LIQUIDITY AND FUNDS MANAGEMENT Section 6.

INTRODUCTION..............................................................2 Contingent Funding Events ......................................... 26

RISK MANAGEMENT PROGRAM ................................2 Stress Testing Liquidity Risk Exposure ....................... 27
Board and Senior Management Oversight .....................2 Potential Funding Sources ........................................... 28
Liquidity Management Strategies ..................................3 Monitoring Framework for Stress Events .................... 28
Collateral Position Management ....................................3 Testing and Updating Contingency Funding Plans...... 29
POLICIES, PROCEDURES, and REPORTING ...............4 Liquidity Event Management Processes ...................... 29
Liquidity Policies and Procedures ..................................4 INTERNAL CONTROLS ............................................... 29
Risk Tolerances ..............................................................5 Independent Reviews ................................................... 30
Liquidity Reporting ........................................................5 EVALUATION OF LIQUIDITY .................................... 30
LIQUIDITY RISK MEASUREMENT ..............................6 Liquidity Component Review...................................... 30
Pro Forma Cash Flow Projections ..................................6 Rating the Liquidity Factor .......................................... 30
Back Testing...............................................................7
Scenario Analysis .......................................................7
FUNDING SOURCES - ASSETS .....................................7
Cash and Due from Accounts .........................................7
Loan Portfolio ................................................................8
Asset Sales and Securitizations ......................................8
Investment Portfolio .......................................................9
FUNDING SOURCES - LIABILITIES .............................9
Core Deposits .................................................................9
Deposit Management Programs ............................... 10
Wholesale Funds .......................................................... 10
Brokered and Higher Rate Deposits ............................. 11
Primary Purpose Exceptions (PPE) .......................... 11
Listing Services ........................................................ 12
Sweep Accounts ....................................................... 12
Network and Reciprocal Deposits ............................ 12
Brokered Deposit Restrictions.................................. 13
Deposit Rate Restrictions ......................................... 14
Brokered Deposits Use ............................................. 15
Uninsured Deposits ...................................................... 15
Public Funds ............................................................. 16
Secured and Preferred Deposits ............................... 17
Large Depositors and Deposit Concentrations ......... 17
Negotiable Certificates of Deposit ........................... 17
Borrowings ................................................................... 18
Federal Reserve Bank Facilities ............................... 18
Federal Home Loan Bank (FHLB) Advances .......... 19
Federal Funds Purchased .......................................... 20
Repurchase Agreements ........................................... 20
Dollar Repurchase Agreements ................................ 21
International Funding Sources.................................. 21
Commercial Paper .................................................... 22
OFF-BALANCE SHEET ITEMS .................................... 22
Loan Commitments ...................................................... 22
Derivatives ................................................................... 22
Other Contingent Liabilities ......................................... 22
LIQUIDITY RISK ANALYSIS AND MITIGATION .... 22
Cushion of Highly Liquid Assets ................................. 22
Evaluation of Asset Encumbrance ............................... 23
Diversified Funding Sources ........................................ 24
Assessing the Stability of Funding Sources ................. 25
Intraday Liquidity Monitoring...................................... 25
The Role of Equity ....................................................... 26
CONTINGENCY FUNDING .......................................... 26
Contingency Funding Plans ......................................... 26

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LIQUIDITY AND FUNDS MANAGEMENT Section 6.1

← Comprehensive and effective programs encompass all

INTRODUCTION elements of an institution’s liquidity, ranging from how
management manages routine liquidity needs to managing
Liquidity is the ability to meet cash and collateral liquidity during a severe stress event. Elements of a sound
obligations at a reasonable cost. Maintaining an adequate liquidity risk management program include:
level of liquidity helps ensure the institution’s ability to
efficiently meet both expected and unexpected cash flow • Effective management and board oversight;
and collateral needs without adversely affecting the • Appropriate liquidity management policies,
institution’s operations or financial condition. Liquidity is procedures, strategies, and risk limits;
essential to meet customer withdrawals, compensate for • Comprehensive liquidity risk measurement and
balance sheet fluctuations, and provide funds for growth. monitoring systems;
Funds management involves estimating liquidity • Adequate levels of marketable assets;
requirements and meeting those needs in a cost-effective • A diverse mix of existing and potential funding
way. Effective funds management involves management sources;
estimating and planning for liquidity demands over various • Comprehensive and actionable contingency funding
periods and considering how funding requirements may plans;
evolve under various scenarios, including adverse • Appropriate plans for potential stress events; and
conditions. This planning includes identifying and • Effective internal controls and independent reviews.
maintaining sufficient levels of cash, liquid assets, and
accessible borrowing lines to meet expected and contingent The formality and sophistication of effective liquidity
liquidity demands. management programs are commensurate with the
institution’s complexity, risk profile, and scope of
Liquidity risk reflects the possibility an institution will be operations, and examiners should assess whether programs
unable to obtain funds, such as customer deposits or meet the institution’s needs. Examiners should consider
borrowed funds, at a reasonable price or within a necessary whether liquidity risk management activities are integrated
period to meet its financial obligations. Failure to into the institution’s overall risk management program and
adequately manage liquidity risk can quickly result in address liquidity risks associated with new or existing
negative consequences, including failure, for an institution business strategies.
despite strong capital and profitability levels. Therefore, it
is critically important that management implement and Close oversight and sound risk management processes
maintain sound policies and procedures to effectively (particularly when planning for potential stress events) are
measure, monitor, and control liquidity risks. especially important if management pursues asset growth
strategies that rely on new or potentially less stable funding
A certain degree of liquidity risk is inherent in banking. An sources.
institution’s challenge is to accurately measure and
prudently manage liquidity demands and funding positions. Board and Senior Management Oversight
To efficiently support daily operations and provide for
contingent liquidity demands, management: Board oversight is critical to effective liquidity risk
management. The board is responsible for establishing the
• Establishes an appropriate liquidity risk management institution’s liquidity risk tolerance and clearly
program, communicating it to all levels of management.
• Ensures adequate resources are available to fund Additionally, the board is responsible for reviewing,
ongoing liquidity needs, approving, and periodically updating liquidity management
• Establishes a funding structure commensurate with the strategies, policies, procedures, and risk limits. When
institution’s risk profile, assessing the effectiveness of board oversight, examiners
• Evaluates exposures to contingent liquidity events, should consider whether the board:
and
• Ensures sufficient resources are available to meet • Understands and periodically reviews the institution’s
contingent liquidity needs. current liquidity position and contingency funding
plans;
← • Understands the institution’s liquidity risks and
RISK MANAGEMENT PROGRAM periodically reviews information necessary to
maintain this understanding;
An institution’s liquidity risk management program • Authorizes an asset/liability management level
establishes the liquidity management framework. committee (ALCO), or similar committee, to perform

