Ideally, the credit union accurately projects expected sources of funds versus projected liquidity needs over future periods. Liquidity risk reports clearly highlight the credit union’s liquidity position, risk exposures, and level of compliance with internal risk limits. The measurement system reports on how the credit union will meet these needs over various time horizons and under various macro-economic and stressed scenarios. Adverse systemic scenarios involve conditions or events that would likely result in an adverse impact on the credit union’s funding needs and sources. Stress testing is a useful tool for credit union management to monitor risk under adverse scenarios.
The credit union begins with base case projections that assume normal cash flows, market conditions, and business operations over a selected period. To stress test, credit unions make more extreme assumptions to determine the amount of volatility for a specific variable that would cause the credit union to exceed policy limits, maximizing borrowing capacities and/or available sources of funding.
For example, stress assumptions may involve using adverse economic scenarios that include a combination of multiple factor changes. Sensitivity analysis may involve the stress testing of a single variable to determine the individual effects on liquidity, net worth, or net interest income. Utilizing both types of stress testing enable a more comprehensive view of the risks being managed.
These stress tests and their outcomes are used to identify and quantify sources of potential liquidity strain and the impact on a credit union’s liquidity position. Stress test results indicate whether current exposures are consistent with a credit union’s liquidity risk tolerance.
Prerequisites
Perform an initial assessment of liquidity before completing this exam step.
People to Interview
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President/Manager
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Chief Financial Officer
Documents to Review
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Liquidity risk reports, including (but not limited to):
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stress tests
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cash flow gaps
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liquidity forecasts
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Liquidity Policy
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ALCO minutes
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Board minutes
Questions to Consider
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Is the frequency of cash flow forecasts, time horizon, and assumptions reasonable?
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Is there timely reporting of remaining capacity of asset-based borrowing at FHLB, FRB and other creditors? Are these remaining capacities reported monthly to the ALCO and board of directors?
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Does the credit union back test their cash flow projections for accuracy?
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Did any adverse scenarios used by the credit union result in a funding deficit? If not, how would management know what type of scenario would cause a liquidity event? Were changes in assumptions from the base case forecast to adverse scenarios reasonable in severity and type?
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Does the credit union report on the potential borrowing capacity from providers given the valuation and updated asset “haircuts” for each of the asset classes and sub-types?
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Does the credit union report on the estimated gain or loss from selling assets?
Last updated August 30, 2021
