Liquidity Basics Measuring and Managing Liquidity. Course Agenda

Transcription

1 Liquidity Basics Measuring and Managing Liquidity David Koch Chief Operating Officer x Course Agenda Understanding Nature of Liquidity Definition of Liquidity Traditional Regulatory Measures How to Classify Sources and Uses Causes of Liquidity Risk in FI s Regulatory Actions and Expectations Building New Measurement Framework Liquidity Coverage Ratio (LCR) Net Stable Funding Ratio (NSFR) Cash Flow Liquidity Gap (Sources & Uses) 2 1

2 What is Liquidity & Where Does it Come From? 3 Liquidity Defined Common Liquidity Definition: The ability to meet demands for cash at a reasonable cost. Liquidity Risk is: The risk that the institution may not have sufficient sources of cash to meet demands What would cause changes in liquidity levels or needs? ALM Process measures risks taken versus returns derived. Risk is to be MANAGED, not MITIGATED Liquidity Risk Regulatory Risk Asset/Liability Management Interest Rate Risk Credit Risk 4 2

3 Liquidity Defined Regulators FDIC/OCC/Federal Reserve Liquidity Definition: The capacity to readily meet cash and collateral obligations at a reasonable cost. Maintaining Adequate levels depends on the institution s ability to meet expected and unexpected cash flow and collateral needs without adversely affecting daily operations or financial performance Sources Assets readily convertible to cash Net operating cash flows Ability to acquire funding through Deposits Borrowings Capital Injections 5 Liquidity Risk Defined Definition of Liquidity Risk : The risk that an institution s financial condition or overall safety and soundness is adversely affected by an inability to meet its obligations Depends on: Business Mix Balance Sheet Structure Cash Flow Profiles of on and off balance sheet obligations 6 3

4 Liquidity Defined Sources of Liquidity Risk : Funding Mismatches Not enough funding to meet withdrawal needs Market Constraints on ability to convert assets into cash or Inability to access sources of funds (market illiquidity) Contingent Liability Events Line of Credit Usage Loan commitments Changes in Economic Conditions Exposure to credit, market, operational, legal, and reputation risks 7 Liquidity Examination Examination Consideration: Access to funding sources Overall Cost of Funds Undue reliance on wholesale or market based funding (brokered CDs) So, we now have the premise and scope of the examination process, what do we need to do? 8 4

5 Recent Regulatory Excerpt From a $50 million Bank exam. The Liquidity Position is strong due to limited growth, lack of reliance on wholesale funding sources, an unencumbered securities portfolio, and sufficient secondary liquidity. Note several concepts: Growth impact on liquidity Current Reliance on Wholesale Asset Based Liquidity Secondary Liquidity 9 Recent Regulatory Excerpt From a $100 million Bank exam. On-balance sheet liquidity has declined due to recent deposit withdrawals. Cash equivalents declined from 17.29% of total assets to 13.36% which is comparable to peer levels. The bank does not have a securities portfolio to serve as a secondary source of liquidity which has resulted in a ratio of loans to deposits of 103% compared to the peer median of 70.17% This bank received a downgrade to a 2 rating 10 5

6 Liquidity Risk Management Maintaining balance between available sources vs. needs while meeting capital planning goals for: Earnings Growth Capital Expected & potential scenarios Effective liquidity management helps produce maximum levels of earnings by investing excess funds While maintaining sufficient flows and sources of funds 11 What Is Asset/Liability Management? Asset/Liability Management (ALM) is the process of planning, controlling and monitoring financial performance to achieve financial goals of the capital plan. Financial Risks are measured to determine if plan can be met in reasonable risk situations Credit Risks Interest Rate Movements Changes in liquidity position Changes in regulatory expectations 12 6

