Liquidity Concerns on the Horizon?

My seven year-old son wanted a really scary costume for Halloween this year. Naturally, I suggested one of the scariest things I could think of: a liquidity crisis! Can you imagine the terrified looks on the faces of the other children when they saw all the red numbers indicating that funding sources weren’t going to meet the funding needs? Oh, the horror!

While it doesn’t appear at the present time that most financial institutions (FIs) are in dire liquidity situations, it certainly appears to be top-of-mind. A recent article from American Banker indicated that liquidity was a major concern for community bankers in the next year. Deposit growth is expected to become more difficult in the near future; and competition for deposits is becoming fiercer with online fintechs targeting the younger generation while larger banks offer sizable incentives to open accounts. Point in case: I recently opened a checking account at a large bank to earn a $400 welcome bonus. It was surprisingly very easy to obtain. I likely won’t keep the account, but it was enough of a reward to give it a try. Bottom line – your cost of funds could get more expensive if you are in a market that is experiencing aggressive pricing by competing FIs and you have the loan demand to satisfy.

Liquidity risk should be something the board of directors and the Asset Liability Committee (ALCO) routinely monitors, with policies in place for risk tolerance and contingencies. Having a good asset liability management (ALM) model and a solid forecast is important to understand the potential for funding shortages from a daily position all the way to a full year out. But also consider adverse scenarios that could make an impact. Think of situations that would be most harmful to your institution, then model them and report the results. For example, if deposit growth declines, will you still be able to meet loan demand? What if your credit facilities won’t lend? A what-if analysis can be a powerful tool to uncover potential risks that are easily overlooked when only reviewing one future path. The objective is to demonstrate your ability to survive the event, not to predict it.

Addressing potential liquidity concerns should just be part of the ALM equation. In the example above and with declining deposit growth, remember to look at other key indicators to make sure action (or inaction) isn’t causing red flags. If liquidity position wasn’t affected poorly enough to cause a concern, but higher funding costs have created an unacceptable margin, then you might need to re-evaluate. Make sure to run your earnings at risk rate shocks on those scenarios as well to see how rising or falling rates could impact the net interest income. Simulating different shapes of the yield curve is imperative in today’s flat and inverted state. And with the potential of a recession nearing, modeling different economic scenarios is important to consider for all aspects of proper balance sheet management. Basically, a good reminder is to look holistically at potential risks that could occur. You don’t want to make knee-jerk reactions to try and solve one problem and create more or worse problems down the road.

See how a hosted ALM model can help.

As you are putting those initial 2020 budgeting plans in place this fall, consider liquidity position and rising funding costs possibilities. Even if it seems unlikely, at least modeling some adverse scenarios should keep you prepared, just in case.

FYI, my son decided a being a ninja was scary enough and a bit easier to explain to Grandma.

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