Key oversight and management processes are typically set forth in policies. Federal regulations require credit unions to establish the following board-approved policies regarding liquidity:
Liquidity Policy—Required for all FICUs, per NCUA regulation § 741.12(a)
- CFP—Required for FICUs with $50 million or more in assets, per NCUA regulation § 741.12(b); suggested as a sound practice for all credit unions
- Access to a contingent federal liquidity source—Required for FICUs with $250 million or more in assets, per NCUA regulation § 741.12(c), a federal or other contingent liquidity source is suggested as a sound practice for all credit unions. A credit union subject to § 741.12(c) may demonstrate access to a contingent federal liquidity source by:
Maintaining regular membership in the CLF—for more information, see NCUA regulation part 725, National Credit Union Administration Central Liquidity Facility
Maintaining membership in the CLF through an Agent, as described in § 725.2(b)
Establishing borrowing access at the Federal Reserve Discount Window by filing the necessary lending agreements and corporate resolutions to obtain credit from a Federal Reserve Bank
- Investment policy—Required for all FCUs, per NCUA regulation § 703.3(d)
The table below summarizes liquidity and CFP requirements based on asset size as outlined in NCUA regulation § 741.12, Liquidity and contingency funding plans.
|FICU Asset Size
Under $50 million
Maintain a basic written liquidity policy that provides a credit union’s board-approved framework for managing liquidity and a list of contingent liquidity sources that can be accessed in adverse circumstances.
|$50 million or more
|In addition to a written liquidity policy, the credit union must establish a CFP that clearly delineates strategies for addressing liquidity shortfalls in emergencies, among other requirements.
|$250 million or more
|In addition to a written liquidity policy and CFP, the credit union must establish access to at least one contingent federal liquidity source (the Federal Reserve’s Discount Window and/or the NCUA’s CLF)
NCUA regulations §§ 702.304(b)(3) and 702.304(b)(4) require credit unions with more than $10 billion in assets to include assessments of liquidity as part of their ongoing strategic planning and capital planning activities. These credit unions must include a discussion of any expected changes to the institution’s business plan that are likely to have a material impact on the credit union’s capital adequacy and liquidity.
The NCUA regulation § 741.12, Liquidity and contingency funding plans, requires all FICUs to establish a written, board-approved liquidity policy that governs how the credit union:
Manages its daily operating cash needs
Meets forecasted liquidity shortfalls
Responds to unforeseen liquidity events
A credit union may establish a stand-alone liquidity policy or integrate it into an existing policy such as an ALM or funds management policy.
A credit union’s liquidity policy is tailored to the size, complexity, and risk profile of the institution. If a credit union assumes more liquidity risk by relying heavily on market-sensitive funds—for example, money market shares—and assets with more dynamic cash flows—for example, mortgage loans—a policy based on best practices would require management to analyze prepayments and conduct a comprehensive forecast for sources and uses of funds. Conversely, if a credit union has a low level of liquidity risk—that is, holds a large percentage of liquid assets and has strong core deposits—its liquidity policy may be more basic.
As a credit union’s size and/or risk profile increases or its cash flows become more complex, its liquidity policy (and corresponding CFP, if applicable) is updated to reflect any changes in the level of liquidity risk.
Formal written liquidity policies and procedures define management responsibilities, strategies, day-to-day liquidity management, measurement, and monitoring of risks and limits.
As described in Letter to Credit Unions 13-CU-10, Guidance on How to Comply with NCUA Regulation §741.12 Liquidity and Contingency Funding Plans, an effective liquidity policy includes the following elements:
Purpose and goals of liquidity management—The liquidity policy establishes the purpose, objectives, and goals of liquidity management. The policy acknowledges that managing liquidity properly results in meeting operating cash needs and commitments such as member withdrawals. It is important for a financial institution to process drafts, dispense currency, and meet loan commitments in a timely manner, and this ability contributes to member confidence. Thus, managing liquidity risk is critical to the wellbeing of a credit union.
Thresholds or limits for liquidity measures and reporting requirements—The liquidity policy conveys the credit union board of director’s tolerance for liquidity risk. The evaluation process includes identifying the appropriate ratios that can signal changing liquidity conditions, preparing periodic cash flow projections, and establishing a minimum cash-on-hand target. The liquidity policy sets forth required minimum balances for short-term and overnight funds that are sufficient to maintain a business-as-usual posture and allow for unexpected stresses in normal funding needs that may arise.
