[Federal Register Volume 75, Number 54 (Monday, March 22, 2010)]
[Notices]
[Pages 13656-13666]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2010-6137]
-----------------------------------------------------------------------
DEPARTMENT OF THE TREASURY
Office of the Comptroller of the Currency
[Docket ID OCC-2010-0004]
FEDERAL RESERVE SYSTEM
[Docket No. OP-1362]
FEDERAL DEPOSIT INSURANCE CORPORATION
DEPARTMENT OF THE TREASURY
Office of Thrift Supervision
[Docket ID OTS-2010-0005]
NATIONAL CREDIT UNION ADMINISTRATION
Interagency Policy Statement on Funding and Liquidity Risk
Management
AGENCY: Office of the Comptroller of the Currency, Treasury (OCC);
Board of Governors of the Federal Reserve System (FRB); Federal Deposit
Insurance Corporation (FDIC); Office of Thrift Supervision, Treasury
(OTS); and National Credit Union Administration (NCUA).
ACTION: Final policy statement.
-----------------------------------------------------------------------
SUMMARY: The OCC, FRB, FDIC, OTS, and NCUA (the agencies) in
conjunction with the Conference of State Bank Supervisors (CSBS), are
adopting this policy statement. The policy statement summarizes the
principles of sound liquidity risk management that the agencies have
issued in the past and, when appropriate, supplements them with the
``Principles for Sound Liquidity Risk Management and Supervision''
issued by the Basel Committee on Banking Supervision (BCBS) in
September 2008.\1\ This policy statement emphasizes supervisory
expectations for all depository institutions including banks, thrifts,
and credit unions.
---------------------------------------------------------------------------
\1\ NCUA is not a member of the Basel Committee on Banking
Supervision and federally insured credit unions are not directly
referenced in the principles issued by the Committee.
DATES: This policy statement is effective on May 21, 2010. Comments on
the Paperwork Reduction Act burden estimates only may be submitted on
---------------------------------------------------------------------------
or before April 21, 2010.
FOR FURTHER INFORMATION CONTACT:
OCC: Kerri Corn, Director for Market Risk, Credit and Market Risk
Division, (202) 874-5670 or J. Ray Diggs, Group Leader: Balance Sheet
Management, Credit and Market Risk Division, (202) 874-5670.
[[Page 13657]]
FRB: James Embersit, Deputy Associate Director, Market and
Liquidity Risk, 202-452-5249 or Mary Arnett, Supervisory Financial
Analyst, Market and Liquidity Risk, 202-721-4534 or Brendan Burke,
Supervisory Financial Analyst, Supervisory Policy and Guidance, 202-
452-2987.
FDIC: Kyle Hadley, Chief Capital Markets Examination Support, (202)
898-6532.
OTS: Rich Gaffin, Financial Analyst, Risk Modeling and Analysis,
(202) 906-6181or Marvin Shaw, Senior Attorney, Regulations and
Legislation Division, (202) 906-6639.
NCUA: Amy Stroud, Program Officer, Office of Examination and
Insurance, (703) 518-6372.
SUPPLEMENTARY INFORMATION:
I. Background
The recent turmoil in the financial markets clearly demonstrated
the importance of good liquidity risk management to the safety and
soundness of financial institutions. In light of this experience,
supervisors worked on an international and national level through
various groups \2\ to assess the lessons learned on individual
institutions' management of liquidity risk and inform future
supervisory efforts on this topic. As one result of these efforts, the
Basel Committee on Banking Supervision issued in September 2008,
Principles for Sound Liquidity Risk Management and Supervision, which
contains 17 principles detailing international supervisory guidance for
sound liquidity risk management.
---------------------------------------------------------------------------
\2\ Significant international groups addressing these issues
include the Basel Committee on Banking Supervision (BCBS), Senior
Supervisors Group, and the Financial Stability Board.
---------------------------------------------------------------------------
II. Comments on the Proposed Policy Statement
On July 6, 2009, the agencies requested public comment on all
aspects of a proposed interagency policy statement \3\ on funding and
liquidity risk management. The comment period closed on September 4,
2009. The agencies received 22 letters from financial institutions,
bank consultants, industry trade groups, and individuals. Overall, the
commenters generally supported the agencies' efforts to consolidate and
supplement supervisory expectations for liquidity risk management.
---------------------------------------------------------------------------
\3\ 74 FR 32035, (July 9, 2009).
---------------------------------------------------------------------------
Many commenters expressed concern regarding the proposed policy
statement's articulation of the principle that separately regulated
entities would be expected to maintain liquidity commensurate with
their own profiles on a stand-alone basis. These commenters indicated
that the language in the proposed statement suggested that each
regulated entity affiliated with a parent financial institution would
be required to maintain its own cushion of liquid assets. This could
result in restrictions on the movement of liquidity within an
organization in a time of stress. Such restrictions are commonly
referred to as ``trapped pools of liquidity''. These commenters assert
that there are advantages to maintaining liquidity on a centralized
basis that were evident during the current market disruption. Further,
they assert that requiring separate pools of liquidity may discourage
the use of operating subsidiaries.
The agencies recognize the need for clarification of the principles
surrounding the management of liquidity with respect to the
circumstances and responsibilities of various types of legal entities
and supervisory interests pertaining to them, and, therefore, have
clarified the scope of application of the policy statement with regard
to the maintenance of liquidity on a legal entity basis. Specifically,
the policy statement indicates that the agencies expect depository
institutions to maintain adequate liquidity both at the consolidated
level and at significant legal entities. The agencies recognize that a
depository institution's approach to liquidity risk management will
depend on the scope of its business operations, business mix, and other
legal or operational constraints. As an overarching principle,
depository institutions should maintain sufficient liquidity to ensure
compliance during economically stressed periods with applicable legal
and regulatory restrictions on the transfer of liquidity among
regulated entities. The agencies have modified the language in the
policy statement to reflect this view.
The principles of liquidity risk management articulated in this
policy statement are broadly applicable to bank and thrift holding
companies, and non-insured subsidiaries of holding companies. However,
because such institutions may face unique liquidity risk profiles and
liquidity management challenges, the Federal Reserve and Office of
Thrift Supervision are articulating the applicability of the policy
statement's principles to these institutions in transmittal letters of
the policy statement to their regulated institutions. As a result, the
guidance for holding companies contained in the original proposal
issued for comment has been omitted from this final policy statement.
Many commenters expressed concern over whether the agencies were
being too prescriptive in the policy statement regarding expectations
for contingency funding plans (CFPs). These commenters asserted that
there needs to be flexibility in the design of CFPs such that
institutions can respond quickly to rapidly moving events that may not
have been anticipated during the design of the CFP. Other commenters
asked whether the policy statement requires institutions to use certain
funding sources (e.g., FHLB advances or brokered deposits) in order to
show diversification of funding within their CFP.
The agencies believe that the policy statement provides adequate
flexibility in supervisory expectations for the development and use of
CFPs. In fact the policy statement provides a basic framework that
allows for compliance across a broad range of business models whether
financial institutions are large or small. While the policy statement
addresses the need to diversify an institution's funding sources, there
is no requirement to use a particular funding source. The agencies
believe that a diversification of funding sources strengthens an
institution's ability to withstand idiosyncratic and market wide
liquidity shocks.
Many commenters representing financial institution trade
organizations (both domestic and international) and special-purpose
organizations such as banker's banks and clearing house organizations
expressed concern over the treatment of federal funds purchased as a
concentration of funding. As of this writing, under a separate
issuance, the agencies issued for public comment, ``Correspondent
Concentrations Risks.'' \4\ That guidance covers supervisory
expectations for the risks that can occur in correspondent
relationships. The draft guidance can be found at http://www.occ.treas.gov/fr/fedregister/74fr48956.pdf.
