CUNA Regulatory Comment Call
July 10, 2009
Interagency Guidance: Funding and Liquidity Risk Management
- The National Credit Union Administration (NCUA), along with other federal financial regulatory agencies, has issued proposed interagency guidance (Guidance) on funding and liquidity risk management.
- The Guidance summarizes liquidity risk management principles previously issued by the regulatory agencies, and in certain instances, more closely aligns them with the "Principles for Sound Liquidity Risk Management and Supervision" issued by the Basel Committee on Banking Supervision in 2008.
- The proposed Guidance requires institutions to have a comprehensive management process for identifying, measuring, monitoring, and controlling liquidity risk.
- Comments are due to the agencies by September 4; please submit your comments to CUNA by August 19.
Please feel free to fax your responses to CUNA at (202) 638-7052, or e-mail them to Senior Vice President and Deputy General Counsel Mary Dunn at email@example.com and Regulatory Counsel Luke Martone at firstname.lastname@example.org. You may also contact us at (800) 356-9655, ext. 6743, with any questions. Click here for the proposed Guidance in the Federal Register.
The proposed Guidance was issued in response to recent market turmoil and addresses the importance of liquidity risk management to the safety and soundness of financial institutions. The proposed Guidance summarizes the principles of sound liquidity risk management previously issued by the NCUA, Federal Reserve, Office of the Comptroller of the Currency, Federal Deposit Insurance Corporation, and the Office of Thrift Supervision (the agencies) in conjunction with the Conference of State Bank Supervisors.
The agencies have jointly released the Guidance in an effort to provide consistent interagency expectations on sound practices for managing funding and liquidity risk. The Guidance addresses the importance of cash flow projections, diversified funding sources, stress testing, an adequate amount of liquid assets, and a contingency funding plan (CFP) to manage liquidity risk.
The agencies' proposed Guidance focuses on all domestic financial institutions, including banks, thrifts, and credit unions.
BRIEF DESCRIPTION OF THE PROPOSED GUIDANCE
The Guidance recommends financial institutions manage liquidity risk using processes and systems that are commensurate with the institutions' complexity, risk profile, and scope of operations. Failure to maintain an "adequate liquidity risk management process" is considered an unsafe and unsound practice.
Proper management of an institution's cash flows is vital to adequately managing its liquidity risk-that is, the risk that the institution's financial condition or overall safety and soundness is adversely affected by its inability to meet liquidity needs. The Guidance recommends that institutions maintain a comprehensive management process for identifying, measuring, monitoring, and controlling liquidity risk, and that the liquidity risk management be fully integrated into the institution's risk management process. Proper liquidity risk management should include:
- Effective corporate governance;
- Appropriate liquidity risk strategies, policies, procedures, and limits;
- Comprehensive liquidity risk measurement and monitoring systems;
- Active management of intraday liquidity and collateral;
- Diversity of funding sources;
- Adequate levels of highly liquid securities;
- Comprehensive CFPs that address emergency cash flow needs; and
- Adequate internal controls/audit processes for assessing the liquidity risk management process.
The board of directors is ultimately responsible for the liquidity risk of an institution. As such, the boardor delegated committee of its membersshould oversee and periodically review the liquidity management strategies, policies, and procedures.
Following board approval, the institution's senior management is responsible for making sure the strategies, policies, and procedures are properly executed. Senior management is also tasked with determining the structure, responsibilities, and controls for managing liquidity risk and for overseeing the institution's liquidity positions. The individuals or committees responsible for making liquidity risk decisions should be clearly identified.
Strategies, Policies, Procedures, and Risk Tolerances
The Guidance recommends that institutions have documented strategies and policies for managing liquidity risk as well as limiting risk exposure. Such strategies should not only address funding sources for daily and seasonal needs, but should also address situations in which liquidity funding is disruptedwhether such disruption be short- or long-term. The strategic planning and budgeting processes should include assessment of the liquidity costs, benefits, and risks.
Additionally, institutions should establish an appropriate liquidity risk tolerance; this will allow management to recognize any inconsistencies between its strategies and the pre-determined tolerance. Management's strategies should be documented in periodic liquidity risk reports. The reports should include items such as: "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."