The liquidity procedures outline when and how the credit union will evaluate and report its liquidity levels relative to the board-approved limits. The policy specifies the reporting requirements, including the nature and frequency of management reporting. This includes clearly defining roles and responsibilities for all aspects of the liquidity management function so the credit union’s board of directors can hold management accountable. Also, the policy must address the conditions that may prompt designated staff to implement contingency plans. The policy outlines threshold or limits, as well as the guidelines. The ALCO minutes document plans to bring the credit union back into compliance with any breached limits, or other actions taken.
Primary and secondary sources of liquidity—The credit union’s liquidity policy specifies what sources the credit union can access and the priority of steps to follow. Primary sources of liquidity may include cash flows from share deposit growth, the repayment or maturity of loans, and investments. Secondary sources may include investment sales and lines of credit.
Tools for liquidity risk management—A credit union’s risk management tools are commensurate with the size and complexity of the credit union. For example, a bucketed sources and uses of funds template (or maturity gap template) can be utilized where appropriate. This type of report template is based on an understanding of how the credit union’s assets and liabilities behave in response to changes in market conditions. Generating a forecast of sources and uses of funds is a fundamental activity for any financial institution.
A credit union with cash flows that are complex or susceptible to high volatility need more sophisticated tools. Capturing the effects of changing market rates or varying assumptions about growth of deposits and loans can highlight potential liquidity shortfalls. Understanding sources of volatility in cash flows will identify potential shortfalls and aid in planning for contingencies.
Periodic review and revisions as needed—As with any major policy, a credit union’s liquidity policy includes the requirement for a periodic review of the policies and plans, and allows for appropriate revisions to reflect the credit union’s current tolerance for risk, balance sheet composition, liquidity strategy, and organizational structure. The frequency of review can be annual, but the policy may also be reassessed whenever the credit union experiences a significant change.
NCUA regulation § 741.12(b) requires all credit unions with assets of $50 million or more to establish a CFP that clearly sets out the strategies for addressing liquidity shortfalls in emergency situations.
A CFP provides a documented framework for managing unexpected liquidity situations. The objective of the CFP is to ensure that the credit union’s sources of liquidity are sufficient to fund normal operations during contingent events. A credit union’s CFP must be commensurate with its size, complexity, risk profile, and scope of operations. As macroeconomic and credit union-specific conditions change, the CFP is revised to reflect these changes. The CFP must address the following elements.
Stress events may have a significant impact on the credit union’s liquidity, given its specific balance-sheet structure, business lines, organizational structure, and other characteristics.
Stress events may include:
Loss of access to unsecured borrowings
Material changes in terms and collateral requirements for secured borrowings
Deterioration in asset quality
Significant operating losses and declining net worth
High or unexpected loan growth
Higher deposit run-off than expected
Changes in market value and price volatility of various asset types
Severe economic conditions or the public’s perception of the market
An inability to renew or replace maturing funding liabilities
Disturbances in payment and settlement systems due to operational or local disasters
Severe draws against open-end lines of credit
Slowdown in cash flows from a change in prepayments
A credit union’s CFP will typically focus on events that, while relatively infrequent, could significantly impact the credit union’s operations. The CFP outlines the various levels of stress severity that can occur during a stress event and identifies the different stages for each type of event, including temporary, short-term, and long-term disruptions.
Ideally, credit unions:
Define the different stages or levels of severity
Design early-warning indicators
Assess potential funding needs at various points in a developing crisis
Specify comprehensive action plans
The length of the scenario will be determined by the type of stress event being modeled and encompasses the duration of the event.
A credit union’s CFP provides a clear description of roles and responsibilities. It also provides for a comprehensive crisis management team with defined roles. Realistic action plans and responsibility assignments are formalized in writing. A credit union following best practices integrates the CFP with other contingent planning activities, such as business continuity planning. The CFP provides for frequent communication among the crisis team, board of directors, management, ALCO, NCUA and applicable state regulators, and other interested parties.
An effective CFP includes a process to identify a potential liquidity event before it becomes a crisis. This can be accomplished through early-warning indicators and triggers as part of normal reporting. Each credit union tailors the indicators and triggers in its CFP to its specific liquidity risk profile.