---------------------------------------------------------------------------
\4\ NCUA did not participate in this proposed guidance.
---------------------------------------------------------------------------
Some commenters expressed concern over limiting the high-quality
liquid assets used in the liquidity buffer to securities such as U.S.
Treasuries. These commenters assert that limiting the liquidity buffer
to these instruments would limit diversification of funding sources and
potentially harm market liquidity.
The agencies agree with some comments on the need for a liquidity
buffer of unencumbered high-quality assets sized to cover an
institution's risk
[[Page 13658]]
given an appropriate stress test. The agencies believe that such
buffers form an essential part of an effective liquidity risk
management system. The question centers on the composition of assets
that make up an institution's liquidity buffer. This is an issue that
not only resonates with this domestic policy statement but with the
Basel Committee on Banking Supervision's (BCBS) ``Principles for Sound
Liquidity Risk Management and Supervision.'' It is the intention of the
agencies for institutions to maintain a buffer of liquid assets that
are of such high quality that they can be easily and immediately
converted into cash. Additionally, these assets should have little or
no loss in value when converted into cash. In addition to the example
used in the policy statement, other examples of high-quality liquid
assets may include government guaranteed debt, excess reserves at the
Federal Reserve, and securities issued by U.S. government sponsored
agencies. The policy statement was amended to include additional
examples.
Some commenters expressed concern over supervisory expectations for
CFP testing. These commenters assert that the agencies need to clarify
their expectations for testing of components of the CFP.
The agencies agreed with the commenters and have amended the policy
statement to include a recognition that testing of certain elements of
the CFP may be impractical. For example, this may include the sale of
assets in which the sale of such assets may have unintended market
consequences. However, other components of the CFP can and should be
tested (e.g., operational components such as ensuring that roles and
responsibilities are up-to-date and appropriate; ensuring that legal
and operational documents are current and appropriate; and ensuring
that cash collateral can be moved where and when needed and back-up
liquidity lines can be drawn).
Two credit union commenters questioned the need for NCUA to adopt
the proposed policy statement in light of existing guidance in NCUA's
Examiner's Guide. The commenters questioned the appropriateness of
imposing new requirements on credit unions. The purpose of the policy
statement is to reiterate the process and liquidity risk management
measures that depository institutions, including federally insured
credit unions, should follow to appropriately manage related risks. The
policy statement does not impose requirements and contemplates
flexibility in its application. The policy statement is also not
intended to replace the NCUA's Examiner's Guide but provides a uniform
set of sound business practices, with the expectation that each
institution will scale the guidance to its complexity and risk profile.
The policy statement, when issued by NCUA, will likely be an attachment
to an NCUA Letter to Credit Unions. The letter will provide additional
guidance to federally insured credit unions on NCUA's expectations. The
two credit union commenters also characterized the policy statement as
imposing additional burden on federally insured credit unions,
specifically as it relates to stress testing and overall liquidity
management reporting. Depending on a credit union's risk profile, such
testing and reporting is already expected. NCUA ``Letter to Credit
Unions 02-CU-05, Examination Program Liquidity Questionnaire'', issued
in March of 2002, includes examiner review of stress testing performed
as well as an overall assessment of the adequacy of management
reporting.\5\ The policy statement does not add to a credit union's
current burden in this regard but rather clarifies NCUA's expectation
for those credit unions with risk profiles warranting a higher degree
of liquidity risk management.
---------------------------------------------------------------------------
\5\ The letter can be found at NCUA's Web site at http://www.ncua.gov/letters/2002/02-CU-05.html.
---------------------------------------------------------------------------
Lastly, the two credit union commenters encouraged NCUA to not
include corporate credit unions within the scope of this policy
statement as the corporate credit union network may be restructured.
NCUA's intent is for the policy statement to apply only to federally
insured, natural person credit unions, not corporate credit unions and
the policy statement has been modified to clarify that point.
Accordingly, for all the reasons discussed above, the agencies have
determined that it is appropriate to adopt as final the proposed policy
statement as amended.
III. Paperwork Reduction Act
In accordance with section 3512 of the Paperwork Reduction Act of
1995, 44 U.S.C. 3501-3521 (PRA), the Agencies may not conduct or
sponsor, and the respondent is not required to respond to, an
information collection unless it displays a currently valid Office of
Management and Budget (OMB) control number. The information collection
requirements contained in this guidance have been submitted to OMB for
approval.
On July 6, 2009,\6\ the agencies sought comment on the burden
estimates for this information collection. The comments are summarized
below.
---------------------------------------------------------------------------
\6\ 74 FR 32035.
---------------------------------------------------------------------------
Comments continue to be invited on:
(a) Whether the collection of information is necessary for the
proper performance of the Federal banking agencies' functions,
including whether the information has practical utility;
(b) The accuracy of the estimates of the burden of the information
collection, including the validity of the methodology and assumptions
used;
(c) Ways to enhance the quality, utility, and clarity of the
information to be collected;
(d) Ways to minimize the burden of the information collection on
respondents, including through the use of automated collection
techniques or other forms of information technology; and
(e) Estimates of capital or start up costs and costs of operation,
maintenance, and purchase of services to provide information.
Comments on these questions should be directed to:
OCC: Communications Division, Office of the Comptroller of the
Currency, Mailstop 2-3, Attention 1557-NEW, 250 E Street, SW.,
Washington, DC 20219. In addition comments may be sent by fax to (202)
874-5274, or by electronic mail to [email protected]. You may
personally inspect and photocopy comments at the OCC, 250 E Street,
SW., Washington, DC. For security reasons, the OCC requires that
visitors make an appointment to inspect comments. You may do so by
calling (202) 874-4700. Upon arrival, visitors will be required to
present valid government-issued photo identification and to submit to
security screening in order to inspect and photocopy comments.
FRB: You may submit comments, identified by Docket No. OP-1362, by
any of the following methods:
Agency Web site: http://www.federalreserve.gov. Follow the
instructions for submitting comments at http://www.federalreserve.gov/generalinfo/foia/ProposedRegs.cfm.
Federal eRulemaking Portal: http://www.regulations.gov.
Follow the instructions for submitting comments.
E-mail: [email protected]. Include the
docket number in the subject line of the message.
FAX: 202/452-3819 or 202/452-3102.
Mail: Jennifer J. Johnson, Secretary, Board of Governors
of the Federal Reserve System, 20th Street and Constitution Avenue,
NW., Washington, DC 20551.
[[Page 13659]]
All public comments are available from the FRB's Web site at http://www.federalreserve.gov/generalinfo/foia/ProposedRegs.cfm as submitted,
unless modified for technical reasons. Accordingly, your comments will
not be edited to remove any identifying or contact information. Public
comments may also be viewed in electronic or paper form in Room MP-500
of the FRB's Martin Building (20th and C Streets, NW.) between 9 a.m.
and 5 p.m. on weekdays.
FDIC: Interested parties are invited to submit written comments.
All comments should refer to the name of the collection, ``Liquidity
Risk Management.'' Comments may be submitted by any of the following
methods:
http://www.FDIC.gov/regulations/laws/federal/propose.html.
E-mail: [email protected].
Mail: Leneta G. Gregorie (202.898.3719), Counsel, Federal
Deposit Insurance Corporation, PA1730-3000, 550 17th Street, NW.,
Washington, DC 20429.