7 Components to ALM Process Achievable Financial Goals Identification of Financial Risk Levels Deployment of Appropriate Risk Measurement Systems Integration of Measurements into Management Process (The ALCO Process) Evaluation of New Ideas Before Implementation Implement New Strategies to Maximize Performance to Goals 13 Earnings ALM Financial Goals No earnings, no survival. Earnings provide engine to grow Capital/Equity Measure of Solvency Balancing Act between Regulatory Need and Shareholder Return Too little in reserve may cause failure in unforeseen events Too much in reserve costs shareholders money Management of Goals Requires Ability to Project Cash Flows on Assets and Liabilities. Financial Risks Develop from changes in actual versus expected cash flows 14 7

8 Understanding Financial Risks What Financial Risks Impact Core Earnings? Credit Risk: Will the borrower of funds repay the committed amount? Liquidity Risk: Will we have enough funds to meet the demands for loans or deposit withdrawals? Interest Rate Risk: To what extent will the core earnings change if market interest rates change? Factors in Measuring Risks Must be able to project cash flows (Principal & Interest) Must understand potential changes in these flows Embedded Options 15 Financial Institutions Risk Management Financial & Business Risk Management Financial Risks Business Risks Operational Risks Liquidity Risk Credit Risk Interest Rate Risk Management Risks People Risks Maturity Mismatch Default Commodity Prices Strategic Risk Legal Risks Asset/Liability Imbalance Downgrade Equity Prices System Risks Cash Flow Counterparty Interest Rate Changes External Risks 16 8

9 Financial Institutions Risk Management Prior Diagram Indicates Silos of Risk Liquidity Is Managed and Measured separate from Credit, Interest Rate, etc. Reality is that the risks are interrelated Liquidity Risk may cause market and credit risk Credit and interest rate risk can cause liquidity risk In addition to cross risk measures within an area, institutions must consider cross area risks How do staff relationships impact financial performance? Reputation risk? Legal risks? How are Business Risks related to Financial and Operational Risks? 17 Factors Effecting Liquidity Risk Internal Factors High levels of off balance sheet exposure Heavy reliance on corporate, brokered or wholesale funding Maturity mismatches Rapid asset growth in excess of deposits Short term deposit concentrations Lack of unencumbered, marketable securities External Factors Highly sensitive depositors Fragile financial markets Low economic performance Lack of trust in banking sector 18 9

10 Recent Regulatory Initiatives Interagency Policy Statement Funding and Liquidity Risk Management Issued 4/5/10 FRB, OCC, FDIC, OTS, NCUA Liquidity Requirements More asset based liquidity (cash & securities) No guidance on how much is enough! Why: It is the only form of liquidity you can absolutely count on being there during a liquidity stress event Less reliance on wholesale funding for core growth What is your core funding plan? Where will you raise the funding needed to: Increase investments? Reduce non-core funding? 19 Impact of 2010 Liquidity Guidance Liquidity Requirements Cash Flow Based Liquidity Measurement How do we to integrate with IRR measurements Stress Tests Like Rate Shocks in IRR? What kinds of stress tests do we have to run? How frequently do we run them? 20 10

11 Historical Measures of Liquidity Measurements Based on Balance Sheet Levels Static Measurements Historically Based Examples: Short Term Assets / Short Term Liabilities Measures coverage of possible loss of funding with assets Volatile Funds Ratio Borrowings / Total Assets Measures the level of non-market funding sources used to build the balances sheet Total Loans / Total Assets Basic Surplus Ratio All Sources minus Uses within 30 days / Total Assets Target Ratio = 3-5% minimum 21 UBPR/FPR Ratios Bank UBPR Ratios Net Non-Core funding ratio Loans/Assets Projection of Net Cash Flows Credit Union FPR Ratios Net Long-term assets/total Assets Total Loans / Total Shares Cash & ST Investments / Total Assets Total Shares, Deposits & Borrowings / Earning Assets Regular Shares & Share Drafts / Total Shares & Borrowings Borrowings / Total Shares & Net Worth 22 11