A credit union that recognizes potential liquidity events early provides itself an opportunity to prepare as circumstances evolve via reporting activity, internal communications, and external communication with outside parties and stakeholders. For example, institutions that rarely interact with the media would benefit from establishing plans to manage press inquiries that may arise during a liquidity event.
The CFP identifies a reliable crisis management team and administrative structure, including realistic action plans for executing the various elements of the plan for given levels of stress. During a stressed event, there is frequent communication among crisis management team members, the board of directors, and other affected managers. Proactive reporting and communication will help coordinate business decisions to minimize further disruptions to liquidity.
A stress event may also require a credit union to generate its regular liquidity risk reports and other supplemental information more frequently than normal, perhaps even daily. The CFP calls for more frequent and detailed reporting as the stress situation intensifies.
Quantitative projection and evaluation of expected funding needs and funding capacity during the stress event are critical elements of the CFP. This entails analyzing the potential erosion in funding at the various stages or severity levels of the stress event, and the potential cash flow mismatches that may occur under the various stress levels. Management bases the analysis on realistic assessments of the behavior of internal and external liquidity sources during the event, and incorporates alternative contingency funding sources. Ideally, the resulting forecast is a realistic analysis of cash inflows, outflows, and funds availability at different intervals during the potential liquidity stress event in order to measure the credit union’s ability to fund operations.
Liquidity pressures may spread from one funding source to another during a stress event; therefore, prudent credit unions identify contingent sources of liquidity, the conditions related to their use, and circumstances under which the sources would be utilized in advance. The CFP identifies and prioritizes which credit union assets are immediately available for pledging or sale and how much a cash sale of these assets will generate during a stress event.
Credit unions that rely upon secured funding might be subject to more expensive pricing or collateral requirements. This is triggered by the deterioration of a specific portfolio of exposures or the overall financial condition of the credit union. The CFP addresses the ability of a financially stressed credit union to meet calls for additional collateral. Prudent credit unions also stress test potential collateral values because devaluations or market uncertainty could reduce the amount of contingent funding that can be obtained from pledging a given asset.
In rare cases, these funding sources may be used in the normal course of business. Therefore, credit unions conduct advance planning and periodic testing to ensure that contingent funding sources are readily available when needed.
For credit unions with assets of $250 million or more, contingent federal funding sources will include either the CLF or Discount Window. Per NCUA regulation § 741.12, Liquidity and contingency funding plans, these sources must be tested periodically.
Credit unions test components of their CFP in order to assess its reliability under times of stress. This test establishes whether identified actions such as loan sales, repurchasing securities, and borrowing arrangements are functioning as intended. NCUA regulation § 741.12(d)(6) requires credit unions to define the frequency that they will test and update the CFP.
Prudent credit unions operate with an awareness that, during real stressed events, prior market access testing does not guarantee that these funding sources will remain available in the same time frames or on the same terms. As part of stress testing, a prudent credit union simulates what could occur if the credit union’s financial condition deteriorates—for example, reducing the market value of assets it could sell and the available credit lines it could borrow.
In addition to the deterioration of the financial condition of the credit union, external conditions such as changes in the market could limit alternative sources of liquidity. As conditions and circumstances change, credit unions revise their CFPs.
For certain components of the CFP, affirmative testing—for example, liquidation of assets—may be impractical. In these instances, credit unions test operational components of the CFP.
Operational components of the CFP include verifying that roles and responsibilities are up-to-date and appropriate, assessing whether communications and coordination between key individuals is adequate, and ensuring that legal and operational documents are up-to-date and appropriate.
Ideally, liquidity risk tolerances or limits are consistent with the credit union’s complexity and liquidity risk profile. Risk tolerances reflect both quantitative targets and qualitative guidelines. Examples of these risk tolerances include:
Limits on projected net cash flow positions (sources and uses of funds) over specified time horizons
Limits or triggers on the structure of short-term and longer-term funding of assets
Guidance on the minimum and maximum average maturity of different categories of assets and liabilities
Smaller credit unions with less complex balance sheets may only need to set forth limits in terms of ratios such as loans to shares, minimum cash on hand, or cash and short-term investments to assets.
Large, more complex credit unions may establish limits in terms of ratios and cash flows.
Last updated August 30, 2021