Hand Delivery: Comments may be hand-delivered to the guard
station at the rear of the 550 17th Street Building (located on F
Street), on business days between 7 a.m. and 5 p.m.
OTS: Send comments, referring to the collection by title of the
proposal or by OMB approval number, to OMB and OTS at these addresses:
Office of Information and Regulatory Affairs, Attention: Desk Officer
for OTS, U.S. Office of Management and Budget, 725-17th Street, NW.,
Room 10235, Washington, DC 20503, or by fax to (202) 395-6974; and
Information Collection Comments, Chief Counsel's Office, Office of
Thrift Supervision, 1700 G Street, NW., Washington, DC 20552, by fax to
(202) 906-6518, or by e-mail to [email protected].
OTS will post comments and the related index on the OTS Internet Site
at http://www.ots.treas.gov. In addition, interested persons may
inspect comments at the Public Reading Room, 1700 G Street, NW., by
appointment. To make an appointment, call (202) 906-5922, send an e-
mail to public.info@ots.treas.gov">public.info@ots.treas.gov, or send a facsimile transmission to
(202) 906-7755.
NCUA: You may submit comments by any of the following methods
(Please send comments by one method only):
Federal eRulemaking Portal: http://www.regulations.gov.
Follow the instructions for submitting comments.
NCUA Web Site: http://www.ncua.gov/Resources/RegulationsOpinionsLaws/ProposedRegulations.aspx Follow the
instructions for submitting comments.
E-mail: Address to [email protected]. Include ``[Your
name] Comments on Proposed Interagency Guidance--Funding and Liquidity
Risk Management,'' in the e-mail subject line.
Fax: (703) 518-6319. Use the subject line described above
for e-mail.
Mail: Address to Mary F. Rupp, Secretary of the Board,
National Credit Union Administration, 1775 Duke Street, Alexandria,
Virginia 22314-3428.
Hand Delivery/Courier: Same as mail address.
Public inspection: All public comments are available on the
agency's Web site at http://www.ncua.gov/Resources/RegulationsOpinionsLaws/ProposedRegulations.aspx as submitted, except
as may not be possible for technical reasons. Public comments will not
be edited to remove any identifying or contact information. Paper
copies of comments may be inspected in NCUA's law library, at 1775 Duke
Street, Alexandria, Virginia 22314, by appointment weekdays between 9
a.m. and 3 p.m. To make an appointment, call (703) 518-6546 or send an
e-mail to --OGC Mail @ncua.gov.
You should send a copy of your comments to the OMB Desk Officer for
the agencies, by mail to U.S. Office of Management and Budget, 725 17th
Street, NW., 10235, Washington, DC 20503, or by fax to (202)
395-6974.
Title of Information Collection: Funding and Liquidity Risk
Management.
OMB Control Numbers: New collection; to be assigned by OMB.
Abstract: Section 14 states that institutions should consider
liquidity costs, benefits, and risks in strategic planning and
budgeting processes. Significant business activities should be
evaluated for liquidity risk exposure as well as profitability. More
complex and sophisticated institutions should incorporate liquidity
costs, benefits, and risks in the internal product pricing, performance
measurement, and new product approval process for all material business
lines, products and activities. Incorporating the cost of liquidity
into these functions should align the risk-taking incentives of
individual business lines with the liquidity risk exposure their
activities create for the institution as a whole. The quantification
and attribution of liquidity risks should be explicit and transparent
at the line management level and should include consideration of how
liquidity would be affected under stressed conditions.
Section 20 would require that liquidity risk reports provide
aggregate information with sufficient supporting detail to enable
management to assess the sensitivity of the institution to changes in
market conditions, its own financial performance, and other important
risk factors. Institutions should also report on the use of and
availability of government support, such as lending and guarantee
programs, and implications on liquidity positions, particularly since
these programs are generally temporary or reserved as a source for
contingent funding.
Comment Summary: The OCC, FRB, and OTS received one comment
regarding its burden estimates under the Paperwork Reduction Act. The
comment, which was from a trade association, stated that some community
banks with less than $10 billion in assets reported to them that the
estimate of 80 burden hours for small respondents is accurate. Other
community banks estimated that it would take significantly longer,
especially in the first year of implementation. The agencies have
determined that, on average, the burden estimate is accurate and,
therefore they have not changed the burden estimates in the final
policy statement.
The NCUA received two comments from trade organizations regarding
the Paperwork Reduction Act, section III, items (a) through (e). One
commenter stated that no additional information should be required of
credit unions if they are following current procedures addressed in
NCUA's Examiner's Guide. Sections 14 and 20 of the proposed guidance
include specific analysis and reporting expectations based on the
complexity of the credit union and risk profile. The time estimates
provided by NCUA reflect the estimated amount of time if credit unions
complied with those expectations. The time burden estimate is not in
addition to complying with NCUA Examiner's Guide and such analysis and
reporting are existing expectations for complex, higher risk credit
unions (refer to Letter to Credit Unions 02-CU-05). It is difficult to
accurately estimate how many credit unions would have an implementation
burden for Sections 14 and 20 under the proposed guidance and the
extent of that additional burden. It is largely dependent upon the
structure of the credit union and the inherent risks present, which
will fluctuate over time. The initial comment period for the guidance
solicited comments on time burden estimates. No specific responses were
provided from credit unions to support or challenge the time estimates
provided. The time estimates provided
[[Page 13660]]
are an average per credit union based on asset size alone and may not
accurately reflect the time necessary for a particular credit union to
comply with the expectations of Sections 14 and 20.
Affected Public:
OCC: National banks, their subsidiaries, and federal branches or
agencies of foreign banks.
FRB: Bank holding companies, state member banks, state-licensed
branches and agencies of foreign banks (other than insured branches),
and corporations organized or operating under sections 25 or 25A of the
Federal Reserve Act (Agreement corporations and Edge corporations).
FDIC: Insured state nonmember banks.
OTS: Federal savings associations and their affiliated holding
companies.
NCUA: Federally-insured credit unions.
Type of Review: Regular.
Estimated Burden:
OCC:
Number of respondents: 1,560 total (13 large (over $100 billion in
assets), 29 mid-size ($10-$100 billion), 1,518 small (less than $10
billion)).
Burden Under Section 14: 720 hours per large respondent, 240 hours
per mid-size respondent, and 80 hours per small respondent.
Burden under Section 20: 4 hours per month.
Total estimated annual burden: 212,640 hours.
FRB:
Number of respondents: 6,156 total (29 large (over $100 billion in
assets); 117 mid-size ($10-$100 billion); and 6,010 small (less than
$10 billion).
Burden under Section 14: 720 hours per large respondent, 240 hours
per mid-size respondent, and 80 hours per small respondent.
Burden under Section 20: 4 hours per month.
Total estimated annual burden: 825,248 hours.
FDIC:
Number of respondents: 5,076 total (10 large (over $20 billion in
assets), 309 mid-size ($1-$20 billion), 4,757 small (less than $1
billion)).
Burden under Section 14: 720 hours per large respondent, 240 hours
per mid-size respondent, and 80 hours per small respondent.
Burden under Section 20: 4 hours per month.
Total estimated annual burden: 705,564.
OTS:
Number of respondents: 801 total (14 large (over $100 billion in
assets), 104 mid-size ($10-$100 billion), 683 small (less than $10
billion)).
Burden under Section 14: 720 hours per large respondent, 240 hours
per mid-size respondent, and 80 hours per small respondent.
Burden under Section 20: 4 hours per month.
Total estimated annual burden: 128,128.
