CFO Focus: Two flawed liquidity risk measurements

Looking at funding concentrations and the net non-core funding dependence ratio makes sense conceptually but can easily break down in practice.

The four most commonly used liquidity measurements are the liquidity ratio, cash flow modeling, the net non-core funding dependency ratio and funding concentrations. Can you guess which among these is “the good,” which is “the bad,” and which is “the ugly?”

If you said, the good ones are the liquidity ratio and cash flow modeling, you are correct! For more details on these good measures, please see our full whitepaper. Another good resource for credit unions looking at liquidity is the liquidity section of the National Credit Union Administration’s examiner’s guide.

The “bad” measure listed here is funding concentrations. Why I think it is bad may not be immediately apparent. Monitoring funding concentrations is extremely valuable and should be part of any sound funds-management program. All credit unions should monitor their sources of funds, understand the risks of each source and set targets for their funding composition. Furthermore, institutions using non-core funding sources should also set individual and aggregate limits for their use. Where “the bad” comes into play is with the liberties regulators sometimes take with what should be considered as non-core funding sources.

For the most part, both credit union managers and examiners agree that non-core funding sources include brokered deposits, internet deposits, correspondent and Federal Home Loan Bank borrowings, and in some cases, large or uninsured deposits. However, examiners have recently expanded the traditional view of non-core liabilities and coined a new term, “potentially volatile funding sources.”

 

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