12 Regulatory Ratio Definitions Net Non-Core Funding Ratio: Measures the extent to which the bank if funding longer term assets (> 1 Yr.) with volatile funds. non-core liabilities, less short-term investments divided by long-term assets Non-core funding is funding that can be very sensitive to changes in interest rates such as brokered deposits, CDs greater than $100,000, and borrowed money Loan/Assets: Measures the extent to which the bank is likely to have liquidity Higher Loan/Asset ratios reduces liquidity levels Lower Loan/Asset ratios impacts earnings & capital 23 Regulatory Ratio Definitions Long term assets / Total Assets: Measures the level of long term assets that are less liquid sum of real estate loans which will not refinance, reprice or mature within 5 years, member business loans, investments with remaining maturities of more than 3 years, NCUSIF deposit, land and building, and other fixed assets divided by total assets. Loan/Share Measures extent to which the CU is relying on capital or borrowings to make loans which are less liquid Cash & ST Investments /Total Assets: Measures available short-term liquidity levels 24 12

13 Regulatory Ratio Definitions Total Shares, Deposits & Borrowings / Earning Assets: This really measures the efficiency of use of funding to generate earnings If it s not in a loan or an investment, where is it? Are buildings and fixed assets liquid? Regular Shares & Share Drafts / Total Shares & Borrowings: Measures the level of core type funding that is considered less volatile Really more of an ALM ratio than liquidity Higher levels are less volatile, requiring lower liquid assets 25 Regulatory Ratio Definitions Borrowings / Total Shares & Net Worth: Measures the reliance on non-member funding. Higher reliance posed liquidity concerns as the sources may be unreliable 26 13

14 Examination Limits/Guidelines - Banks Allowable Cash Flow Gaps over short to intermediate time frame Target amounts of unpledged liquid asset reserves Asset Concentration thresholds on illiquid or less liquid sources Funding Concentration limits to limit large exposures Contingent liability metrics Unfunded loan commitments vs. available funding Risk of collateral changes on available sources 27 Limits/Guidelines Credit Unions Total Loans / Assets Borrowings & Non-member deposits / Total Shares and Liabilities Cash & Short Term Investments / Total Assets Regular Shares & Share Drafts / Total Shares & Borrowings Other Ratios: Loan/Share Contingent Liabilities / Cash & Investments Net Liquid Assets / Liabilities & Shares Volatile Liabilities / Cash & ST Investments Growth in Volatile Liabilities / Assets Estimate Loan Maturity 28 14

15 Liquidity Definitions vs. Ratios Definition: The capacity to readily meet cash and collateral obligations at a reasonable cost. What is missing from all these UBPR/FPR Ratios and Examination Review? 29 General Rule: Basic Liquidity Trap The more liquid as asset or liability, the lower the rate earned or paid Regulatory Pressure Increased levels of liquid assets Lower levels of volatile liabilities Large deposits, Brokered CDs Impact More liquid assets = lower yield on asses Downward Pressure on Earnings Less Volatile Liabilities = More Core Funding How do we raise more core funding? 30 15

16 Old approach Static Measure Evolution Policy limits built around these measures Monitoring systems focused primarily on these measures. Primary weakness Measure liquidity at a point in time (old balance sheet) Fail to consider business plan or strategy May be outdated measures of liquidity Fail to consider potential stress events Current Trends Show Movement toward use as Triggers Green light, yellow light, red light Example Loan/Deposit Ratio Green L/D < 80% (normal heartbeat) Yellow L/D 80-90% (heart arrhythmia) Red L/D >90% (heart attack) Define actions taken in response to triggers 31 What are Triggers Definition Ratios or events being monitored to assess trends in performance UBPR or FPR Ratios Used as early warning indicators Allows for historical liquidity or call report ratios in policy without them becoming primary measures. They are NOT policy limits 32 16