NCUA:
Number of respondents: 7,736 total (153 large (over $1 billion in
assets), 501 mid-size ($250 million to $1 billion), and 7,082 small
(less than $250 million)).
Burden under Section 14: 240 hours per large respondent, 80 hours
per mid-size respondent, and 20 hours per small respondent.
Burden under Section 20: 2 hours per month.
Total estimated annual burden: 404,104.
IV. Guidance
The text of the Interagency Policy Statement on Funding and
Liquidity Risk Management is as follows:
Interagency Policy Statement on Funding and Liquidity Risk Management
1. The Office of the Comptroller of the Currency (OCC), Board of
Governors of the Federal Reserve System (FRB), Federal Deposit
Insurance Corporation (FDIC), the Office of Thrift Supervision (OTS),
and the National Credit Union Administration (NCUA) (collectively, the
agencies) in conjunction with the Conference of State Bank Supervisors
(CSBS) \7\ are issuing this guidance to provide consistent interagency
expectations on sound practices for managing funding and liquidity
risk. The guidance summarizes the principles of sound liquidity risk
management that the agencies have issued in the past \8\ and, where
appropriate, harmonizes these principles with the international
statement recently issued by the Basel Committee on Banking Supervision
titled ``Principles for Sound Liquidity Risk Management and
Supervision.'' \9\
---------------------------------------------------------------------------
\7\ The various state banking supervisors may implement this
policy statement through their individual supervisory process.
\8\ For national banks, see the Comptroller's Handbook on
Liquidity. For state member banks and bank holding companies, see
the Federal Reserve's Commercial Bank Examination Manual (section
4020), Bank Holding Company Supervision Manual (section 4010), and
Trading and Capital Markets Activities Manual (section 2030). For
state non-member banks, see the FDIC's Revised Examination Guidance
for Liquidity and Funds Management (Trans. No. 2002-01) (Nov. 19,
2001) as well as Financial Institution Letter 84-2008, Liquidity
Risk Management (August 2008). For savings associations, see the
Office of Thrift Supervision's Examination Handbook, section 530,
``Cash Flow and Liquidity Management''; and the Holding Companies
Handbook, section 600. For federally insured credit unions, see
Letter to Credit Unions No. 02-CU-05, Examination Program Liquidity
Questionnaire (March 2002). Also see Basel Committee on Banking
Supervision, ``Principles for Sound Liquidity Risk Management and
Supervision,'' (September 2008).
\9\ Basel Committee on Banking Supervision, ``Principles for
Sound Liquidity Risk Management and Supervision'', September 2008.
See http://www.bis.org/publ/bcbs144.htm. Federally insured credit
unions are not directly referenced in the principles issued by the
Basel Committee.
---------------------------------------------------------------------------
2. Recent events illustrate that liquidity risk management at many
financial institutions is in need of improvement. Deficiencies include
insufficient holdings of liquid assets, funding risky or illiquid asset
portfolios with potentially volatile short-term liabilities, and a lack
of meaningful cash flow projections and liquidity contingency plans.
3. The following guidance reiterates the process that institutions
should follow to appropriately identify, measure, monitor, and control
their funding and liquidity risk. In particular, the guidance re-
emphasizes the importance of cash flow projections, diversified funding
sources, stress testing, a cushion of liquid assets, and a formal well-
developed contingency funding plan (CFP) as primary tools for measuring
and managing liquidity risk. The agencies expect every depository
financial institution \10\ to manage liquidity risk using processes and
systems that are commensurate with the institution's complexity, risk
profile, and scope of operations. Liquidity risk management processes
and plans should be well documented and available for supervisory
review. Failure to maintain an adequate liquidity risk management
process will be considered an unsafe and unsound practice.
---------------------------------------------------------------------------
\10\ Unless otherwise indicated, this interagency guidance uses
the term ``depository financial institutions'' or ``institutions''
to include banks, saving associations, and federally insured natural
person credit unions. Federally insured credit unions (FICUs) do not
have holding company affiliations, and, therefore, references to
holding companies contained within this guidance are not applicable
to FICUs.
---------------------------------------------------------------------------
Liquidity and Liquidity Risk
4. Liquidity is a financial institution's capacity to meet its cash
and collateral obligations at a reasonable cost. Maintaining an
adequate level of liquidity depends on the institution's ability to
efficiently meet both expected and unexpected cash flows and collateral
needs without adversely affecting either daily operations or the
financial condition of the institution.
5. Liquidity risk is the risk that an institution's financial
condition or overall safety and soundness is adversely affected by an
inability (or perceived inability) to meet its
[[Page 13661]]
obligations. An institution's obligations, and the funding sources used
to meet them, depend significantly on its business mix, balance-sheet
structure, and the cash flow profiles of its on- and off-balance-sheet
obligations. In managing their cash flows, institutions confront
various situations that can give rise to increased liquidity risk.
These include funding mismatches, market constraints on the ability to
convert assets into cash or in accessing sources of funds (i.e., market
liquidity), and contingent liquidity events. Changes in economic
conditions or exposure to credit, market, operation, legal, and
reputation risks also can affect an institution's liquidity risk
profile and should be considered in the assessment of liquidity and
asset/liability management.
Sound Practices of Liquidity Risk Management
6. An institution's liquidity management process should be
sufficient to meet its daily funding needs and cover both expected and
unexpected deviations from normal operations. Accordingly, institutions
should have a comprehensive management process for identifying,
measuring, monitoring, and controlling liquidity risk. Because of the
critical importance to the viability of the institution, liquidity risk
management should be fully integrated into the institution's risk
management processes. Critical elements of sound liquidity risk
management include:
Effective corporate governance consisting of oversight by
the board of directors and active involvement by management in an
institution's control of liquidity risk.
Appropriate strategies, policies, procedures, and limits
used to manage and mitigate liquidity risk.
Comprehensive liquidity risk measurement and monitoring
systems (including assessments of the current and prospective cash
flows or sources and uses of funds) that are commensurate with the
complexity and business activities of the institution.
Active management of intraday liquidity and collateral.
An appropriately diverse mix of existing and potential
future funding sources.
Adequate levels of highly liquid marketable securities
free of legal, regulatory, or operational impediments, that can be used
to meet liquidity needs in stressful situations.
Comprehensive contingency funding plans (CFPs) that
sufficiently address potential adverse liquidity events and emergency
cash flow requirements.
Internal controls and internal audit processes sufficient
to determine the adequacy of the institution's liquidity risk
management process.
Supervisors will assess these critical elements in their reviews of
an institution's liquidity risk management process in relation to its
size, complexity, and scope of operations.
Corporate Governance
7. The board of directors is ultimately responsible for the
liquidity risk assumed by the institution. As a result, the board
should ensure that the institution's liquidity risk tolerance is
established and communicated in such a manner that all levels of
management clearly understand the institution's approach to managing
the trade-offs between liquidity risk and short-term profits. The board
of directors or its delegated committee of board members should oversee
the establishment and approval of liquidity management strategies,
policies and procedures, and review them at least annually. In
addition, the board should ensure that it:
Understands the nature of the liquidity risks of its
institution and periodically reviews information necessary to maintain
this understanding.
Establishes executive-level lines of authority and
responsibility for managing the institution's liquidity risk.
Enforces management's duties to identify, measure,
monitor, and control liquidity risk.
Understands and periodically reviews the institution's
CFPs for handling potential adverse liquidity events.
Understands the liquidity risk profiles of important
subsidiaries and affiliates as appropriate.
