Do Examiners Read Their Agency's Publications?

While responding to an examiner's criticism of a client's Liquidity Policy limits, I rediscovered a very good article from the Fall 2006 FDIC Outlook titled An Assessment of Traditional Liquidity Ratios.  One of the authors of the article is Kyle L. Hadley, Senior Capital Markets Specialist, FDIC Division of Supervision and Consumer Protection.  I know Kyle and respect his work.

A few of the key comments from the article: 

[B]alance sheet ratios can vary widely among institutions with identified liquidity concerns. Consequently, some traditional ratios may not be the most accurate indicators of an institution's true liquidity position, and may be misleading when considered in isolation. In the past, the assumption was that banks with liquidity concerns would have poor ratios and thus would be easily distinguishable from institutions with a more favorable liquidity position. However, given the changing balance sheet structure and uniqueness of individual bank funding strategies, poor ratios do not necessarily mean banks are under liquidity pressures, and favorable ratios do not always depict a strong liquidity position.

[The Non-Core Funding Dependency Ratio] ratio is based on the premise that non-core liabilities are better suited to fund short-term investments rather than long-term assets. In theory, a lower ratio implies that an institution is better able to meet its' liquidity needs. Today there are many concerns with the original premise of this dependency ratio. Highly stable funding items, such as long-term borrowings and long-standing large deposits, are considered non-core, while most highly volatile internet deposits are considered core deposits. Additionally, all loans regardless of time to expected repayment are considered long-term.

[T]he pledged securities-to-total securities ratio could have minimal application under the liquidity management strategies used by some insured institutions.

The relative simplicity of such ratios and the ease by which they can be compared with historical trends at peer institutions increased their attractiveness. However, in today's more complex funding environment, these ratios, while still useful, may not adequately reflect an institution's liquidity position. In fact, ratio-based analysis can hide potential problems and leave a bank unknowingly exposed to considerable liquidity risk.

Despite these relevant and accurate observations made over six years ago, field examiners still focus on on-balance sheet liquidity, non-core funding dependence, pledged securities / total securities and loan to deposit ratios, criticizing banks based on their ratios and policy limits relative to industry or peer norms, often without thinking through the rational bank-specific mitigating factors that reduce perceived risk.  Why?  I'll allow the article to answer:

The relative simplicity of such ratios and the ease by which they can be compared with historical trends at peer institutions increased their attractiveness. However, in today's more complex funding environment, these ratios, while still useful, may not adequately reflect an institution's liquidity position.

Ratio-based analysis using outdated measures, combined with an examiner's unwillingness to consider the big picture, can make healthy banks look sick, leading to criticism and creating additional work for management.  Responding to unnecessary examination criticism is very time consuming, and it diverts community bankers from their most important tasks -- serving their community's financial needs.

My favorite response to examiner criticism is to use their own agency's words against them.  I may not win many friends field examiner crowd by doing so, but it will at least make me feel better.