidity and risk management.

Shawn O’Brien is president of QwickRate. He can be reached at 678-797-4079 or shawn.obrien@qwickrate.com. For a complimentary funding sources checklist and pre-modeling analysis worksheet to jumpstart your contingency planning efforts, please contact QwickRate at 800-285-8626.

Unauthorized reproduction of all or part of this material without the express written consent of the author is strictly prohibited. All rights reserved.