8. Senior management is responsible for ensuring that board-
approved strategies, policies, and procedures for managing liquidity
(on both a long-term and day-to-day basis) are appropriately executed
within the lines of authority and responsibility designated for
managing and controlling liquidity risk. This includes overseeing the
development and implementation of appropriate risk measurement and
reporting systems, liquid buffers (e.g., cash, unencumbered marketable
securities, and market instruments), CFPs, and an adequate internal
control infrastructure. Senior management is also responsible for
regularly reporting to the board of directors on the liquidity risk
profile of the institution.
9. Senior management should determine the structure,
responsibilities, and controls for managing liquidity risk and for
overseeing the liquidity positions of the institution. These elements
should be clearly documented in liquidity risk policies and procedures.
For institutions comprised of multiple entities, such elements should
be fully specified and documented in policies for each material legal
entity and subsidiary. Senior management should be able to monitor
liquidity risks for each entity across the institution on an ongoing
basis. Processes should be in place to ensure that the group's senior
management is actively monitoring and quickly responding to all
material developments and reporting to the boards of directors as
appropriate.
10. Institutions should clearly identify the individuals or
committees responsible for implementing and making liquidity risk
decisions. When an institution uses an asset/liability committee (ALCO)
or other similar senior management committee, the committee should
actively monitor the institution's liquidity profile and should have
sufficiently broad representation across major institutional functions
that can directly or indirectly influence the institution's liquidity
risk profile (e.g., lending, investment securities, wholesale and
retail funding). Committee members should include senior managers with
authority over the units responsible for executing liquidity-related
transactions and other activities within the liquidity risk management
process. In addition, the committee should ensure that the risk
measurement system adequately identifies and quantifies risk exposure.
The committee also should ensure that the reporting process
communicates accurate, timely, and relevant information about the level
and sources of risk exposure.
Strategies, Policies, Procedures, and Risk Tolerances
11. Institutions should have documented strategies for managing
liquidity risk and clear policies and procedures for limiting and
controlling risk exposures that appropriately reflect the institution's
risk tolerances. Strategies should identify primary sources of funding
for meeting daily operating cash outflows, as well as seasonal and
cyclical cash flow fluctuations. Strategies should also address
alternative responses to various
[[Page 13662]]
adverse business scenarios.\11\ Policies and procedures should provide
for the formulation of plans and courses of actions for dealing with
potential temporary, intermediate-term, and long-term liquidity
disruptions. Policies, procedures, and limits also should address
liquidity separately for individual currencies, legal entities, and
business lines, when appropriate and material, and should allow for
legal, regulatory, and operational limits for the transferability of
liquidity as well. Senior management should coordinate the
institution's liquidity risk management with disaster, contingency, and
strategic planning efforts, as well as with business line and risk
management objectives, strategies, and tactics.
---------------------------------------------------------------------------
\11\ In formulating liquidity management strategies, members of
complex banking groups should take into consideration their legal
structures (e.g., branches versus separate legal entities and
operating subsidiaries), key business lines, markets, products, and
jurisdictions in which they operate.
---------------------------------------------------------------------------
12. Policies should clearly articulate a liquidity risk tolerance
that is appropriate for the business strategy of the institution
considering its complexity, business mix, liquidity risk profile, and
its role in the financial system. Policies should also contain
provisions for documenting and periodically reviewing assumptions used
in liquidity projections. Policy guidelines should employ both
quantitative targets and qualitative guidelines. For example, these
measurements, limits, and guidelines may be specified in terms of the
following measures and conditions, as applicable:
Cash flow projections that include discrete and cumulative
cash flow mismatches or gaps over specified future time horizons under
both expected and adverse business conditions.
Target amounts of unencumbered liquid asset reserves.
Measures used to identify unstable liabilities and liquid
asset coverage ratios. For example, these may include ratios of
wholesale funding to total liabilities, potentially volatile retail
(e.g., high-cost or out-of-market) deposits to total deposits, and
other liability dependency measures, such as short-term borrowings as a
percent of total funding.
Asset concentrations that could increase liquidity risk
through a limited ability to convert to cash (e.g., complex financial
instruments,\12\ bank-owned (corporate-owned) life insurance, and less
marketable loan portfolios).
---------------------------------------------------------------------------
\12\ Financial instruments that are illiquid, difficult to
value, or marked by the presence of cash flows that are irregular,
uncertain, or difficult to model.
---------------------------------------------------------------------------
Funding concentrations that address diversification of
funding sources and types, such as large liability and borrowed funds
dependency, secured versus unsecured funding sources, exposures to
single providers of funds, exposures to funds providers by market
segments, and different types of brokered deposits or wholesale
funding.
Funding concentrations that address the term, re-pricing,
and market characteristics of funding sources with consideration given
to the nature of the assets they fund. This may include diversification
targets for short-, medium-, and long-term funding; instrument type and
securitization vehicles; and guidance on concentrations for currencies
and geographical markets.
Contingent liability exposures such as unfunded loan
commitments, lines of credit supporting asset sales or securitizations,
and collateral requirements for derivatives transactions and various
types of secured lending.
Exposures of material activities, such as securitization,
derivatives, trading, transaction processing, and international
activities, to broad systemic and adverse financial market events. This
is most applicable to institutions with complex and sophisticated
liquidity risk profiles.
Alternative measures and conditions may be appropriate for
certain institutions.
13. Policies also should specify the nature and frequency of
management reporting. In normal business environments, senior managers
should receive liquidity risk reports at least monthly, while the board
of directors should receive liquidity risk reports at least quarterly.
Depending upon the complexity of the institution's business mix and
liquidity risk profile, management reporting may need to be more
frequent. Regardless of an institution's complexity, it should have the
ability to increase the frequency of reporting on short notice, if the
need arises. Liquidity risk reports should impart to senior management
and the board a clear understanding of the institution's liquidity risk
exposure, compliance with risk limits, consistency between management's
strategies and tactics, and consistency between these strategies and
the board's expressed risk tolerance.
14. Institutions should consider liquidity costs, benefits, and
risks in strategic planning and budgeting processes. Significant
business activities should be evaluated for both liquidity risk
exposure and profitability. More complex and sophisticated institutions
should incorporate liquidity costs, benefits, and risks in the internal
product pricing, performance measurement, and new product approval
process for all material business lines, products, and activities.
Incorporating the cost of liquidity into these functions should align
the risk-taking incentives of individual business lines with the
liquidity risk exposure their activities create for the institution as
a whole. The quantification and attribution of liquidity risks should
be explicit and transparent at the line management level and should
include consideration of how liquidity would be affected under stressed
conditions.
Liquidity Risk Measurement, Monitoring, and Reporting
15. The process of measuring liquidity risk should include robust
methods for comprehensively projecting cash flows arising from assets,
liabilities, and off-balance-sheet items over an appropriate set of
time horizons. For example, time buckets may be daily for very short
timeframes out to weekly, monthly, and quarterly for longer time
frames. Pro forma cash flow statements are a critical tool for
adequately managing liquidity risk. Cash flow projections can range
from simple spreadsheets to very detailed reports depending upon the
complexity and sophistication of the institution and its liquidity risk
profile under alternative scenarios. Given the critical importance that
assumptions play in constructing measures of liquidity risk and
projections of cash flows, institutions should ensure that the
assumptions used are reasonable, appropriate, and adequately
documented. Institutions should periodically review and formally
approve these assumptions. Institutions should focus particular
attention on the assumptions used in assessing the liquidity risk of
complex assets, liabilities, and off-balance-sheet positions.