17 Triggers vs. Limits Triggers (Monitoring Ratios) Can be set to watch for different possible changes to future liquidity. Maturity Mismatch is an indicator of potential risk. Measurement of maturity mismatch can be an early warning indicator of possible risks A/L Imbalance Measure of asset/liability mix vs. goals gives an easy measure of possible problems Cash Flow projections tells more complete story on potential needs Common for monthly ratios to be set on individual risk components with quarterly overall limit tests 33 Liquidity Sources & Uses Asset Sources Cash and Cash Equivalents Securities or Loans available for sale Maturing Loans &Securities Loan & Security repayments Liability Sources New Deposit Growth Borrowing Sources Asset Uses Loan Originations Investment Purchases Fixed Asset Purchases Draws on Lines of Credit Liability Uses Deposit Outflows Maturing Borrowings Note: Majority of Sources and Uses are based on Cash Flows associated with assets & liabilities 34 17

18 Major Cash Flow Assumptions Option Risk: The risk that the expected cash flows change due to contract options Call Options Put Options Prepayment Options Bump Rate CD/Early Withdrawal Options Changes in Cash Flows Impact Liquidity Levels Income Levels Potentially Credit Risk Levels Lower repayment of loans an indicator of credit problems? 35 Major Cash Flow Assumptions Prepayment Speeds on Loans & Securities Determining Prepayment Levels Schedule Contractual Repayments Observe Actual Repayments Subtract Actual from Scheduled to arrive at prepayment $ Convert to annual % prepayment by dividing by average balance Compare to National Prepayment speeds to develop factor Example: National Bloomberg Prepayment Speeds = 12% CPR Calculated Speeds = 8% CPR Factor for ALM Model = Bloomberg speeds * 67% Use Bloomberg speeds for all changing rates 36 18

19 Control of Liquidity Sources Sources Uses High Estimated Loan Repayments Investment Purchase Term Borrowing Sources Investment Maturities Overnight Borrowings National CDs Local Deposit Growth Advance Repayments Loan Originations Public Fund CDs Overnight Borrowings Local Deposits Many liquidity reports group sources and uses in order of ALCO/Institution Control How do we control sources & uses? Low Brokered CDs Brokered CDs 37 Liquidity Definitions Asset Based or Core Liquidity: Cash and other financial assets that can be easily converted to cash for operational needs Withdrawals Originations Total (Cash Flow Based) Liquidity : Does your projection maintain sufficient sources to meet financial obligations: withdrawals, loan demands and other commitments. To what extent is liquidity changing level and/or form Should include measures of debt or borrowing capacity

20 Sound Liquidity Practices Governance BOD and management Appropriate strategies, policies, procedures Cash flow oriented measurement systems Intraday collateral and liquidity management Diverse mix of present and potential funding sources Adequate levels of highly liquid marketable securities Comprehensive contingency funding plans addressing adverse events Internal controls and `audit requirements 39 A Practical Approach to Liquidity MEASURING ASSET BASED LIQUIDITY 40 20

21 Asset Based Liquidity Considered most reliable source of liquidity Many failed institutions had high levels of borrowings and low levels of asset based liquidity, therefore more is better. But, How Much is Enough? Answering the question How long can you survive a crisis without having access to wholesale funding? Requires: An understanding of the sources of asset based liquidity An estimation of the sensitivity of liabilities at risk A method for calculation 41 Calculating Asset Based Liquidity Sources of Asset Based Liquidity Cash & Cash Equivalents (FF, MMA, etc.) Unpledged Securities (at market value or deeper discounts) Scheduled Investment cash flows and maturities Scheduled Loan cash flows and maturities Uses that you have to cover Firm Loan commitments Maturing Borrowings/Non-Core funding Maturing CDs Some amount of Non-maturity balances considered at risk Potential draw down on lines of credit 42 21

22 Basic Surplus Long time measure of 30 day need 43 Basic Surplus Add to the basic measure in step 2 FHLB availability 44 22

