Examiners typically use ratios to determine an initial assessment of a credit union’s liquidity risk. To supplement the initial risk assessment, examination planning, and scope development processes, examiners use the credit union’s FPR and the RADAR dashboard to observe trend changes in key ALM related ratios over time. Examiners use their best judgment when interpreting and developing preliminary risk assessments when using ratio analysis.
Asset based Ratios
Loans/Assets
The loans-to-assets ratio measures total loans outstanding as a percentage of total assets. A prudent credit union strives to maintain a loans-to-assets ratio that allows it to meet members’ loan demand and still meet other liquidity needs. Generally, the higher the loans-to-assets ratio, the less liquid the balance sheet.
Loans/Shares
The loans-to-shares ratio focuses on a credit union's ability to fund loans from member and nonmember shares. The higher the ratio, the greater the likelihood the credit union might need to obtain funding from external sources.
This ratio is similar to the loans-to-assets ratio but focuses only on the credit union's ability to fund loans from member and nonmember shares. The same relationship applies to the loans-to-assets ratio—the higher the loans-to-shares ratio, the less liquid the balance sheet.
Examiners assess a credit union’s capital level and ability to source borrowed funds to determine if a high loans-to-shares ratio could be a liquidity risk. Further, if a credit union is relying on short-term nonmember shares, an examiner determines if the credit union can maintain its loan volume in light of the higher volatility of these shares.
Cash and Short-Term Investments/Assets
This ratio indicates how much cash is available to meet short-term liquidity needs. This ratio can change dramatically in a short period and, like other liquidity ratios, is not a sole indicator of liquidity adequacy. Examiners consider any trends in this ratio to determine whether the current level of cash and short-term investments is consistent with historic levels.
When evaluating this ratio and its trend, examiners develop an understanding of the composition of short-term investments. For example, in addition to maturities, short-term investments could include longer-term variable rate amortizing instruments (mortgage-backed securities) that reprice under one year but have low associated cash flows.
Unfunded Commitments/Cash and Short-Term Investments
This ratio reflects the portion of members’ unfunded credit commitments—for example, credit cards, HELOCs, MBLs—covered by the more liquid assets on the balance sheet. Examiners assess whether credit unions have enough liquid assets relative to the historical experience in the amounts that members draw on HELOC and open credit card lines.
Pledged Assets/Total Assets
This ratio reflects the amount of assets—for example, loans or investments—that are already pledged. A more detailed review is needed to determine the remaining capacity to borrow using assets still available to pledge.
Liability Based Ratios
Borrowings/Total Shares and Net Worth
This ratio reflects a credit union’s level of external borrowings relative to member shares and net worth. For example, if a credit union is seeking higher earnings to fund growth, it may assume a higher degree of leverage through external borrowings. Long-term fixed rate borrowings may also be used to reduce NEV/IRR volatility.
Nonmember Deposits/Total Deposits
This ratio reflects a credit union’s use of external funding sources, such as brokered certificates. Nonmember deposits may indicate a credit union’s loan demand is growing faster than member deposits and it is therefore unable to meet its cash needs through member shares. Using brokered certificates is also another way to raise cash quickly without having to increase member certificate rates.
Borrowings and Nonmember Deposits/Total Shares and Liabilities
The presence of borrowings and nonmember deposits may indicate a credit union is unable to meet its cash needs through member shares. Because these funds (such as brokered certificates and borrowings) may incur higher costs and be more volatile than member shares, the condition generally requires a higher level of oversight. Examiners assess whether a credit union uses increases in FHLB term borrowings to reduce liquidity risk or interest rate risk.
Growth in Volatile Liabilities/Assets
This ratio reflects the level of volatile funding on a credit union’s balance sheet. Money market shares and short-term borrowed funds, certificates, and nonmember deposits are often more volatile sources of funding. This ratio does not consider IRA shares as volatile liabilities, because tax rules may inhibit significant withdrawals.
Volatile Funds/Total Shares and Borrowings
This ratio simply reflects a credit union’s percentage of funding other than regular shares or share drafts relative to all other sources of funding.
Regular Shares and Share Drafts/Total Shares and Borrowings
This ratio reflects the level of non-volatile shares on a credit union’s balance sheet relative to all sources of funding. A credit union can reasonably depend on the availability of these stable funds to meet liquidity demands.
Prerequisites
Conduct an initial assessment of liquidity before completing this exam step.
People to Interview
-
President/Manager
-
Chief Financial Officer
Documents to Review
-
FPR
-
RADAR dashboard
-
Liquidity Policy
-
ALCO Minutes
-
Board Minutes
Questions to Consider
-
What liquidity ratios are measured, monitored, and/or reported by the credit union?
-
Does the Liquidity Policy contain limits for any of the liquidity ratios that are measured?
-
Is the ALCO and/or the Board informed of the ratios in comparison with any Board-approved limits?
-
Are exceptions to the limits reported to the Board/ALCO and are discussions on getting back within tolerance limits documented?
Last updated April 29, 2022