Assumptions applied to positions with uncertain cash flows, including
the stability of retail and brokered deposits and secondary market
issuances and borrowings, are especially important when they are used
to evaluate the availability of alternative sources of funds under
adverse contingent liquidity scenarios. Such scenarios include, but are
not limited to, deterioration in the institution's asset quality or
capital adequacy.
16. Institutions should ensure that assets are properly valued
according to relevant financial reporting and supervisory standards. An
institution should fully factor into its risk
[[Page 13663]]
management practices the consideration that valuations may deteriorate
under market stress and take this into account in assessing the
feasibility and impact of asset sales on its liquidity position during
stress events.
17. Institutions should ensure that their vulnerabilities to
changing liquidity needs and liquidity capacities are appropriately
assessed within meaningful time horizons, including intraday, day-to-
day, short-term weekly and monthly horizons, medium-term horizons of up
to one year, and longer-term liquidity needs of one year or more. These
assessments should include vulnerabilities to events, activities, and
strategies that can significantly strain the capability to generate
internal cash.
Stress Testing
18. Institutions should conduct stress tests regularly for a
variety of institution-specific and marketwide events across multiple
time horizons. The magnitude and frequency of stress testing should be
commensurate with the complexity of the financial institution and the
level of its risk exposures. Stress test outcomes should be used to
identify and quantify sources of potential liquidity strain and to
analyze possible impacts on the institution's cash flows, liquidity
position, profitability, and solvency. Stress tests should also be used
to ensure that current exposures are consistent with the financial
institution's established liquidity risk tolerance. Management's active
involvement and support is critical to the effectiveness of the stress
testing process. Management should discuss the results of stress tests
and take remedial or mitigating actions to limit the institution's
exposures, build up a liquidity cushion, and adjust its liquidity
profile to fit its risk tolerance. The results of stress tests should
also play a key role in shaping the institution's contingency planning.
As such, stress testing and contingency planning are closely
intertwined.
Collateral Position Management
19. An institution should have the ability to calculate all of its
collateral positions in a timely manner, including the value of assets
currently pledged relative to the amount of security required and
unencumbered assets available to be pledged. An institution's level of
available collateral should be monitored by legal entity, jurisdiction,
and currency exposure, and systems should be capable of monitoring
shifts between intraday and overnight or term collateral usage. An
institution should be aware of the operational and timing requirements
associated with accessing the collateral given its physical location
(i.e., the custodian institution or securities settlement system with
which the collateral is held). Institutions should also fully
understand the potential demand on required and available collateral
arising from various types of contractual contingencies during periods
of both marketwide and institution-specific stress.
Management Reporting
20. Liquidity risk reports should provide aggregate information
with sufficient supporting detail to enable management to assess the
sensitivity of the institution to changes in market conditions, its own
financial performance, and other important risk factors. The types of
reports or information and their timing will vary according to the
complexity of the institution's operations and risk profile. Reportable
items may include but are not limited to cash flow gaps, cash flow
projections, asset and funding concentrations, critical assumptions
used in cash flow projections, key early warning or risk indicators,
funding availability, status of contingent funding sources, or
collateral usage. Institutions should also report on the use of and
availability of government support, such as lending and guarantee
programs, and implications on liquidity positions, particularly since
these programs are generally temporary or reserved as a source for
contingent funding.
Liquidity Across Currencies, Legal Entities, and Business Lines
21. A depository institution should actively monitor and control
liquidity risk exposures and funding needs within and across
currencies, legal entities, and business lines. Also, depository
institutions should take into account operational limitations to the
transferability of liquidity, and should maintain sufficient liquidity
to ensure compliance during economically stressed periods with
applicable legal and regulatory restrictions on the transfer of
liquidity among regulated entities. The degree of centralization in
managing liquidity should be appropriate for the depository
institution's business mix and liquidity risk profile.\13\ The agencies
expect depository institutions to maintain adequate liquidity both at
the consolidated level and at significant legal entities.
---------------------------------------------------------------------------
\13\ Institutions subject to multiple regulatory jurisdictions
should have management strategies and processes that recognize the
potential limitations of liquidity transferability, as well as the
need to meet the liquidity requirements of foreign jurisdictions.
---------------------------------------------------------------------------
22. Regardless of its organizational structure, it is important
that an institution actively monitor and control liquidity risks at the
level of individual legal entities, and the group as a whole,
incorporating processes that aggregate data across multiple systems in
order to develop a group-wide view of liquidity risk exposures. It is
also important that the institution identify constraints on the
transfer of liquidity within the group.
23. Assumptions regarding the transferability of funds and
collateral should be described in liquidity risk management plans.
Intraday Liquidity Position Management
24. Intraday liquidity monitoring is an important component of the
liquidity risk management process for institutions engaged in
significant payment, settlement, and clearing activities. An
institution's failure to manage intraday liquidity effectively, under
normal and stressed conditions, could leave it unable to meet payment
and settlement obligations in a timely manner, adversely affecting its
own liquidity position and that of its counterparties. Among large,
complex organizations, the interdependencies that exist among payment
systems and the inability to meet certain critical payments has the
potential to lead to systemic disruptions that can prevent the smooth
functioning of all payment systems and money markets. Therefore,
institutions with material payment, settlement and clearing activities
should actively manage their intraday liquidity positions and risks to
meet payment and settlement obligations on a timely basis under both
normal and stressed conditions. Senior management should develop and
adopt an intraday liquidity strategy that allows the institution to:
Monitor and measure expected daily gross liquidity inflows
and outflows.
Manage and mobilize collateral when necessary to obtain
intraday credit.
Identify and prioritize time-specific and other critical
obligations in order to meet them when expected.
Settle other less critical obligations as soon as
possible.
Control credit to customers when necessary.
Ensure that liquidity planners understand the amounts of
collateral and liquidity needed to perform payment-system obligations
when assessing the organization's overall liquidity needs.
[[Page 13664]]
Diversified Funding
25. An institution should establish a funding strategy that
provides effective diversification in the sources and tenor of funding.
It should maintain an ongoing presence in its chosen funding markets
and strong relationships with funds providers to promote effective
diversification of funding sources. An institution should regularly
gauge its capacity to raise funds quickly from each source. It should
identify the main factors that affect its ability to raise funds and
monitor those factors closely to ensure that estimates of fund raising
capacity remain valid.
26. An institution should diversify available funding sources in
the short-, medium-, and long-term. Diversification targets should be
part of the medium- to long-term funding plans and should be aligned
with the budgeting and business planning process. Funding plans should
take into account correlations between sources of funds and market
conditions. Funding should also be diversified across a full range of
retail as well as secured and unsecured wholesale sources of funds,
consistent with the institution's sophistication and complexity.
Management should also consider the funding implications of any
government programs or guarantees it uses. As with wholesale funding,
the potential unavailability of government programs over the
intermediate- and long-tem should be fully considered in the
development of liquidity risk management strategies, tactics, and risk
tolerances. Funding diversification should be implemented using limits
addressing counterparties, secured versus unsecured market funding,
instrument type, securitization vehicle, and geographic market. In
general, funding concentrations should be avoided. Undue over-reliance
on any one source of funding is considered an unsafe and unsound
practice.
27. An essential component of ensuring funding diversity is
maintaining market access. Market access is critical for effective
liquidity risk management as it affects both the ability to raise new
funds and to liquidate assets. Senior management should ensure that
market access is being actively managed, monitored, and tested by the
appropriate staff. Such efforts should be consistent with the
institution's liquidity risk profile and sources of funding. For
example, access to the capital markets is an important consideration
for most large complex institutions, whereas the availability of
correspondent lines of credit and other sources of wholesale funds are
critical for smaller, less complex institutions.
