Regulatory Hurdle to Overcome: Satisfying Liquidity Adequacy

In a move aimed at bolstering financial stability, regulators are increasing scrutiny of institutions’ liquidity adequacy, requiring them to provide detailed cash flow information when on-balance sheet liquidity falls below 10%. This may result in additional reporting or periodic reporting, such as daily, weekly, monthly, or quarterly.

Liquidity Resources: A Key Metric

On-balance sheet liquidity represents the sum of readily convertible assets divided by deposit liabilities, short-term borrowings, and other non-depository sources of funding. Loans on the balance sheet or in the “pipeline” are included in this calculation, as well as contingency funding that can be arranged over a few days.

Off-Balance Sheet Liquidity: A Secondary Source

Off-balance sheet liquidity, or secondary sources of liquidity, may require collateral and include readily available lines of credit with correspondent institutions, Federal Home Loan Bank (FHLB), or the Federal Reserve Bank. However, institutions must ensure that these resources are not double-counted in their calculations.

Contingency Funding Plans: A Critical Component

Contingency funding plans should outline specific steps to take if an unexpected liquidity need arises, including stress testing to consider the impact of losing liquidity sources. Loss of liquidity sources may result from deteriorating financial conditions or reduced access to correspondent funding.

Dependence on Volatile Funding: A Risk Factor

Institutions with high levels of dependence on volatile funding sources, such as brokered deposits and correspondent funding, are at risk of reduced access to these resources in times of need. This can significantly limit capital raising options and weaken the franchise value of a financial institution.

Internal Controls: A Key to Compliance

An institution’s internal controls must ensure that it manages liquidity risk consistent with board-approved policy. Regular reviews and evaluations by an independent party are essential to assessing compliance with supervisory guidance and industry sound practices.

Conclusion

Regulatory scrutiny is increasing on institutions’ liquidity adequacy, requiring them to provide detailed cash flow information and demonstrate robust internal controls. Institutions must prioritize liquidity management and contingency planning to mitigate risks and ensure financial stability.