Bank Exam Prep

As LSU’s football players take time out of their BCS Championship preparations to cram for finals (we need them to make their grades so we can beat Alabama again), please take some time to prepare for the liquidity discussions that are likely to occur during your next exam.

The March 2010 Interagency Policy Statement on Funding And Liquidity Risk Management reiterated the importance of cash flow projections, diversified funding sources, stress testing, a cushion of liquid assets, and a formal contingency funding plan as primary tools for measuring and managing liquidity risk.  Here are a few ways that you can use your APC reports to show examiners that you are following their guidance.  (Before using any of these answers, be sure the facts are appropriate for your institution.)

Examiner Question:  Have you stratified the bank’s liquidity / identified the bank’s cushion of liquid assets?
APC Solution:  We designed a Forward Liquidity Model in Excel that identifies the types of on-balance sheet liquidity and segregates them into relatively homogeneous pools (“Cash and Cash Equivalents”, “Liquidity Cushion” and “Other”).  This spreadsheet, which is designed to be maintained by bank personnel on a monthly or quarterly basis, identifies the bank’s liquidity pools and projects the bank’s future liquidity position.  The second page of the Forward Liquidity Model uses the current liquidity volume and projections of future cash flows to estimate the bank’s liquidity over the next year.

Examiner Question:  How do you analyze the bank’s future liquidity position?  Have you developed cash flow projections (sources and uses of funds model)?
APC Solution:  The spreadsheet allows bank personnel to make monthly projections of cash flows for all major balance sheet categories (loans, illiquid assets, deposits, borrowings, capital) to project the net liquidity over the next twelve months.  Cash flows into or out of the securities portfolio are not included in the model, as all securities are assumed to be liquid and would not impact the bank’s liquidity position.
Bank’s Response:  This is the model (hand over most recent report) that [bank employee] uses to identify our on-balance sheet sources of liquidity and project liquidity over the coming year.

Examiner Question:  Tell me about your methods for ensuring diversified funding sources…
APC Solutions:  The Deposit Distribution by Type graph on page four of the standard monthly report set shows that you monitor deposit mix on a monthly basis.  The CD and FHLB repricing schedules (included in the last 15 pages of the standard report set) show the tenor (remaining maturity) of funding.  The Nonmaturity Deposit Rate Projections report (page 10) show your consideration of the behavior of nonmaturity deposits.  Our standard Liquidity and Funds Management Policy discusses sources of funding and sets limits on various types of nontraditional funding.
Bank’s Response:  We have several reports (point to appropriate pages in the APC monthly report set) that provide insights into funding diversity and behavior.  In addition to local deposits, we consider FHLB advances, Qwickrate / National CD Rateline funding and brokered deposits as important tools in ensuring a diversity of source and tenor of funding.  Our Funds Management Policy provides guidance on the appropriate use of each nontraditional funding source.  We also consider the bank’s interest rate risk position when determining which funding sources to pursue.

Examiner Question:  Do you have a formalized contingency funding plan (stressed liquidity model)?
APC Solution:  Our standard Liquidity and Funds Management Policy has an entire section dedicated to contingency funding.

Examiner Questions:  Do you stress test your liquidity?  Do you have a contingent funding model?
APC Solution:  We have developed a simple stress model that shows the sources available to fund rapid deposit runoff.  Using Call Report information, we run this report quarterly.
Bank’s Response:  Our Liquidity Policy addresses contingency funding.  (Be sure to read this section of the policy before you discuss it).  This model (hand over most recent report) shows how we could fund up to $X million of rapid deposit runoff using a variety of funding sources, including excess cash and overnight funds, liquid securities (that can be sold, pledged or REPO’ed), Fed Fund / Discount Window / FHLB borrowing capacity and loan sales.  We also have the capacity to raise funds through Qwickrate / National CD Rateline.

As you cram for your next exam, please call or email if there is anything we can do to help.  You have lots of important things to do and lots of customers to care for.  So do we!  You are our customer, and one of our most important tasks is making your exam experience as good as possible.