28. An institution should identify alternative sources of funding
that strengthen its capacity to withstand a variety of severe
institution-specific and marketwide liquidity shocks. Depending upon
the nature, severity, and duration of the liquidity shock, potential
sources of funding include, but are not limited to, the following:
Deposit growth.
Lengthening maturities of liabilities.
Issuance of debt instruments.\14\
---------------------------------------------------------------------------
\14\ Federally insured credit unions can borrow funds (which
includes issuing debt) as given in section 106 of the Federal Credit
Union Act (FCUA). Section 106 of the FCUA as well as section 741.2
of the NCUA Rules and Regulations establish specific limitations on
the amount that can be borrowed. Federal Credit Unions can borrow
from natural persons in accordance with the requirements of part
701.38 of the NCUA Rules and Regulations.
---------------------------------------------------------------------------
Sale of subsidiaries or lines of business.
Asset securitization.
Sale (either outright or through repurchase agreements) or
pledging of liquid assets.
Drawing down committed facilities.
Borrowing.
Cushion of Liquid Assets
29. Liquid assets are an important source of both primary
(operating liquidity) and secondary (contingent liquidity) funding at
many institutions. Indeed, a critical component of an institution's
ability to effectively respond to potential liquidity stress is the
availability of a cushion of highly liquid assets without legal,
regulatory, or operational impediments (i.e., unencumbered) that can be
sold or pledged to obtain funds in a range of stress scenarios. These
assets should be held as insurance against a range of liquidity stress
scenarios including those that involve the loss or impairment of
typically available unsecured and/or secured funding sources. The size
of the cushion of such high-quality liquid assets should be supported
by estimates of liquidity needs performed under an institution's stress
testing as well as aligned with the risk tolerance and risk profile of
the institution. Management estimates of liquidity needs during periods
of stress should incorporate both contractual and noncontractual cash
flows, including the possibility of funds being withdrawn. Such
estimates should also assume the inability to obtain unsecured and
uninsured funding as well as the loss or impairment of access to funds
secured by assets other than the safest, most liquid assets.
30. Management should ensure that unencumbered, highly liquid
assets are readily available and are not pledged to payment systems or
clearing houses. The quality of unencumbered liquid assets is important
as it will ensure accessibility during the time of most need. An
institution could use its holdings of high-quality securities, for
example, U.S. Treasury securities, securities issued by U.S.
government-sponsored agencies, excess reserves at the central bank or
similar instruments, and enter into repurchase agreements in response
to the most severe stress scenarios.
Contingency Funding Plan \15\
---------------------------------------------------------------------------
\15\ Financial institutions that have had their liquidity
supported by temporary government programs administered by the
Department of the Treasury, Federal Reserve and/or FDIC should not
base their liquidity strategies on the belief that such programs
will remain in place indefinitely.
---------------------------------------------------------------------------
31. All financial institutions, regardless of size and complexity,
should have a formal CFP that clearly sets out the strategies for
addressing liquidity shortfalls in emergency situations. A CFP should
delineate policies to manage a range of stress environments, establish
clear lines of responsibility, and articulate clear implementation and
escalation procedures. It should be regularly tested and updated to
ensure that it is operationally sound. For certain components of the
CFP, affirmative testing (e.g., liquidation of assets) may be
impractical. In these instances, institutions should be sure to test
operational components of the CFP. For example, ensuring that roles and
responsibilities are up-to-date and appropriate; ensuring that legal
and operational documents are up-to-date and appropriate; and ensuring
that cash and collateral can be moved where and when needed, and
ensuring that contingent liquidity lines can be drawn when needed.
32. Contingent liquidity events are unexpected situations or
business conditions that may increase liquidity risk. The events may be
institution-specific or arise from external factors and may include:
The institution's inability to fund asset growth.
The institution's inability to renew or replace maturing
funding liabilities.
Customers unexpectedly exercising options to withdraw
deposits or exercise off-balance-sheet commitments.
Changes in market value and price volatility of various
asset types.
Changes in economic conditions, market perception, or
dislocations in the financial markets.
[[Page 13665]]
Disturbances in payment and settlement systems due to
operational or local disasters.
33. Insured institutions should be prepared for the specific
contingencies that will be applicable to them if they become less than
Well Capitalized pursuant to Prompt Correction Action (PCA) provisions
under the Federal Deposit Insurance Corporation Improvement Act.\16\
Contingencies may include restricted rates paid for deposits, the need
to seek approval from the FDIC/NCUA to accept brokered deposits, and
the inability to accept any brokered deposits.\17\
---------------------------------------------------------------------------
\16\ See 12 U.S.C. 1831o; 12 CFR 6 (OCC), 12 CFR 208.40 (FRB),
12 CFR 325.101 (FDIC), and 12 CFR 565 (OTS) and 12 U.S.C. 1790d; 12
CFR 702 (NCUA).
\17\ Section 38 of the FDI Act (12 U.S.C. 1831o) requires
insured depository institutions that are not well capitalized to
receive approval prior to engaging in certain activities. Section 38
restricts or prohibits certain activities and requires an insured
depository institution to submit a capital restoration plan when it
becomes undercapitalized. Section 216 of the Federal Credit Union
Act and part 702 of the NCUA Rules and Regulations establish the
requirements and restrictions for federally insured credit unions
under Prompt Corrective Action. For brokered, nonmember deposits,
additional restrictions apply to federal credit unions as given in
parts 701.32 and 742 of the NCUA Rules and Regulations.
---------------------------------------------------------------------------
34. A CFP provides a documented framework for managing unexpected
liquidity situations. The objective of the CFP is to ensure that the
institution's sources of liquidity are sufficient to fund normal
operating requirements under contingent events. A CFP also identifies
alternative contingent liquidity resources \18\ that can be employed
under adverse liquidity circumstances. An institution's CFP should be
commensurate with its complexity, risk profile, and scope of
operations. As macroeconomic and institution-specific conditions
change, CFPs should be revised to reflect these changes
---------------------------------------------------------------------------
\18\ There may be time constraints, sometimes lasting weeks,
encountered in initially establishing lines with FRB and/or FHLB. As
a result, financial institutions should plan to have these lines set
up well in advance.
---------------------------------------------------------------------------
35. Contingent liquidity events can range from high-probability/
low-impact events to low-probability/high-impact events. Institutions
should incorporate planning for high-probability/low-impact liquidity
risks into the day-to-day management of sources and uses of funds.
Institutions can generally accomplish this by assessing possible
variations around expected cash flow projections and providing for
adequate liquidity reserves and other means of raising funds in the
normal course of business. In contrast, all financial institution CFPs
will typically focus on events that, while relatively infrequent, could
significantly impact the institution's operations. A CFP should:
Identify Stress Events. Stress events are those that may
have a significant impact on the institution's liquidity given its
specific balance-sheet structure, business lines, organizational
structure, and other characteristics. Possible stress events may
include deterioration in asset quality, changes in agency credit
ratings, PCA capital categories and CAMELS \19\ ratings downgrades,
widening of credit default spreads, operating losses, declining
financial institution equity prices, negative press coverage, or other
events that may call into question an institution's ability to meet its
obligations.
---------------------------------------------------------------------------
\19\ Federally insured credit unions are evaluated using the
``CAMEL'' rating system, which is substantially similar to the
``CAMELS'' system without the ``S'' component for rating Sensitivity
to market risk. Information on NCUA's rating system can be found in
Letter to Credit Unions 07-CU-12, CAMEL Rating System.