An institution's policies and procedures should contain measurements and limits relating to cash flow projections, target amounts of unpledged liquid asset reserves, asset concentrations, funding concentrations, and contingent liability exposures.
Liquidity Risk Measurement, Monitoring, and Reporting
Proper liquidity risk measurement should include components to project cash flows arising from assets, liabilities, and off balance-sheet items. Any assumptions used in the measurement process should be reasonable and reviewed periodically.
The Guidance also recommends that institutions be able to determine all of their collateral positions in a timely manner, including currently pledged assets, as well as unencumbered assets available to be pledged.
Periodic stress testing for various institution-specific and market-wide events should be conducted. Test results should determine what, if any, action management will take to alleviate the institution's liquidity risk.
Intraday Liquidity Position Management
Institutions engaged in "significant payment, settlement, and clearing activities" should establish processes for monitoring intraday liquidity. Such processes should include active management of the institution's intraday liquidity positions and risks to meet payment and settlement obligations under both normal and stressed conditions.
Proper intraday liquidity strategy should allow the institution to: monitor and measure expected daily gross liquidity in/outflows; manage and mobilize collateral when needed for intraday credit; identify and prioritize time-specific and other critical obligations; settle less critical obligations as soon as possible; control credit to customers when necessary; and ensure liquidity planners understand the collateral and liquidity needed for payment system obligations.
The Guidance encourages institutions to establish a funding strategy that effectively diversifies the sources and maturities of funding. An institution should regularly assess its ability to raise funds quickly from each source, and identify any impediments to these funds.
The diversity requirement applies to funding sources in the short-, medium-, and long-term. Institutions should understand and account for the intermittent nature of any government programs they may be relying on when developing liquidity risk management strategies. Undue over-reliance on any one source of funding is considered an unsafe and unsound practice; therefore funding concentrations should generally be avoided.
Senior management should ensure active management of market accesswhich is an essential component of proper diversification.
Cushion of Liquid Assets
Institutions should hold an appropriate amount of liquid assets as insurance against certain liquidity stress scenarios. The results of stress tests, as well as an institution's risk tolerance and profile, should dictate the size of the cushion of liquid assets.
Contingency Funding Plan (CFP)
The Guidance recommends that all financial institutions develop and implement a formal CFP to address liquidity shortfalls in emergency situations. Contingent liquidity events are unexpected situations that may increase liquidity risk, and may be institution-specific or due to external factors, such as dislocations in the financial markets. Additionally, certain contingencies will arise for insured institutions that become less than Well Capitalized pursuant to Prompt Correction Action.
A CFP provides a documented framework for managing unexpected liquidity needs. It is meant to ensure that the institution's sources of liquidity are sufficient to fund normal operating requirements during contingent events.
Generally, a CFP should: identify stress events; assess levels of severity and timing; assess funding sources and needsincluding liquidity gap analyses and stress tests; identify potential funding sources; establish liquidity event management processes; and establish a monitoring framework for contingent events.
Appropriate internal controls should address relevant elements of the risk management process, the adequacy of risk identification, risk measurement, reporting, and compliance with rules and regulations.
An institution's liquidity risk management process should be regularly reviewed by an independent party.
QUESTIONS TO CONSIDER REGARDING THE PROPOSED GUIDANCE
- Are the proposed responsibilities of the board of directors and senior management appropriate?
- Is the proposed Guidance regarding strategies, policies, and procedures of risk management consistent with current practices?
- Does the proposed guidance regarding diversified funding appear manageable?
- Does conformance with the proposed Contingency Funding Plan appear manageable?
- The proposed Guidance in its entirety (absent a section on holding companies) applies to all financial institutions and credit unions of all sizes and complexities. Is uniform application appropriate?
- Will compliance with any aspects of the proposed Guidance be problematic?
- Any other comments, questions, or concerns?
Eric Richard General Counsel (202) 508-6742 email@example.com |
Mary Mitchell Dunn SVP & Deputy General Counsel (202) 508-6736 firstname.lastname@example.org
Jeffrey Bloch Assistant General Counsel (202) 508-6732 email@example.com
Luke Martone Senior Regulatory Counsel (202) 508-6743 firstname.lastname@example.org