Staying Agile

In the last two years, the Fed has implemented 11 increases in the target Fed Funds rate, amounting to a total of 525 basis points. These moves were aimed at tempering the overheated economy in the wake of the COVID pandemic.

As a result of these increases, we have seen massive shifts in deposit balances as consumers have become more aware of opportunities to move balances from lower yielding non-maturity deposits into higher yielding CDs and alternative investment products. While we can’t be sure of what future market rate movements will be, or when they will occur, every financial institution must be prepared for any outcome.

Considering this era is marked by economic uncertainty and rapid shifts, understanding liquidity's critical role continues to be paramount. Here are three key reasons maintaining a strong liquidity risk management program in 2024 and beyond is not a suggestion, but a necessity, for community banks and credit unions.

Resilience Amidst Uncertainty:

Economic volatility and geopolitical tensions underscore the need for financial institutions to be agile. Liquidity management allows financial institutions to prepare for unpredictable funding needs with tools such as cash flow modeling, stress testing, what-if scenario testing, contingency funding planning, etc.

Proactively ensuring adequate cash or convertible assets for short-term obligations warrants financial stability, even in turbulent times. Whether global recessions or localized financial shocks, a robust liquidity strategy acts as a buffer against unforeseen crises. As we saw in 2023 with high-profile financial institutions succumbing to failure, a consistent pulse on every facet of the organization, including but not limited to asset liability management, is imperative.

Stress Testing for Preparedness:

Stress testing is a main component of liquidity risk management, and examiners will be looking to see that you’re utilizing it properly. By simulating adverse scenarios, financial managers gauge the organization's ability to withstand shocks, ensuring they possess the reserves necessary to weather any storm. Multiple stress tests should be modeled, including material institution-specific and systemic events. Because of this, it’s more important than ever to have a dynamic planning model which can adequately handle these tasks (i.e. if you’re still using simple spreadsheets, you may need to reconsider your technology).

Compliance with regulatory requirements not only safeguards the financial institution, but also fosters trust among customers and investors. The increasing focus of regulatory authorities on liquidity management underscores its criticality in the banking sector.

Strategic Advantage of Liquidity Risk Management:

While essential to regulators, liquidity management isn't solely about compliance; it's a strategic advantage. It empowers organizations to capitalize on market opportunities, support business growth, and enhance overall financial performance. When utilized in a practical manner, modeling for the various aspects of liquidity and cash flow can be very helpful for business planning.

Thriving in this dynamic financial landscape requires more than survival—it demands suitable liquidity strategies that ensure stability, flexibility, and sustained success.

In conclusion, liquidity management isn't merely a regulatory obligation; it's a tool to safeguard stability and ongoing resilience in today's fluctuating economy. Adapting to the ever-changing economy is essential to remaining relevant, regulatory compliant, and prepared for whatever’s ahead. Stay informed and tailor your strategies to proactively embrace all of the important elements of asset liability management.

If you struggle with any facet of liquidity/cash flow modeling, or if you’re unsure if your liquidity risk management program measures up, we can help. Plansmith has the software and advisory services to assist any-sized financial institution. And, if outsourcing is something you’re considering, our team of former FDIC and NCUA examiners can assist you by adding expertise without increasing staff, providing experienced and objective analysis, developing plans to mitigate a variety of risk, and improving ALCO board reporting.