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specific tasks and to oversee liquidity and funds • Evaluates liquidity and profitability risks associated
management, and reviews the minutes of the ALCO; with new business activities and strategies.
• Establishes executive-level lines of authority and
responsibility for managing the institution’s liquidity Collateral Position Management
risk;
• Provides appropriate resources to management for Financial assets are a key funding source, as they can
identifying, measuring, monitoring, and controlling generate substantial cash inflows through principal and
liquidity risks; and interest payments. Financial assets can also provide funds
• Understands the liquidity risk profiles of significant when sold or when used as collateral for borrowings.
subsidiaries and affiliates. Management routinely pledges assets when borrowing
funds or obtaining credit lines from the Federal Home Loan
Management is responsible for appropriately implementing Bank (FHLB), the Federal Reserve discount window, or
board-approved liquidity policies, procedures, and other institutions.
strategies. This responsibility includes overseeing the
development and implementation of appropriate risk Collateral management is the practice of identifying and
measurement and reporting systems, contingency funding managing the institution’s assets that may be pledged as
plans, and internal controls. Management is also collateral to another party. An effective collateral
responsible for regularly reporting the institution’s liquidity management program aids in monetizing (i.e. converting to
risk profile to the board. cash via collateralized borrowing) potentially less liquid
assets for use in conducting payments, funding loans, or
Examiners should evaluate whether the ALCO (or similar satisfying deposit withdrawals.
committee) actively monitors the institution’s liquidity
profile. Effective ALCOs have representation across major Characteristics of an effective collateral management
functions (e.g., lending, investments, wholesale and retail system may include the ability to:
funding) that may influence the liquidity risk profile. The
committee is usually responsible for ensuring that liquidity • Identify and track the movement of pledged collateral,
reports include accurate, timely, and relevant information including the entity to which the collateral is pledged,
on risk exposures. the entity that has custody of the collateral, and
unencumbered available collateral, at the individual
Examiners should evaluate corporate governance by instrument level.
reviewing liquidity management processes (including daily, • Have a centralized view into all pledged collateral,
monthly, and quarterly activities), committee minutes, including the value of collateral pledged relative to the
liquidity and funds management policies and procedures, amount required and the availability of unencumbered
and by holding discussions with management. collateral by type and amount.
Additionally, examiners should consider the findings of • Manage collateral positions to avoid accidental double
independent reviews and prior reports of examination when encumbrance. Typically, each funds provider would
assessing the effectiveness of corrective actions. need to release or subordinate its lien before another
counterparty will advance secured credit (examiners
Liquidity Management Strategies should recognize that providers of funds on a secured
basis, such as the FHLB and Federal Reserve, do not
Liquidity management involves short- and long-term share collateral or liens on an institution’s pledged
strategies that can change over time, especially during times assets).
of stress. Therefore, the institution’s policies often require • Identify all borrowing agreements (contractual or
management to meet regularly and consider liquidity costs, otherwise) that may require the institution to provide
benefits, and risks as part of the institution’s overall additional collateral, substitute existing collateral, or
strategic planning and budgeting processes. As part of this deliver collateral, such as requirements that may be
process, management: triggered by changes in an institution’s financial
condition.
• Performs periodic liquidity and profitability • Monitor the change in market value, credit quality,
evaluations for existing activities and strategies; and performance of collateral instruments so as to be
• Identifies primary and contingent funding sources able to anticipate and meet calls for additional
needed to meet daily operations, as well as seasonal collateral.
and cyclical cash flow fluctuations;
• Ensures liquidity management strategies are consistent
with the board’s expressed risk tolerance; and

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Smaller institutions or those with limited amounts of ←

