Banking regulators give update on liquidity risk management

ARTICLE | July 19, 2023

Authored by RSM US LLP

In a recent webcast update for banks, the Federal Reserve Board of Governors, the Office of the Comptroller of the Currency and the Federal Deposit Insurance Corp. focused on the importance of liquidity risk management, the technological impact of bank deposit outflows and numerous other issues highlighted by the bank failures earlier this year.

The May 24 webcast came as financial institutions continue navigating the fallout from the failures of Silicon Valley Bank, Signature Bank of New York and First Republic Bank. Liquidity stress testing, concentration risks and a host of customer considerations are just some areas institutions have been reassessing since those events. 

Here are five topics regulators zeroed in on during their update:

1. Liquidity risk management: The regulators emphasized that the Interagency Policy Statement on Funding and Liquidity Risk Management from 2010, otherwise known as SR 10-06, remains the primary regulatory guidance on sound asset and liability management principles. The policy statement outlines eight critical elements of liquidity and funds management that bank management should consider as they review and improve their anti-money laundering (ALM) principles.
2. Stress testing and assumptions: Webcast panelists highlighted the importance of carefully developed stress testing model assumptions and emphasized the need to update these assumptions frequently as the environment evolves. Assumptions related to depositor behavior should be updated to reflect competition, changing interest rates and current industry trends.

   The regulators further recommended that banks go beyond traditional quantitative measures and introduce conservative, qualitative overlays onto their analyses. Factors that have recently proven volatile to the industry include industry concentrations, uninsured depositors and deposit outflows under a range of scenarios, all of which have funding implications that banks need to understand and plan for.

3. Contingency funding planning and sources: Planning and operational readiness of contingent funding sources was another major focus during the session. Panelists emphasized that funding sources are often limited in times of stress, and the best practice is to ensure several diverse funding options are operationally ready, signed for and secured prior to financial stress, as well as periodically tested to ensure access.

   Panelists made it clear that the regulatory agencies would not criticize bankers for taking advantage of secondary funding sources such as the Fed discount window and the Bank Term Funding Program, which they described as prudent and reliable contingent funding source.

4. Technological impacts on deposit outflows: When panelists were asked if institutions should assume accelerated deposit outflows in their stress tests to account for technological advancements, they made clear that advances in technology have dramatically accelerated the speed at which depositors are able to withdraw funds.

   The regulators encouraged institutions to consider the increased speed of depositor withdrawals when forming contingency funding plans, and to reevaluate the granularity of time horizons in their stress testing to capture the impact of potentially immediate depositor withdrawals.

   Depending on a bank’s depositor base, cash outflow projections in terms of days or even hours could be more appropriate than weeks or months. In turn, banks should understand the functional time required to access sources of contingent funding and plan accordingly.

5. Focuses during the upcoming exam cycle: The panelists concluded their prepared comments with insight on the upcoming supervisory cycle. The regulators emphasized that there are no new expectations in place regarding liquidity risk management, and that existing standards like SR 10-06 will provide the basis for exam procedures.

   However, bank management can expect increased discussion with examiners around their ALM program given the current environment. Examiners expect banks to monitor deposit behavior closely, update model assumptions prudently and demonstrate operational readiness of their contingent funding sources.

   Examiners will scrutinize uninsured deposits and deposit concentrations, along with the impact of unrealized losses in the securities portfolio on bank liquidity, interest rate risk, earnings and capital.

Looking forward

For banks reviewing their funding and liquidity policies, the existing guidance has not changed. What has changed is the focus and emphasis by the regulatory agencies on the existing supervisory guidance.

It will be critical for banks to have sufficient documentation supporting liquidity model assumptions and how adjustments or changes to models were considered. Bankers should expect much more scrutiny applied to all aspects of their asset liability management program given the level of inherent risk in the present environment.