---------------------------------------------------------------------------
Assess Levels of Severity and Timing. The CFP should
delineate the various levels of stress severity that can occur during a
contingent liquidity event and identify the different stages for each
type of event. The events, stages, and severity levels identified
should include temporary disruptions, as well as those that might be
more intermediate term or longer-term. Institutions can use the
different stages or levels of severity identified to design early-
warning indicators, assess potential funding needs at various points in
a developing crisis, and specify comprehensive action plans. The length
of the scenario will be determined by the type of stress event being
modeled and should encompass the duration of the event.
Assess Funding Sources and Needs. A critical element of
the CFP is the quantitative projection and evaluation of expected
funding needs and funding capacity during the stress event. This
entails an analysis of the potential erosion in funding at alternative
stages or severity levels of the stress event and the potential cash
flow mismatches that may occur during the various stress levels.
Management should base such analysis on realistic assessments of the
behavior of funds providers during the event and incorporate
alternative contingency funding sources. The analysis also should
include all material on- and off-balance-sheet cash flows and their
related effects. The result should be a realistic analysis of cash
inflows, outflows, and funds availability at different time intervals
during the potential liquidity stress event in order to measure the
institution's ability to fund operations. Common tools to assess
funding mismatches include:
[cir] Liquidity gap analysis--A cash flow report that essentially
represents a base case estimate of where funding surpluses and
shortfalls will occur over various future time frames.
[cir] Stress tests--A pro forma cash flow report with the ability
to estimate future funding surpluses and shortfalls under various
liquidity stress scenarios and the institution's ability to fund
expected asset growth projections or sustain an orderly liquidation of
assets under various stress events.
Identify Potential Funding Sources. Because liquidity
pressures may spread from one funding source to another during a
significant liquidity event, institutions should identify alternative
sources of liquidity and ensure ready access to contingent funding
sources. In some cases, these funding sources may rarely be used in the
normal course of business. Therefore, institutions should conduct
advance planning and periodic testing to ensure that contingent funding
sources are readily available when needed.
Establish Liquidity Event Management Processes. The CFP
should provide for a reliable crisis management team and administrative
structure, including realistic action plans used to execute the various
elements of the plan for given levels of stress. Frequent communication
and reporting among team members, the board of directors, and other
affected managers optimize the effectiveness of a contingency plan
during an adverse liquidity event by ensuring that business decisions
are coordinated to minimize further disruptions to liquidity. Such
events may also require the daily computation of regular liquidity risk
reports and supplemental information. The CFP should provide for more
frequent and more detailed reporting as the stress situation
intensifies.
Establish a Monitoring Framework for Contingent Events.
Institution management should monitor for potential liquidity stress
events by using early-warning indicators and event triggers. The
institution should tailor these indicators to its specific liquidity
risk profile. The early recognition of potential events allows the
institution to position itself into progressive states of readiness as
the event evolves, while providing a framework to report or communicate
within the institution and to outside parties. Early-warning signals
may include, but are not limited to, negative publicity concerning an
asset class owned by the institution, increased potential for
deterioration in
[[Page 13666]]
the institution's financial condition, widening debt or credit default
swap spreads, and increased concerns over the funding of off-balance-
sheet items.
36. To mitigate the potential for reputation contagion, effective
communication with counterparties, credit-rating agencies, and other
stakeholders when liquidity problems arise is of vital importance.
Smaller institutions that rarely interact with the media should have
plans in place for how they will manage press inquiries that may arise
during a liquidity event. In addition, groupwide contingency funding
plans, liquidity cushions, and multiple sources of funding are
mechanisms that may mitigate reputation concerns.
37. In addition to early-warning indicators, institutions that
issue public debt, use warehouse financing, securitize assets, or
engage in material over-the-counter derivative transactions typically
have exposure to event triggers embedded in the legal documentation
governing these transactions. Institutions that rely upon brokered
deposits should also incorporate PCA-related downgrade triggers into
their CFPs since a change in PCA status could have a material bearing
on the availability of this funding source. Contingent event triggers
should be an integral part of the liquidity risk monitoring system.
Institutions that originate and/or purchase loans for asset
securitization programs pose heightened liquidity risk concerns due to
the unexpected funding needs associated with an early amortization
event or disruption of warehouse funding. Institutions that securitize
assets should have liquidity contingency plans that address these
risks.
38. Institutions that rely upon secured funding sources also are
subject to potentially higher margin or collateral requirements that
may be triggered upon the deterioration of a specific portfolio of
exposures or the overall financial condition of the institution. The
ability of a financially stressed institution to meet calls for
additional collateral should be considered in the CFP. Potential
collateral values also should be subject to stress tests since
devaluations or market uncertainty could reduce the amount of
contingent funding that can be obtained from pledging a given asset.
Additionally, triggering events should be understood and monitored by
liquidity managers.
39. Institutions should test various elements of the CFP to assess
their reliability under times of stress. Institutions that rarely use
the type of funds they identify as standby sources of liquidity in a
stress situation, such as the sale or securitization of loans,
securities repurchase agreements, Federal Reserve discount window
borrowing, or other sources of funds, should periodically test the
operational elements of these sources to ensure that they work as
anticipated. However, institutions should be aware that during real
stress events, prior market access testing does not guarantee that
these funding sources will remain available within the same time frames
and/or on the same terms.
40. Larger, more complex institutions can benefit by employing
operational simulations to test communications, coordination, and
decision making involving managers with different responsibilities, in
different geographic locations, or at different operating subsidiaries.
Simulations or tests run late in the day can highlight specific
problems such as difficulty in selling assets or borrowing new funds at
a time when business in the capital markets may be less active.
Internal Controls
41. An institution's internal controls consist of procedures,
approval processes, reconciliations, reviews, and other mechanisms
designed to provide assurance that the institution manages liquidity
risk consistent with board-approved policy. Appropriate internal
controls should address relevant elements of the risk management
process, including adherence to policies and procedures, the adequacy
of risk identification, risk measurement, reporting, and compliance
with applicable rules and regulations.
42. Management should ensure that an independent party regularly
reviews and evaluates the various components of the institution's
liquidity risk management process. These reviews should assess the
extent to which the institution's liquidity risk management complies
with both supervisory guidance and industry sound practices, taking
into account the level of sophistication and complexity of the
institution's liquidity risk profile.\20\ Smaller, less-complex
institutions may achieve independence by assigning this responsibility
to the audit function or other qualified individuals independent of the
risk management process. The independent review process should report
key issues requiring attention including instances of noncompliance to
the appropriate level of management for prompt corrective action
consistent with approved policy.
---------------------------------------------------------------------------
\20\ This includes the standards established in this interagency
guidance as well as the supporting material each agency provides in
its examination manuals and handbooks directed at their supervised
institutions. Industry standards include those advanced by
recognized industry associations and groups.
Dated: March 3, 2010.
John C. Dugan,
Comptroller of the Currency.
By order of the Board of Governors of the Federal Reserve
System, March 15, 2010.
Jennifer J. Johnson,
Secretary of the Board.
Dated at Washington, DC, the 4th day of March 2010.
By order of the Federal Deposit Insurance Corporation.
Valerie J. Best,
Assistant Executive Secretary.
Dated: March 16, 2010.
By the Office of Thrift Supervision.
John E. Bowman,
Acting Director.
Dated: March 4, 2010.
By the National Credit Union Administration Board.
Mary F. Rupp,
Secretary of the Board.
[FR Doc. 2010-6137 Filed 3-19-10; 8:45 am]
BILLING CODE 6720-01-P; 4810-33-P; 6210-01-P; 6714-01-P; 7535-01-P