borrowings may be able to adequately manage collateral POLICIES, PROCEDURES, AND
needs through manual processes and monitor collateral
REPORTING
levels by reviewing monthly or quarterly reports. Larger
institutions; those with material payment, settlement, and
clearing activities; or those more active in using secured Liquidity Policies and Procedures
financing (e.g. repurchase agreements, public deposits, or
FHLB borrowings) will benefit from actively monitoring Comprehensive written policies, procedures, and risk limits
short- (including intraday), medium-, and long-term form the basis of liquidity risk management programs. All
collateral positions and may engage in a practice known as institutions benefit from board-approved liquidity
collateral optimization. management policies and procedures specifically tailored
for their institution.
During a liquidity stress event, management’s ability to
respond quickly to emergency funding needs is critical and Even when operating under a holding company with
may depend on the quality and effectiveness of the pledged centralized planning and decision making, each institution’s
collateral reporting and tracking systems. In practice, board has a legal responsibility to maintain policies,
demands for collateral must often be met within just a few procedures, and risk limits tailored to its individual
hours. In order to meet the timeliness requirements, an institution’s risk profile. And each institution’s board is
institution may pledge cash or readily available highly responsible for ensuring that the structure, responsibility,
liquid investment securities, such as U.S. Treasuries. and controls for managing the institution’s liquidity risk are
However, given more time, it may be able to substitute less clearly documented. To fulfill its oversight responsibilities,
liquid instruments and return the more liquid instruments to a prudent board regularly monitors reports that highlight
available inventory. The practice of replacing previously institution-specific liquidity factors.
pledged collateral with less liquid collateral that will still be
deemed acceptable by the secured party is known as Boards that review and approve liquidity policies at least
collateral optimization. This activity increases an annually ensure such policies remain relevant and
institution’s ability to rapidly obtain funding from its more appropriate for the institution’s business model, complexity,
liquid collateral, but also requires more advanced and risk profile. Written policies are important for defining
management and reporting systems. the scope of the liquidity risk management program and
ensuring that:
Examiners should determine whether the institution has
collateral management and reporting systems that are • Sufficient resources are devoted to liquidity
commensurate with the institution’s funding structure, management,
potential borrowing needs, and overall risk profile, • Liquidity risk management is incorporated into the
including determining whether reporting systems facilitate institution’s overall risk management process, and
the monitoring and management of assets pledged and of • Management and the board share an understanding of
assets that can be pledged as collateral for borrowed funds. strategic decisions regarding liquidity.
This determination includes reviewing collateral tracking or
pledged asset reports. Effective policies and procedures address liquidity matters
(such as legal, regulatory, and operational issues) separately
Examiners should also determine whether management: for legal entities, business lines, and, when appropriate,
individual currencies. Sound liquidity and funds
• Considers potential changes to collateral requirements management policies typically:
in cash flow projections, stress tests, and contingency
funding plans; and • Provide for the effective operation of the ALCO. The
• Understands the operational and timing requirements ALCO policies address responsibilities for assessing
associated with accessing collateral (such as at a current and projected liquidity positions,
custodian institution or a securities settlement location implementing board-approved strategies, reviewing
where the collateral is held). policy exceptions, documenting committee actions,
and reporting to the board;
• Provide for the periodic review of the deposit
structure. Effective reviews typically include
assessments of the volume and trend of total deposits,
the types and rates of deposits, the maturity
distribution of time deposits, and competitor rate
information. Other information considered in the

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reviews, when applicable, includes the volume, trend, • Targeted cash flow gaps over discrete and cumulative
and concentration of large deposits, public funds, out- periods and under expected and adverse business
of-area deposits, uninsured deposits, potentially rate- conditions;
sensitive deposits, and wholesale deposits, including • Expected levels of unencumbered liquid assets;
brokered and other deposits received through third- • Measures for liquid asset coverage ratios (e.g., liquid
party arrangements; assets to total assets, cash and confirmed borrowing
• Address permissible funding sources and capacity to uninsured deposits).
concentration limits. Items addressed generally • Limits on potentially unstable liabilities;
include funding types with similar rate sensitivity or • Concentration limits on assets that may be difficult to
volatility, such as brokered or Internet deposits and convert into cash (such as complex financial
deposits generated through promotional offers; instruments, depreciated securities, bank-owned life
• Provide a method of computing the institution’s cost insurance, and less-marketable loan portfolios);
of funds; • Limits on the level of borrowings, brokered funds, or
• Establish procedures for measuring and monitoring exposures to single fund providers or market
liquidity. Procedures generally include static segments;
measurements and cash flow projections that forecast • Funding diversification standards by tenor, source,
base case and a range of stress scenarios; and type;
• Address the type and mix of permitted investments. • Limits on contingent liability exposures such as
Items addressed typically include the maturity unfunded loan commitments or lines of credit;
distribution of the portfolio, which investments are • Collateral requirements for derivative transactions and
available for liquidity purposes, and the level and secured lending;
quality of unpledged investments; • Limits on material exposures in complex activities
• Provide for an adequate system of internal controls. (such as securitizations, derivatives, trading, and
Controls typically require periodic, independent international activities).
reviews of liquidity management processes and
compliance with policies, procedures, and risk limits; Examiners should consider whether management and the
• Include a contingency funding plan (CFP) that board establish meaningful risk limits, periodically evaluate
identifies alternate funding sources if liquidity the appropriateness of established limits, and compare
projections are incorrect or a liquidity crisis arises and actual results to approved risk limits. Identified policy
describes potential stress scenarios; exceptions, as well as the appropriateness and promptness
• Require periodic testing of borrowing lines and of corrective actions in response to these exceptions, are
consider operational impediments to implementing the typically noted in board or committee minutes.
CFP;
• Establish procedures for reviewing and documenting Liquidity Reporting
assumptions used in liquidity projections;
• Define procedures for approving exceptions to Timely and accurate information is a prerequisite to sound
policies, limits, and authorizations; funds management practices. Institutions benefit from
• Identify permissible wholesale funding sources; liquidity risk reports that clearly highlight the institution’s
• Define authority levels and procedures for accessing liquidity position, risk exposures, and level of compliance
wholesale funding sources; with internal risk limits.
• Establish a process for measuring and monitoring
unused borrowing capacity and for verifying, and Examiners should assess liquidity reporting procedures.
positioning, unencumbered collateral; Typically, institution personnel tasked with ongoing
• Convey the board’s risk tolerance by establishing liquidity administration receive liquidity risk reports at least
target liquidity ratios and parameters under various daily. Senior officers may receive liquidity reports weekly
time horizons and scenarios; and or monthly, and the board may receive liquidity risk reports
• Include other items unique to the institution. monthly or quarterly. Depending on the complexity of
business activities and the liquidity risk profile, institutions
Risk Tolerances may need to increase, sometimes on short notice, the
frequency of liquidity reporting.
Examiners should consider whether liquidity policies
accurately reflect the board’s risk tolerance and delineate The format and content of liquidity reports will vary
qualitative and quantitative guidelines commensurate with depending on the characteristics of each institution and its
the institution’s risk profile and balance sheet complexity. funds management practices. Examiners should consider
Typical risk guidelines include: whether an institution’s management information systems

