Liquidity Takes Center Stage – 5 Questions to Ask Yourself
November 2, 2022
5 minute read – Feast or famine. It was only a couple of years ago that deposits were coming in a deluge, but things change quickly and the need for liquidity is now top of mind for many.
It’s not that deposits have dried up. Share balances are still far higher than they would have been without the unusual influx seen in 2020 and 2021. But deposit growth has slowed and the focus is shifting. Liquidity has never left the radar – deposit and payments strategies have been major topics in planning sessions, and liquidity analyses and what-ifs have been discussed all along, but it’s clear that the urgency has increased.
The systemic effects of scarcer liquidity, such as pricing pressures, tend to affect everyone whether your liquidity position is tight now or not. Getting clarity around these strategic liquidity questions will help your organization mount a well-thought-out and cohesive response:
- What’s happening beneath the surface for your customers? Digging into trends surrounding average deposit balances can provide insights into what people are experiencing and inform relevant responses. For example, how much of the growth over the past few years has come from higher average balances and how much has come from new accounts? What’s been happening more recently? Average balances that are coming down could be people having to spend more to compensate for inflation, or it could be outflows to other institutions, the market, or cryptocurrency. Can your data tell you this? More insights can be gained by understanding whether lower average balance accounts or higher average balance accounts are experiencing outflows. Customers who are having to spend more and simply don’t have the money to deposit, is a situation that calls for a different response than customers who are finding better returns on their money.
- What is your deposit and payments strategy? Get clarity on your ideal sources of liquidity. Many business models depend on building deposits through checking/spending accounts, which are generally less expensive than other forms of liquidity. Other business models regularly rely on borrowings and are built to cover the higher costs. Take a clear-eyed view of how successful you feel the strategy will be going forward and whether more needs to be done to ensure access to funds. Once you are clear on what your ideal sources for liquidity are, it’s time to consider the next question.
- What levers are you willing to pull to bridge liquidity gaps? Sometimes your ideal sources of liquidity aren’t enough. Proactively thinking through which actions you’re willing to take, and in what order, can help ensure there is consensus when gaps need to be bridged quickly. Be sure to take into account the amount of time it takes to pull different levers. Some options require significant lead time to get set up. Also factor in how long they can be sustained. Common sources to consider include:
- Promotional rate CDs – usually pull in “hot money” while also shifting less expensive existing deposits to more expensive products
- Brokered CDs
- Selling investments – many are at a significant loss
- Slowing lending or certain types of lending – could also help rebalance the loan portfolio
- Selling loans through participations or in the secondary market
- How could your response to tight liquidity affect strategy and goals? As an example, when market rates rose, some institutions experienced fast loan growth because their loan rates remained lower than market for a time. While this likely helped meet lending goals, adding loans at low rates while utilizing more expensive sources of liquidity to meet asset growth goals or loan demand might result in an undesirable profitability picture. Goals are not made to be changed lightly, but keep in mind that rapid changes in market rates, consumer behavior, product pricing, and liquidity costs could cause some goals to become detrimental to the overall financial picture, at least in the short term. Good analysis and conscious decision-making on how to adjust, if necessary, is key.
- Are your sources of liquidity still valid? It’s a good idea to dust off the plan and confirm that borrowing sources are still in place. It’s also a good idea to test the emergency funding plan. Bear in mind that in bad financial times borrowing capacity is sometimes reduced by suppliers, so include that possibility as you think through meeting liquidity challenges. Consider collateral and how selling loans or investments could change borrowing capacity. Also think through what options you’ll have if promotional CDs are not as effective as you thought or demand for participations decreases.
Staying a few steps ahead of liquidity needs is always a good idea, but it’s especially important now. As you think through your options, consider a range of what-ifs to help prepare for a variety of scenarios.