23 Basic Surplus Add in other non-core funding sources in Step 3 45 Advantages Easy measure of real sources Quantifies level of sources by type Provides a measure consistent with policy control limits Basic Surplus Disadvantages Usually used on historical balance sheet Ignores primary source of most community FI liquidity Loan Repayments! Ignores Off Balance Sheet Risks Lines of Credit Firm Commitments to Originate Compare Basic Surplus to New Liquidity Coverage Ratio 46 23

24 Asset Based Liquidity: LCR Ratio Basel Liquidity Coverage Ratio (LCR) Test Can you survive a 30 day stress event with assets only? Numerator Cash & Due From Highly Liquid Unencumbered Marketable Securities Denominator Projected Deposit Runoff Loss of all Non-Core Funding renewing in time horizon Projected Increased Line Draw Downs Less Cash Inflows from loans (& securities?) - Limited amounts included Note that this is the first Liquidity rate to consider loan cash flows as a source! 47 Deposit Definitions Stable/Less Stable Basel Says Stable is Fully insured Meaningful business relationship Applies to retail, small business, large business Penalties adequate on CDs just count 30 day maturities Penalties inadequate count all the balances Less Stable Deposits not meeting the above definition Bank Regulators (Likely) Fully Insured Call Reports Internal systems? Not sure how bank regulators will deal with penalty issue 48 24

25 Liquidity Coverage Ratio Numerator (Basel Approach) We would add stressed cash flows coming off loans and non-highly liquid securities. Available liquid assets in 30 days 49 Liquidity Coverage Ratio Funding Outflows Denominator Sum of Outflows = Potential 30 day liquidity needs 50 25

26 Liquidity Coverage Ratio Net Loan Outflows 51 Liquidity Coverage Ratio Available Needs FARIN Suggested LCR Changes: Move Loan Cash Flows to the Numerator to track all Sources together Establish consistency on deposit outflow assumptions with core deposit study info used in IRR Calculations Remove limit on amount of total loan flows counted (Move to numerator eliminates negative denominator Remove prepayment limitation assumptions on loan flows Consider calculating how much runoff would be necessary to fail assuming sources are solid

27 Net Stable Funding Ratio Ratio Introduced in Original Basel III Proposal Designed to look at 1 Year Potential Funding Needs Numerator stable funding Denominator assets needing stable funding Guideline - >=100% Not planned to phase-in until 2019 Why we choose not incorporate into Liquidity Calculations Static ratio Lots of clarification needed Late phase-in Unsure how US regulators will interpret Adopting internal sources and uses provides more meaningful measurement Regulatory Attempt at Sources & Uses But Static! 53 Net Stable Funding Ratio Compares Available Liquidity Sources To Known maturities & loan renewal/payoffs Plus OBS exposures 54 27

28 Net Stable Funding Ratio Example shows institution short $34 million Options for Correcting? Lower reliance on assets with higher funding needs Fixed assets require $1 for every $1 How fast can this be changed? Lower off balance sheet exposures Firm commitments Reduce outstanding lines of credit Change mix in deposit funding or terms or both High concentration of brokered deposits < 1 Yr which are not given full credit Rely on Wholesale Funding 55 Net Stable Funding Ratio Advantages Can be easily captured from call report data Requires minimal new changes Eliminates Assumption Risk from Analysis Disadvantages Removes all unused wholesale sourcing from calculation Not Effective in Examining the Cost/Benefit of various alternative strategies Rewards long-term borrowing position without regard to cost 56 28