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and internal reports provide accurate, pertinent information Cash flow forecasts can be useful for all institutions and
such as: become essential when operational areas (e.g., loans,
deposits, investments) are complex or managed separately
• Liquidity needs and the sources of funds available to from other areas. Cash flow projections enhance
meet these needs over various time horizons and management’s ability to evaluate and manage these areas
scenarios (reports are often referred to as pro forma individually and collectively.
cash flow reports, sources and uses reports, or
scenario analyses); The sophistication of cash flow forecasting ranges from the
• Collateral positions and funds providers (lienholders), use of simple spreadsheets to comprehensive liquidity risk
including pledged and unpledged assets (and when models. Some vendors that offer interest rate risk (IRR)
necessary, the availability of collateral by legal entity, models also provide options for modeling liquidity cash
jurisdiction, and currency exposure); flows because the base information is already maintained
• Public funds and other material providers of funds for IRR modeling. When reviewing liquidity risk models,
(including rate and maturity information); examiners should verify that management compares
• Funding categories and concentrations; funding sources and uses over various periods and that
• Asset yields, liability costs, net interest margins, and modeling assumptions are appropriate for evaluating
variations from the prior month and budget (beneficial liquidity risk rather than IRR.
reports are detailed enough to permit an analysis of
interest margin variations); Cash flow projections typically forecast funding sources
• Early warning indicators for contingency funding and uses over short-, medium-, and long-term time horizons.
events or signs of increasing liquidity pressure; Non-complex community institutions that are in sound
condition may forecast short-term positions monthly. More
• Conformance with policy risk limits and the status of
complex institutions may need to perform weekly or daily
policy exceptions;
forecasts, and institutions with large payment systems and
• Interest rate projections and economic conditions in
settlement activities may need to conduct intraday
the institution’s trade area;
measurements. All institutions can benefit from having the
• Information concerning non-relationship or higher
ability to increase the frequency of monitoring and reporting
cost funding programs;
during a stress event.
• The stability of deposit customers, providers of
wholesale funds (including brokered deposits), and Effective cash flow analysis allows management to plan for
other deposits received through third-party tactical (short-term) and strategic (medium- and long-term)
arrangements; liquidity needs. Examiners should review the institution’s
• The level of highly liquid assets; procedures, assumptions, and information used to develop
• Stress test results; and cash flow projections. For example, examiners should
• Other items unique to the institution. consider whether funding sources and uses are adequately
stratified, as excessive account aggregations in liquidity
← analysis can mask substantial liquidity risk. Similar to
LIQUIDITY RISK MEASUREMENT measuring IRR, there are advantages to using account-level
information. For some institutions, gathering and
To identify potential funding gaps, management typically measuring information on specific accounts may not be
monitors cash flows, assesses the stability of funding feasible due to information system limitations. Although
sources, and projects future funding needs. When assessing the advantages of using detailed account information may
an institution’s liquidity rating, examiners should evaluate not be as evident for a non-complex institution, generally,
an institution’s liquidity risk measurement and monitoring all institutions can benefit from using more detailed account
procedures. information in their liquidity models.

Pro Forma Cash Flow Projections Examiners should carefully assess the assumptions that
management uses when projecting cash flows. Reliability
Historically, most institutions used single, point-in-time is enhanced when projections are based on reasonable
(static) measurements (such as loan-to-deposit or loan-to- assumptions and reliable data. Additionally, the accuracy
asset ratios) to assess their liquidity position. Static and reliability of cash flow projections are enhanced when
liquidity measures provide valuable information and remain projected cash flows consider contractual and expected cash
a key part of institutions’ liquidity analysis. However, cash flows. For example, the accuracy of cash flow projections
flow forecasting can enhance an institution’s ability to for construction loans is enhanced when management
monitor and manage liquidity risk. estimates the amount of available credit that will be drawn
in a given period rather than including the full amount of
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contractual obligations. Additionally, forecasts for scenarios remain stable, established borrowing facilities
maturing time deposits, particularly those obtained through have been operationalized and are largely unused, and other
special rate promotions, can be enhanced if the analysis risk characteristics are predictable. A higher level of
considers the probable retention rate of maturing deposits. unencumbered liquid assets may be required if:

Modeling assumptions play a critical role in projecting cash • Institution customers have numerous alternative
flows and measuring liquidity risks. Therefore, institutions investment options,
benefit from ensuring key assumptions are reasonable, well • Recent trends show a substantial reduction in large
documented, and periodically reviewed and approved by the liability accounts,
board. Ensuring the accuracy of assumptions is also • The institution has a material reliance on potentially
important when assessing the liquidity risk of complex less stable funding sources, such as large, uninsured
assets, liabilities, and off-balance sheet positions and can be deposits,
critical when evaluating the availability of funding sources • The loan portfolio includes a high volume of non-
under adverse liquidity scenarios. Accurate and reliable marketable loans,
cash flow forecasting can benefit institutions by identifying • The institution expects several customers to make
liquidity risks. material draws on unused lines of credit,
• Deposits include substantial amounts of short-term
Back Testing municipal accounts,
• A concentration of credits was extended to an industry
The reliability of cash flow projections may also be with existing or anticipated financial problems,
enhanced if management evaluates assumptions about
• A close relationship exists between individual demand
customer behavior, separately estimates gross cash flows on
accounts and principal employers in the trade area
both sides of the balance sheet, and compares modeling
who have financial problems,
projections to actual results (back testing). Back testing
• A material amount of assets is pledged to support
allows management to make adjustments to cash flow
wholesale borrowings,
models and modeling assumptions, as appropriate, to reflect
changes in cash flow characteristics. • The institution’s access to capital markets is impaired,
• Stress testing results indicate the need for increased
Scenario Analysis levels of unencumbered, liquid assets, or
• The institution is experiencing financial duress.
Cash flow projections can also be used in scenario analysis
and to develop CFPs. Management typically starts with An institution’s assets provide varying degrees of liquidity
base case projections that assume normal cash flows, market and can create cash inflows and outflows. Institutions
conditions, and business operations over the selected time generally retain a certain level of highly liquid assets to meet
horizon. Management then tests stress scenarios by immediate funding needs, and hold other types of
changing various cash flow assumptions in the base case investments to provide liquidity for meeting ongoing
scenario. For example, if the stress scenario assumed a operational needs and responding to contingent funding
change in the Prompt Corrective Action (PCA) capital events. To balance profitability goals and liquidity
category that triggered interest rate restrictions and brokered demands, management typically weighs the full benefits
deposit limitations, it is appropriate for management to (yield and increased marketability) of holding liquid assets
adjust assumptions to reflect the possible limitation or against the expected higher returns associated with less
elimination of access to affected funding sources. liquid assets. Income derived from holding longer-term,
Management typically uses the stress testing results in higher-yielding assets may be offset if management is
developing funding plans to mitigate these risks, including forced to sell the assets quickly due to adverse balance sheet
determining appropriate amounts for – or sizing – the fluctuations.
liquidity buffer and contingent borrowing lines.
Cash and Due from Accounts
←
FUNDING SOURCES - ASSETS Cash and due from accounts are essential for meeting daily
liquidity needs. Management relies on cash and due from
The amount of liquid assets that an institution maintains is accounts to fund deposit account withdrawals (particularly
generally a function of the stability of its funding structure, in stress situations), disburse loan proceeds, cover cash
the risk characteristics of its balance sheet, and the adequacy letters, fund operations, meet reserve requirements when
of its liquidity risk measurement program. Generally, a applicable, and facilitate correspondent transactions.
lower level of unencumbered liquid assets may be sufficient
if funding sources in base case and in various stress
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Loan Portfolio Assets that are typically securitized include credit card
receivables, automobile receivables, commercial and
The loan portfolio is an important factor in liquidity residential mortgage loans, commercial loans, home equity
management. Loan payments provide steady cash flows, loans, and student loans.
and loans can be used as collateral for secured borrowings
or sold for cash in the secondary loan market. However, the Securitization can be an effective funding method for some
quality of the loan portfolio can directly impact liquidity. institutions. However, there are several risks associated
For example, if an institution encounters asset quality with using securitization as a funding source. For example:
issues, operational cash flows may be affected by the level
of non-accrual borrowers and late payments. • Some securitizations have early amortization clauses
to protect investors if the performance of the
For many institutions, loans serve as collateral for wholesale underlying assets does not meet specified criteria. If
borrowings such as FHLB advances. If asset quality issues an early amortization clause is triggered, the issuing
exist, management may find that delinquent loans do not institution is legally obligated to begin paying
qualify as collateral. Also, higher amounts of collateral may principal to bondholders earlier than originally
be required because of doubts about the overall quality of anticipated and fund new receivables that would have
the portfolio or because of market volatility that affects the otherwise been transferred to the trust. Institutions
value of the loan collateral. These “haircuts” can be involved in securitizations benefit from monitoring
substantial and are an important consideration in stress tests. asset performance to better anticipate the cash flow
and funding ramifications of early amortization
Comprehensive liquidity analysis considers contractual clauses.
requirements and customers’ behavior when forecasting • If the issuing institution has a large concentration of
loan cash flows. Prepayments and renewals can residual assets, the institution’s overall cash flow
significantly affect contractual cash flows for many types of might be dependent on the residual cash flows from
loans. Customer prepayments are a common consideration the performance of the underlying assets. If the
for residential mortgage loans (and mortgage-backed performance of the underlying assets is worse than
securities) and can be a factor for commercial and projected, the institution’s overall cash flow will be
commercial real estate loans (and related securities). less than anticipated.
Assumptions related to revolving lines of credit and balloon • Residual assets retained by the issuing institution are
loans can also have a material effect on cash flows. typically illiquid assets for which there is no active
Examiners should determine whether management’s loan market. Additionally, the assets are not acceptable
cash flow assumptions are supported by historical data. collateral to pledge for borrowings.
• An issuer’s market reputation can affect its ability to
Asset Sales and Securitizations securitize assets. If the institution’s reputation is
damaged, issuers might not be able to economically
As noted above, assets can be used as collateral for secured securitize assets and generate cash from future sales of
borrowings or sold for cash in the secondary market. Sales loans to the trust. This is especially true for
in the secondary market can provide fee income, relief from institutions that are relatively new to the securitization
interest rate risk, and a funding source for the institution. market.
However, for an asset to be saleable at a reasonable price in • The timeframe required to securitize loans held for
the secondary market, it will generally have to conform to sale may be considerable, especially if the institution
market (investor) requirements. Because loans and loan has limited securitization experience or encounters
portfolios may have unique features or defects that hinder unforeseen problems.
or prevent their sale into the secondary market, management
would benefit from thoroughly reviewing loan Institutions that identify asset sales or securitizations as
characteristics and documenting assumptions related to loan contingent liquidity sources, particularly institutions that
portfolios when developing cash flow projections. rarely sell or securitize loans, benefit from periodically
testing the operational procedures required to access these
Some institutions are able to use securitizations as a funding funding sources. Market-access testing helps ensure
vehicle by converting a pool of assets into cash. Asset procedures work as anticipated and helps gauge the time
securitization typically involves the transfer or sale of on- needed to generate funds; however, testing does not
balance sheet assets to a third party that issues mortgage- guarantee the funding sources will be available or on
backed securities (MBS) or asset-backed securities (ABS). satisfactory terms during stress events.
These instruments are then sold to investors. The investors
are paid with the cash flow from the transferred assets. A thorough understanding of applicable accounting and
regulatory rules is critical when securitizing assets.
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Accounting standards establish conditions to achieve sales reduce the value of longer-duration investments
treatment of financial assets. The standards influence the pledged to secured borrowings.
use of securitizations as a funding source, because
transactions that do not qualify for sales treatment require ←
the selling institution to account for the transfer as a secured FUNDING SOURCES - LIABILITIES
borrowing with a pledge of collateral. As such,
management must account for, and risk weight, the Deposits are the most common funding source for most
transferred financial assets as if the transfer had not institutions; however, other liability sources, such as
occurred. Accordingly, management should continue to borrowings, can also provide funding for daily business
report the transferred assets in financial statements with no activities, or as alternatives to using assets to satisfy
change in the measurement of the transferred financial liquidity needs. Deposits and other liability sources are
assets. often differentiated by their stability and customer profile
characteristics.
When financial assets are securitized and accounted for as a
sale, institutions often provide contractual credit
Core Deposits
enhancements, which may involve over-collateralization,
retained subordinated interests, asset repurchase
Core deposits are generally stable, lower-cost funding
obligations, cash collateral accounts, spread accounts, or
sources that typically lag behind other funding sources in
interest-only strips. Part 324 of the FDIC Rules and
repricing during a period of rising interest rates. The
Regulations requires the issuing institution to hold capital
deposits are typically funds of local customers that also have
against the retained credit risk arising from these contractual
a borrowing or other relationship with the institution.
credit enhancements.
Convenient branch locations, superior customer service,
extensive ATM networks, and low- or no-fee accounts are
There can also be non-contractual support for ABS
factors that contribute to the stability of the deposits. Other
transactions that would be considered implicit recourse.
factors include the insured status of the account and the type
This implicit recourse may create credit, liquidity, and
of depositor (e.g., retail, commercial, and municipal).
regulatory capital implications for issuers that provide
support for ABS transactions. Institutions typically provide
Examiners should assess the stability of deposit accounts
implicit recourse in situations where management perceives
when reviewing liquidity and funds management practices.
that the failure to provide support, even though not
Generally, higher-cost, non-relationship deposits, such as
contractually required, would damage the institution’s
Internet deposits or deposits obtained through special-rate
future access to the ABS market. For risk-based capital
promotions, may be considered less-stable funding sources.
purposes, institutions deemed to be providing implicit
Brokered deposits are not considered core deposits or a
recourse are generally required to hold capital against the
stable funding source due to their brokered status and
entire outstanding amount of assets sold, as though they
wholesale characteristics.
remained on the books.
Core deposits are defined in the Uniform Bank Performance
Investment Portfolio Report (UBPR) User’s Guide as the sum of all transaction
accounts, money market deposit accounts (MMDAs), non-
An institution’s investment portfolio can provide liquidity transaction other savings deposits (excluding MMDAs), and
through regular cash flows, maturing securities, the sale of time deposits of $250,000 and below, less fully insured
securities for cash, or by pledging securities as collateral for brokered deposits of $250,000 and less. However,
borrowings, repurchase agreements, or other transactions. examiners should not assume that all deposits meeting the
Institutions can benefit from periodically assessing the UBPR definition of core are necessarily stable or that all
quality and marketability of the investment portfolio to deposits defined as non-core are automatically volatile.
determine:
In some instances, core deposits included in the UPBR’s
• The level of unencumbered securities available to core deposit definition might exhibit characteristics
pledge for borrowings, associated with less stable funding sources. For example,
• The financial impact of unrealized holding gains and out-of-area certificates of deposit (CDs) of $250,000 or less
losses, that are obtained from a listing service may have less
• The effect of changes in asset quality, and stability although they are included in core deposits under
• The potential need to provide additional collateral the UBPR definition, given the lack of direct relationship
should rapid changes in market rates significantly and motivation of such depositors seeking competitive
rates. As another example, transactional account deposits

