Published in: CUNA Councils
Effectively forecasting liquidity remains vital for credit unions as we head into the new year. Regardless of rate forecasts and growth expectations, healthy credit unions must ensure that adequate liquidity sources are available in the event of the unexpected. Credit unions of all sizes should employ tools and resources that provide comprehensive liquidity forecasts and ongoing stress tests in order to evaluate the overall effectiveness of their liquidity policies.
Defining Liquidity and Liquidity Risk
A simple definition of liquidity is the capacity to meet cash and collateral obligations at a reasonable cost. This includes both expected and unexpected events. Liquidity risk is the risk of not being able to obtain funds at a reasonable price within a reasonable time period to meet those obligations as they come due.
Within the past twenty years, we’ve had two significant events that demonstrate why sound liquidity forecasting is imperative for the credit union industry. During the summer of 2008, Fannie and Freddie were conserved and Lehman Brothers and Merrill Lynch failed. While those broker-dealers didn’t have a deposit base like credit unions do, their failure shows that a global event can impact a bank or credit union regardless of size. The Federal Home Loan Bank, which many credit unions rely upon for their borrowings, was impacted. Also, the liquidity crisis also impacted the spreads on all assets and, therefore, the execution of security sales by credit unions.
In 1998, the Asian flu led to currency devaluations which flowed through Europe to the U.S. All major broker-dealers had given friendly terms to a hedge fund that made wrong way bets during this period, causing another liquidity crisis with far-reaching impacts.
These events changed the regulatory environment and led to the Interagency Policy Statement on Funding & Liquidity Risk Management in March 2010. Banks and credit unions are now required to have much more in-depth liquidity forecasting as a result.