Accelerating Issues: Liquidity Management

What is liquidity management?

Liquidity management is the process of ensuring you have the cash necessary to cover demands for cash.

Demands on cash are:

  • Members withdrawing deposits (this is the biggest concern)
  • Borrowings you must pay on
  • Members wanting loans (including draws on lines of credit)

Sources of cash are:

  • Balance sheet items
  • Cash
  • Cash equivalents
  • Short-term investments
  • Investments available for sale
  • Cash flow
  • Loan payments
  • Investments coming due
  • Access to market sources of funds
  • Corporate credit union
  • Federal Home Loan Bank
  • Contingent liquidity providers
  • Discount window
  • CLF (central liquidity facility)

It’s a pretty smart idea to make sure you have enough cash on hand to meet member needs. Not having cash on hand could lead to a reputation hit, and in the most extreme case a panic or rush on the credit union.

Requirements

This is a great resource from NCUA, published in October 2013:

How liquid should your credit union be? NCUA says: “Identify the largest liquidity outflow your CU has ever experienced and how long it persisted, then set your on-balance sheet liquidity target based on that experience. This cushion allows you to buy some time to avoid service disruptions and enter external funding arrangements if they become necessary.”

Starting March 31, 2014, NCUA has specific requirements for credit unions regarding liquidity risk management.

A federally insured credit union (FICU) with less than $50 million in assets must maintain a basic written liquidity policy. The policy can be part of an existing policy, such as an ALM or funds management policy. Either way, it must provide:

  1. A board-approved framework for managing liquidity; how the CU:
  2. Meets daily operating cash needs
  3. Meets forecasted liquidity shortfalls
  4. Responds to unforeseen contingencies
  5. A list of contingent liquidity sources the credit union can employ under adverse circumstances.

This policy does not need to be elaborate, but it must cover certain basic elements that are fundamental to all depository institutions, including all of the following elements:

  • Purpose and goals of liquidity management
  • Thresholds or limits for liquidity measures and reporting requirements
  • Primary and secondary sources of liquidity
  • Tools for liquidity risk management
  • Periodic review and revisions, as needed

According to NCUA: “Your liquidity policy should be tailored to the size and complexity of your credit union. If your credit union has a high reliance on market-sensitive funds (e.g., money market shares) and assets with more dynamic cash flows (e.g., mortgage loans), you would need to analyze prepayments and conduct a comprehensive forecast for your sources and uses of funds. Conversely, if you hold a large percentage of liquid assets, have strong core deposits, and do not make mortgage loans, your liquidity risk is likely to be less dynamic and your plan may be more basic. As your size increases, liquidity risk typically increases in amount and complexity.”

For credit unions with more than $50 million in assets, they must also have the written liquidity policy as well as a contingency funding plan (CFP) that clearly sets out strategies for addressing liquidity shortfalls in emergencies.

  • Include a process to forecast and assess whether the credit union’s liquidity sources are adequate to meet normal and contingent needs.
  • Identify specific contingency sources.
  • Specify how the credit union will manage a range of liquidity-stress events.
  • Identify the lines of authority within the credit union responsible for managing liquidity events.
  • Outline the management processes the credit union will follow when responding to liquidity events.
  • Specify the frequency that the credit union will test its plan and make any necessary updates.

Some measures and tools of liquidity

So how do you measure your liquidity? What tools are available? Spreadsheets, of course, are very useful here. But what will you do with a spreadsheet? Why, ratios, of course!

All specific amounts given below are one credit union’s guidelines. They aren’t gospel. Also, don’t forget to look at/for seasonal trends.

  • Changes in net cash flow. Not necessarily a ratio (but can be expressed as a ratio of assets), it’s smart to track how your cash increases or decreases each month. Some credit unions track it on a weekly or daily basis.
  • Cash/assets. the most basic measure of liquidity.
  • Short-term Investments/total assets. The ratio shows how much of the Credit Union's assets can be readily converted into cash. Short-term investments are securities with remaining maturities of 1-year or less.
  • Cash and short-term investments/total assets. Measures how much cash you can have in a short period of time.
  • Loans/assets. This ratio should not exceed 85%.
  • Investments/assets. Ordinarily, this ratio should not be less than 10%. The investment maturities within this 10% minimum should be relatively short for liquidity purposes. (Cash is not an investment for the purpose of this ratio and minimum. Cash is not a form of liquidity because it is necessary for day-to-day operations.)
  • Non-member certificates/total assets. Ordinarily, this ratio should not exceed 5%.
  • Borrowed funds/total assets. For general liquidity and cash management purposes, the ratio should not exceed 5%. A higher percentage may make sense as part of an income enhancement strategy.
  • Volatile liabilities/short-term investments. The ratio indicates how much of the Credit Union's volatile liabilities such as CD's of $100,000 or more are matched by short-term assets.
  • Loans/core deposits. The ratio shows how much of the loan portfolio is funded by stable deposits. Core deposits are share and passbook deposits and CD's less than $100,000.