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LIQUIDITY AND FUNDS MANAGEMENT Section 6.1

brought to the institution through an arrangement with a monetary and fiscal policies on the institution’s service area
third party (whether a broker-dealer, financial technology and capital markets in general.
firm, reciprocal network, or other third party) and which
may qualify for an exception from brokered deposit Effective deposit management programs are monitored and
treatment, may also be less stable as movement of such adjusted as necessary. The long-term success of such
deposits is often controlled by a third party. Management programs is closely related to management’s ability to
and examiners should not automatically view “core” identify the need for changes quickly. Effective programs
deposits as a stable funding source without additional include procedures for accurately projecting deposit trends
analysis. and carefully monitoring the potential volatility of accounts
(e.g., stable, fluctuating, seasonal, brokered).
Alternatively, some deposit accounts generally viewed as
volatile, non-core funds by UBPR definitions (for example, Wholesale Funds
CDs larger than $250,000) might be considered relatively
stable after a closer analysis. For instance, a local depositor Wholesale funds include, but are not limited to, brokered
might have CDs larger than $250,000 that may be deposits, deposits obtained through programs marketed by
considered stable because the depositor has maintained third parties (such as a broker-dealer, financial technology
those deposits with the institution for several years. firm, reciprocal network, or other third party) even though
However, while some deposit relationships over $250,000 not defined or reported as brokered deposits, Internet
remain stable when the institution is in good condition, such deposits, deposits obtained through listing services, foreign
relationships, because of their uninsured status, might deposits, public funds, federal funds purchased, FHLB
become less stable if the institution experiences financial advances, correspondent line of credit advances, and other
problems. Additionally, deposits identified as stable during borrowings.
good economic conditions may not be reliable funding
sources during stress events. Therefore, examiners should Providers of wholesale funds closely track institutions’
consider whether management identifies deposit accounts financial condition and may cease or curtail funding,
likely to be unstable in times of stress and appropriately increase interest rates, or increase collateral requirements if
evaluates these deposits in its liquidity stress testing and in they determine an institution’s financial condition is
determining the adequacy of the liquidity buffer. deteriorating. As a result, some institutions may experience
liquidity problems due to a lack of wholesale funding
Deposit Management Programs availability when funding needs increase.

