Pub. 16 2019 Issue 4

20 O V E R A C E N T U R Y : B U I L D I N G B E T T E R B A N K S — H E L P I N G N E W M E X I C O R E A L I Z E D R E A M S TOOLS FOR MANAGING LIQUIDITY RISK Lessons Learned on Liquidity Risk The FDIC and other regulators continue to underscore the importance of sound liquidity risk management for finan - cial institutions. The focus on liquidity has been building for some time as steady loan growth during the past several years has resulted in a decrease in short-term liquid assets and an increased reliance on wholesale funding sources. These are familiar patterns in the late phase of an economic cycle. In the wake of the 2008-09 financial crisis, for example, the FDIC noted that disruptions in the credit and capital markets had exposed weaknesses in liquidity risk measurement and management systems. Among other things, specific mention was made of banks that relied on “liability-based” funding strategies or those that have “other complex liquidity risk ex- posures.” Those institutions were encouraged to use dynamic cash flow analysis to monitor their liquidity exposures and to have robust contingency funding plans. That remains good advice today for any who haven’t done so. Funding the Bank: A Brief History For generations, community banking was a process of gathering deposits from households and businesses that held excess cash and making loans to others who needed credit. A variety of changes took place in the early 1980s that were to have profound effects on the business of banking for years to come. Legislation removed intrastate banking restrictions and deregulated deposit rates. Competition among banks soared as banks were allowed to go outside of their geographic mar- ket to seek deposits. In the wake of those changes, bankers realized they would need to explore alternative sources for funding their banks. Today, both small and large banks regu- larly use wholesale sources and rate-sensitive deposits as part of their funding strategies. Contingency Funding Plans (CFP) Banks should develop a contingency funding plan if they do not currently have one. This plan comports with the liquidity