29 LCR Concept - Numerator Level 1 assets (0% haircut) Generally Basel 1 0% risk weight assets Broad stable markets Full government guarantees Can be repo d Everyone accepts as collateral Level 2 Assets (15% haircut) Generally Basel 1 20% risk weight assets, but there are exceptions Broad stable markets markets Lack full government guarantees Can be repo d Everyone accepts as collateral Non-Qualifying Everything else Note that we work with market value rather than book value of assets. 57 Limits Basel limits Level 2 to no more than 40% of total qualifying assets Problem: 80% of US bank government security holdings are in GSEs subject to 40% limit Unsure of how US banking regulators will handle this although in large bank FDIC assessment, no limit was placed We elected to not enforce this portion for now waiting until US bank regulators react to this provision. Phase in scheduled for 2015 Plenty of time between now and then to restructure 58 29

30 OCC Liquid Assets OCC Handbook 59 US Treasuries Liquidity/Yield Relationship Basel Criteria other than risk weight We added as they are likely to be additional US Regulatory factors Our judgment based on above criteria Nothing controversial about this security clearly a Level 1, only potential issue is adjustment for long-term Treasuries because of interest rate risk 60 30

31 Federal Reserve EBA No controversy here, clearly a Level 1 61 Fed Funds Sold We placed in level 2 if unsecured 62 31

32 GSE Bullets Under Basel definitions, this is a Level 2. Given 80% of US bank federal government securities are GSAs, how will bank regulators treat? Other issue is interest rate risk in long-term bullets. 63 Money Market Instruments Under Basel definitions, this is a Level 2. Given 80% of US bank federal government securities are GSAs, how will bank regulators treat? 64 32

33 Callable Agencies Under Basel definitions, this is a Level 2. Given 80% of US bank federal government securities are GSAs, how will bank regulators treat? Other issue is interest rate risk in long-term bullets and option risk associated with call options. 65 Agency Asset-Backed Under Basel definitions, this is a Level 2. Given 80% of US bank federal government securities are GSAs, how will bank regulators treat? Other issue is interest rate risk and option risk associated with prepayment options

34 Agency Mortgage Obligations Under Basel definitions, this is a Level 2. Given 80% of US bank federal government securities are GSAs, how will bank regulators treat? Other issue is interest rate risk and option risk associated with prepayment options and the structure of the classes. 67 Corporate Bonds If credit grade is AA- or higher, qualifies as level 2 under Basel in spite of 100% risk weight. Additional issue is interest rate risk on ling-term, and option risk if they are callable

35 Commercial Paper Appears to meet Basel Level 2 tests in spite of 100% risk weight. 69 Bank Issued CDs Will be controversial On one hand they are fully secured. On the other hand they generally are not accepted as collateral or in repo transactions We re betting they won t make the Level 2 cut we could be wrong 70 35

36 Municipal Bonds Not really dealt with by Basel. We applied same criteria as with corporate bonds. Troubled market right now. Additional issues are potential interest rate risk and option risk. 71 Revenue Bonds Not really dealt with by Basel. We applied same criteria as with corporate bonds. Troubled market right now. Additional issues are potential interest rate risk and option risk. Could have more credit risk than general obligation bonds

37 Asset-Backed Securities Nobody s favorite security now. Very unlikely to make the level 2 cut. 73 Cash & Level 1 Securities Level 1 - Fully guaranteed agencies Ginnie Mae Could be expanded to include all bullet agency securities? 74 37

38 Level 2 Securities Note: Under Basel III Liquidity, Level 2 assets are limited to 40% of total. Unclear How US banking regulators will react so we aren t enforcing this limit at this point. Also unclear how US banking regulators will consider MBS, Corporate, and Municipal Bonds. Note that in the large bank FDIC assessment rules, MBS were excluded but there was no haircut. 75 Non-Qualifying Securities LCR Numerator Does not consider 40% limit. We placed bank CDs in this category as they are not easily marketed, and repo d