The critical role deposits play in an institution’s successful The Internet, listing services, and other automated services
operation demonstrates the importance of implementing enable investors who focus on yield to easily identify high-
programs for retaining or expanding the deposit base. yield deposits. Customers who focus primarily on yield are
Strong competition for depositors’ funds and customers’ a less stable source of funding than customers with typical
preference to receive market deposit rates also highlight the deposit relationships. If more attractive returns become
benefit of deposit management programs. Effective deposit available, these customers may rapidly transfer funds to new
management programs generally include: institutions or investments in a manner similar to that of
wholesale investors.
• Regular reports detailing existing deposit types and
levels, It is important to measure the impact of the loss of wholesale
• Projections for asset and deposit growth, funding sources on the institution’s liquidity position. The
• Associated cost and interest-rate scenarios, challenge of measuring, monitoring, and managing liquidity
• Clearly defined marketing strategies, risk typically increases as the use of wholesale and
• Procedures to compare results against projections, and nontraditional funding sources increases. Institutions that
• Steps to revise the plans when needed. rely more heavily on wholesale funding will often need
enhanced funds management and measurement processes
Deposit management programs generally take into account and may require more comprehensive scenario modeling.
the make-up of the market-area economy, local and national In addition, contingency planning and capital management
economic conditions, and the potential for investing take on added significance for institutions that rely heavily
deposits at acceptable margins. Other considerations on wholesale funding.
include management expertise, the adequacy of institution
operations, the location and size of facilities, the nature and
degree of bank and non-bank competition, and the effect of

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LIQUIDITY AND FUNDS MANAGEMENT Section 6.1

Brokered and Higher Rate Deposits relationship with those customers, most of which an
institution may rely upon without notice to the FDIC.
Section 29 of the FDI Act establishes certain brokered However, as discussed below, a third party, or an institution
deposit restrictions on institutions that are not well filing on behalf of a third party, must provide the FDIC with
capitalized. Section 337.6 of the FDIC Rules and a written notice that the third party will rely on a designated
Regulations implements Section 29 and defines a brokered business exception described in Section
deposit as a deposit obtained through or with assistance of a 337.6(a)(5)(v)(I)(1)(i)-(ii) of the FDIC Rules and
deposit broker. The term deposit broker is generally defined Regulations. In addition, for business relationships that are
by Section 29 as any person engaged in the business of not identified as a designated business exception, an agent
placing deposits, or facilitating the placement of deposits, or nominee (or an institution on its behalf) may submit a
of third parties with institutions or the business of placing written application and receive approval from the FDIC to
deposits with insured depository institutions for the purpose qualify for a PPE as described in Section
of selling interests in those deposits to third parties; and an 337.6(a)(5)(v)(I)(2). Specific requirements related to PPE
agent or trustee who establishes a deposit account to filings are addressed in Section 303.243(b).
facilitate a business arrangement with an insured depository
institution to use the proceeds of the account to fund a The two designated business relationship PPEs requiring a
prearranged loan. notice to the FDIC are:

Section 337.6 exempts from the deposit broker definition • The “25 percent test,” where less than 25 percent of
third parties that have exclusive deposit relationships with the total assets that the agent or nominee has under
only one institution and defines relevant terms, including administration for its customers is placed at depository
“placing,” “facilitating,” “engaged in the business of institutions; and
placing deposits,” “engaged in the business of facilitating • “Enabling transactions,” where 100 percent of funds
the placement of deposits,” and “engaged in the business.” that the agent or nominee places, or assists in placing,
Refer to section 337.6(a)(5)(i)-(iv) for these definitions. at depository institutions are placed into transactional
The rule excludes an entity with a “primary purpose accounts that do not pay any fees, interest, or other
exception” from the deposit broker definition. remuneration to the underlying depositor.

Even if a third party would otherwise fit the definition of a The FDIC may, with notice, revoke a PPE of a third party
“deposit broker,” the brokered deposit statute and regulation if:
provide nine statutory exceptions and one additional
regulatory exception to this definition of deposit broker • The third party no longer meets the criteria for a
(refer to section 337.6(a)(5)(v)). Certain business designated exception;
relationships are designated as meeting the primary purpose • The notice or subsequent reporting is inaccurate; or
exception (PPE). Institutions and non-bank third parties • The notice filer fails to submit required reports. 1
may also request a PPE for a particular business line that
does not meet one of the designated exceptions by filing an Involvement of Additional Third Parties
application with the FDIC under Section 303.243(b) of the
FDIC Rules and Regulations. An institution that receives deposits from an unaffiliated
third party with a PPE for a particular business line must
Primary Purpose Exceptions (PPE) determine whether there are any additional third parties
involved in the deposit placement arrangement that qualify
The PPE applies when, with respect to a particular business as a deposit broker, because the institution is responsible for
line, the primary purpose of the agent’s or nominee’s accurately reporting the deposits on its Call Report. If an
business relationship with its customers is not the placement additional third party is involved that would qualify as a
of funds with insured depository institutions. “deposit broker” under 12 CFR § 337.6(a)(5), for example
if the additional third party is engaging in “matchmaking
The revised rule designates 14 business relationships as activities” under 12 CFR § 337.6(a)(5)(iii)(C), then the
meeting the PPE. In December 2021, the FDIC designated deposits received from that arrangement must be reported
an additional business line as qualifying for a PPE (refer to as a brokered deposit by the institution, even if the
87 FR 1065). Whether an agent or nominee qualifies for the unaffiliated third party has a primary purpose exception for
PPE is based on analysis of the agent’s or nominee’s the relevant business line. Note that even when the sweep

