C. Myblog

Are You Feeling Liquid?

February 2, 2012

It may be the last thing you think you need to worry about—needing liquidity.

However, the things furthest from your mind could be the most important to think about in the risk management process.  Risk management is, in part, an exercise of thinking about and preparing for the unexpected.  When was the last time threats to liquidity were discussed in your ALCO?  What could lead to a bad liquidity scenario?  What could be the impact to earnings and net worth in this bad liquidity scenario?  When was the last time contingency liquidity sources were tested—not just for availability but operationally?  It is no different than having a backup generator for power.  Having it is good but making sure it works is the critical part.

While low loan growth and too much liquidity are more common topics right now, it is important, at least annually, that the ALCO discusses contingent liquidity and the results from testing contingency liquidity sources.

In liquidity modeling and discussions it is important to consider the impact of the investment portfolio.  Some credit unions are purchasing longer investments, many of which are not amortizing and/or have optionality (prepayments, call features, etc.).  The risk management process should consider the cash flow and earnings implications, including:

  • What if these bonds do not get called (or prepay) as expected?
  • What is the potential impact on liquidity?

It is common for credit unions to assume they will be able to liquidate their bonds if needed.  It is important to consider the implications of not being able to sell them in a timely fashion or the financial impact of selling them at a loss, such as after a rate increase.

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