Liquidity Savior Flashcards
What is liquidity risk?
The risk of not being able to obtain funds at a reasonable price within a reasonable time period to meet obligations as they become due.
What are the Board’s responsibility with respect to liquidity?
1- Understand nature and level of liquidity risk
2- Establish tolerance for liquidity risk
3- Approve significant policies related to liquidity management
4- Ensure senior management is taking the necessary steps to monitor and control liquidity risk.
What is senior management’s responsibility with respect to liquidity?
1- Establish procedures, guidelines, internal controls, and limits for managing and monitoring liquidity
2- Preparing contingency funding plans
3- Reviewing position regularly and monitoring internal/external factors
4- Periodically reviewing liquidity strategies, policies, and procedures
What are some wholesale funding sources (these are sensitive to the banks credit risk profile and interest rate environment)?
1- Federal funds 2- Public funds (often must be secured and typically fluctuate on a seasonal basis due) 3- FHLB Advances 4- Fed’s primary credit program 5- Foreign deposits 6- Brokered deposits 7- Internet deposits
What is the Fed’s Primary Credit Program?
The discount window is available to any bank that maintains deposits subject to reserve requirements. It usually takes US Treasuries, MBS and ABS, Muni Sovereign, or Corporate securities, or loans. Borrowings are available for not more than 60 days in 120 day period. The types of credit include:
• Primary: Generally overnight to meet temporary needs.
(Available to adequately capitalized composite 1, 2, or 3 rated institutions)
• Secondary: Institutions that do not qualify for primary credit; this comes at a higher cost
• Extended: Institutions under liquidity strain
• Emergency: Rare circumstances
What is a repurchase agreement and what are the terms?
The party to a repo transactions sells the security today, and simultaneously agrees to buy that same security at the same price (with interest) at some point in the future. The vast majority of repurchase agreements mature in three months or less. One-day transactions are known as overnight repos, while transactions longer in duration are term repos. A dollar repurchase agreement requires the buyer to return a substantially similar, but not identical, securities. Savings associations are typically the primary participants of dollar repurchase agreements.
What makes a bank a correspondent bank?
Where an average aggregate balance exceeds the lesser of $100M or ½% of total deposits
What are excluded from being correspondent accounts?
- Time deposits at prevailing market rates
* Account is maintained solely for effecting Fed funds transactions
What is commercial paper?
A short-term (270 days or less) negotiable promissory note typically purchased by institutional investors that is rated on the issuers financial condition and issued by a bank holding company, large commercial bank, or large commercial business.
What are the risks for asset securitization (transforms a pool of assets into cash)
- Early Amortization Clauses - Some have early amortization clauses to protect investors if performance of underlying assets do not meet pre-specified criteria
- Residual Assets CF - If bank has a large concentration of residual assets, overall cash flow might be dependent on residual cash flows from performance of underlying assets
- Reputation - may affect ability to generate cash from future securitizations if damaged
- Liquidity Risk - Residual assets retained are typically illiquid
What items are typically provided for in a liquidity policy?
- ALCO - Provide for the establishment of an asset/liability committee. Define who will be on the committee, what its responsibilities will be, how often it will meet, how it will obtain input from the board and how its results will be reported back to the board.
- Deposit Structure - Provide for a periodic review of the bank’s deposit structure. Include the volume and trend of total deposits and the volume and trend of the various types of deposits offered, the maturity distribution of time deposits, rates being paid on each type of deposit, rates being paid by trade area competition, caps on large time deposits, public funds, out-of-area deposits, and any other information needed.
- Funding Concentrations – Policies and procedures that address funding concentration in or excessive reliance on any single source or type of funding, such as brokered funds, deposits obtained through the internet or other types of advertising, and other similar rate sensitive or credit sensitive deposits.
- COF - Provide a method of computing the bank’s cost of funds.
- Permissible Investments - In conjunction with the bank’s investment policy, determine which types of investments are permitted, determine the desired mix among those investments, determine the maturity distribution and what amount of funds will be available, and review pledging requirements.
- Risk Tolerances – Conveys the board’s risk tolerances and establishes target liquidity ratios such as loan-to-deposit ratio, longer-term assets funded by less stable funding sources, individual limits on borrowed funds by type and source, or a minimum limit on the amount of short-term investments.
- Adequate System of Internal Controls – ensures the independent and periodic review of the liquidity management process, and compliance with policies and procedures.
- Compliance – Ensures that senior management and the board are given the means to periodically review compliance with policy guidelines, such as compliance with established limits and legal reserve requirements, and verify that duties are properly segregated.
- Contingency Funding – addresses alternative sources of funds if initial projections of funding sources and uses are incorrect or if a liquidity crisis arises. Establishes bank lines and periodically tests their use.
- Monitoring Liquidity – Establishes a process for measuring and monitoring liquidity, such as generating pro-forma cash flow projections or using models.
- Approval Procedures – Defines approval procedures for exceptions to policies, limits, and authorizations.
- Tax planning
- Wholesale Funding Sources – Provides authority and procedures to access wholesale funding sources, and includes guidelines for the types and terms of each wholesale funding source permitted. Defines and establishes a process for measuring and monitoring unused borrowing capacity.
What are some liquidity “warning signals?”
1- Rapid growth and volatile funding
2- Negative publicity
3- Decline in asset quality
4- Potential/Actual credit rating downgrades
5- Cancellation of loan commitments
6- Wide secondary market spreads on senior debt
7- Counterparties increase collateral requirements and demand more
8- Counterparties decrease/terminate borrowing lines
9- Counterparties unwilling to deal in unsecured & long-term transactions
What are the indicators of a serious liquidity problem?
1- Large turndowns in brokered deposit markets
2- Rating sensitive providers (money managers and public entities) abandon the bank
3- Early withdrawal requests from depositors, or the bank has to repurchase its paper in the market
4- Transaction sizes decreasing and counterparties unwilling to enter into short-term transactions
5- Increasing spreads paid on deposits relative to local competitors and national and regional composites
What are some UFIRS considerations for liquidity?
With the exception of the management component, perhaps more than any other component rating, liquidity should be assigned in the context of other financial factors (banks with weak earnings, low capital and deteriorating assets may find financing to be more expensive or borrowing line maturities reduced).
Consideration should be given to current level and prospective sources of liquidity compared to funding needs, as well as the adequacy of funds management practices. Liquidity is rated 1 through 5 with regard to the following:
- Volatility of deposit
- Reliance on interest-sensitive funds and frequency and level of borrowings
- Unused borrowing capacity
- Capability of management
- Level of diversification of funding sources
- Ability to securitize assets
- Availability of assets readily convertible into cash
- Ability to pledge assets
- Impact of holding company and affiliates
- Access to money markets
- The institutions capital and earnings
- Nature, volume, and anticipated usage of the institutions credit commitments