39 Balance Sheet Strategies Barbell Basic Strategy - Investments Maintain short term cash against volatile liabilities Extend extra funds out the yield curve for earnings Basic Strategy Balance Sheet If Loan Maturities are longer, stay shorter with investments Match short term CD and volatile funds with short term bonds and cash 77 Ladder Balance Sheet Strategies Basic Strategy Investments Dollar Cost Averaging Build investments to have steady stream of maturing funds every month. 3 Year Ladder Example: $3.6 million of investments in bonds with $100k maturing every month for 3 years Simple protection against rate movement As rates rise, you reinvest every month into higher rates As rates fall, you reinvest every month on the way down Less volatility in returns, but lower overall returns than other strategies 78 39

40 Focus of Liquidity $100 Million Bank Long term mortgage lender Traditional Liquidity Focus: Investment are Primary Source Total Cash & Investments = $8.025 million Total Earnings Assets = $82.2 million 79 Focus of Liquidity Liability Maturities and Potential Exposures Maturing CDs and Non-Maturity Deposit Assumption on volatile funds Maturing Borrowings 80 40

41 Focus of Liquidity Asset Based Liquidity vs. Liability Exposure Includes projected loan repayments in addition to cash and investments 81 A Practical Approach to Liquidity MEASURING CASH FLOW BASED LIQUIDITY 82 41

42 Liquidity Gap Report Pro forma cash flow analysis: Projected sources and uses of funds over various scenarios Like rate movements or what-if plans Show exposures to variables and report to board and establish contingencies What sources change and why (optionality, credit risk, performance risk) What uses change and why (loan demand, potential deposit outflow, etc.) Assumptions should be reasonable and appropriate. Institutions with reliance on securitization and sale for cash should consider impact of conditions that may effect availability of funds. 83 Liquidity Gap Report Liquidity Gap Report Summary of Cash Flow sources and uses impact on liquidity Use a forecast (Plan) for growth assumptions Use starting cash flows to project inflows and outflows Allows for Assessment of Contingency Funding Plan Stress Tests to Determine Liquidity needs Impact of missing deposit growth by 10% What if loan repayments accelerate or slow? What happens to total ratio if access to key funding sources is gone? Brokered CDs FHLB 84 42

43 Asset Sources/Uses First two of forecast show Assets are a net drain of funds in years 1 & 2: $25.7 million Investments are providing sources of funds to fund loan growth $3.8 million over 2 years Loans using $29 million in funding by end of Yr Liability Sources/Uses Non-maturity funding providing $2.7 million over 2 years CDs expected to provide $6.9 million. Equity growth from earnings also contributing (not shown) Remainder is borrowed by model. Sources MUST = USES 86 43

44 Sources/Uses Summary Sec 1 Sec 2 Sec 3 Section 1 Net Cash flow sources/uses Removing balancing accounts. Section 2 Adds in asset and liability adjustments Section 3 Recalculates Gap with adjustments and buffers 87 Sources/Uses Summary Cumulative Cash Flow Based Liquidity Gap No borrowings, securities, or OBS commitments 2. Adjustment to Liquidity Available securities, borrowings, and potential customer draws on liquidity 3. Cumulative Liquidity Gap/Assets our primary measure of long-term liquidity includes adjustments for investments, borrowings & OBS commitments 88 44

45 Sources/Uses Summary Test passed because of wholesale and investments available for liquidity, NOT CASH FLOW. Determining Adequacy of limits by applying realistic stress tests and deciding how low you can go. 89 Using Liquidity Gap Advantages Dynamic measure derived from business plan Considers sources and uses of funds Gap between sources and uses is liquidity buffer Buffer includes cash flow mismatch, asset based buffer (LCR), and liability based buffer (unused borrowing capacity) Liquidity gap/assets can be used as control ratio Can be stress tested Recommendation Primary long-term measure of liquidity in policy statement Limits set on pre- and poststress ratios 90 45

46 Putting this to Work Review your existing Liquidity Management Process Are you measuring triggers or real ratios? What Asset-Based Measures are you using? Do you run a cash flow based measure? Develop Your Revised Reports to Integrate with ALCO Reporting Do you measure forward-looking ratios or only historical Develop Trends in Performance and compare to projections