Before the disruptions in financial markets, “planning for the unexpected” was typically described as contingency planning for disaster recovery. In today’s uncertain environment, planning for the unexpected involves a different contingency: alternative sources of liquidity.
One source of potential liquidity for banks is the Federal Reserve discount window. For smaller banks, the Fed’s primary credit program (a Fed discount window lending program) has become attractive. Loans under this program are available for up to 90 days and are priced at the primary credit rate—currently, the federal funds rate plus 25 basis points. Other banks may be interested in the Term Auction Facility (TAF). Under this program, auctions are announced and funds made available through a bidding process, similar to the process used in Treasury auctions.
For both of these facilities, the institution must be in generally sound financial condition, have filed legal documents with the Federal Reserve and pledged acceptable collateral. Details can be found on the Fed’s discount window web site.
Banks that are not eligible for participation in the TAF have special liquidity planning challenges. Contingency liquidity sources may not be as reliable as expected. For example, when an institution is designated as “undercapitalized” for prompt corrective purposes, it must seek a waiver from the FDIC for the acceptance, renewal or rollover of brokered deposits. (See Prompt Corrective Action.) Moreover, the effective yield on deposits may be subject to interest rate restrictions. (See Part 337.6(b)(3)(ii) of the FDIC’s Rules and Regulations.) Funding arrangements may also be reduced, or the lender may request the pledge of additional collateral.
Therefore, contingency liquidity planning should consider funding concentrations. Concentrations might include a large reliance on uninsured deposits, dependency on a few large depositors or a single lender, or large blocks of funds maturing near the same point in time.
Contingent liabilities should also be considered, such as unfunded loan commitments and letters of credit. Rapid changes in contingent liabilities can result in a quick drain on liquidity when sources of liquidity are no longer available.
Reviewing your bank’s liquidity position with your board of directors is a good idea. Plan for the unexpected—be comfortable that your sources are available should conditions unexpectedly change.
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