1 Filers that submit a notice under the “25 percent” test must

provide quarterly updates; filers that submit a notice under the

“enabling transactions” test must provide an annual certification.
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LIQUIDITY AND FUNDS MANAGEMENT Section 6.1

deposits are placed by the third party directly, the IDI must brokered deposits unless the third-party brokerage firm
consider whether an additional third party may be meets the PPE.
“facilitating the placement of the deposits.”
Sweep accounts that rely on the PPE must fit a designated
For example, the FDIC has received PPE notice filings from exception from the definition of deposit broker. The entity
broker dealers asserting that an additional third party will qualify for the “25 percent test” designated exception if
involved in the unaffiliated sweep program provides the it is in a business relationship where, with respect to a
broker dealers with “administrative services.” It has been particular business line, less than 25 percent of the total
the FDIC’s experience that such services include activities assets that the entity has under administration for its
that meet the facilitation part of the deposit broker customers is placed at depository institutions and where the
definition, for example by engaging in matchmaking entity has filed a notice with the FDIC. The entity may also
activities. When receiving sweep deposits under such an rely on another exception from the definition of deposit
arrangement, it is the institution’s responsibility to evaluate broker for which it qualifies.
the third party’s role and determine whether that role
constitutes facilitating the placement of deposits, including Network and Reciprocal Deposits
by engaging in matchmaking activities, when it files its Call
Report. Institutions sometimes participate in networks established
for the purpose of sharing deposits. In such a network, a
During examinations, examiners should determine whether participating institution places funds, either directly or
institutions are relying upon PPEs to except certain deposits through a third-party network sponsor, at other participating
involving third parties and assess the institution’s Call network institutions in order for its customer to receive full
Report filing documentation supporting the institution’s deposit insurance coverage.
reliance on the PPE.
Some networks establish reciprocal agreements allowing
Listing Services participating institutions to send and receive deposits with
the same maturity (if any) and in the same aggregate amount
A listing service is a company that compiles information simultaneously. This reciprocal agreement allows
about the interest rates offered by institutions on deposit institutions to maintain the same volume of funds they had
products. A particular company can be a listing service when the customer made the initial deposit, while providing
(compiler of information) as well as a deposit broker participating customers with deposits in excess of the
(facilitating the placement of deposits). Whether a listing $250,000 deposit insurance limit additional deposit
service, or a similar service that posts information about insurance through placement at other insured depository
deposit rates, is a deposit broker will likely depend on institutions. While reciprocal deposits meet the definition
whether the service meets the criteria under the of a brokered deposit, under certain conditions a limited
“facilitation” part of the deposit broker definition. Based on amount of reciprocal deposits may be excluded from
the “facilitation” definition, a listing service that passively treatment and reporting as brokered deposits.
posts rate information and sends trade confirmations
between the depositor and the institution is unlikely to be a Section 29(i) of the FDI Act (implemented through Section
deposit broker. However, if a listing service provides 337.6(e) of the FDIC Rules and Regulations) excludes a
services that meet one of the three prongs of the capped amount of reciprocal deposits from treatment as
“facilitation” definition, then it would be considered a brokered deposits for those insured depository institutions
deposit broker. that qualify as an “agent institution.” The amount of
reciprocal deposits that an agent institution may except from
Sweep Accounts treatment as brokered deposits may not exceed the lesser of
$5 billion or 20 percent of total liabilities (referred to as the
Some brokerage firms and investment companies that invest “general cap”). To qualify as an “agent institution,” the
money in stocks, bonds, and other investments on behalf of institution must meet one of the following:
clients operate sweep programs in which customers are
given the option to sweep uninvested cash into a bank • When most recently examined, under section 10(d) of
deposit. This arrangement provides the brokerage customer the FDI Act, was found to have a composite condition
with additional yield and insurance coverage on swept of outstanding or good, and is well capitalized 2; or
funds. These swept funds are generally considered

2 As noted under “Brokered Deposit Restrictions,” if an institution level, it will no longer be considered well capitalized for the
is under any type of formal agreement pursuant to Section 8 of the purposes of Part 337.
FDI Act with a directive to meet or maintain any specific capital
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LIQUIDITY AND FUNDS MANAGEMENT Section 6.1

• Has obtained a brokered deposit waiver from the Capitalized for PCA purposes. As of this date, Bank
FDIC; or A becomes subject to the special cap, which is $80
• Does not receive an amount of reciprocal deposits that million (the average of total reciprocal deposits
causes the total amount of reciprocal deposits held by reported on the Call Reports for the quarters ending
the agent institution to be greater than the average of 03/31/Y3, 12/31/Y2, 09/30/Y2, and 06/30/Y2).
the total amount of reciprocal deposits held by the
agent institution on the last day of each of the four • 06/30/Y3 Call Report scenarios (assume that the
calendar quarters preceding the calendar quarter in special cap is lower than the general cap):
which the agent institution was found not to have a
composite condition of outstanding or good or was o If Bank A does not receive additional reciprocal
determined to be not well capitalized (also referred to deposits after 05/15/Y3, the institution retains
as the “special cap”). agent status and may treat $90 million as non-
brokered under the general cap. Bank A reports
Treatment and reporting may be impacted if an institution total reciprocal deposits of $110 million on
receives reciprocal deposits that exceed its applicable cap Schedule RC-E, and $20 million as brokered
(general cap or special cap). Agent institutions that are in reciprocal deposits on Schedule RC-O.
outstanding or good composite condition (i.e., well rated)
and are well capitalized, or are adequately capitalized and o If Bank A receives additional reciprocal deposits
have obtained a brokered deposit waiver, are subject to the in any amount after 05/15/Y3, it loses agent
general cap, and therefore would report and treat the amount status, and all of its reciprocal deposits ($110
of reciprocals deposits that exceed the general cap as million) must be reported as brokered on
brokered deposits. Agent institutions that are not well Schedules RC-E and RC-O.
capitalized or not well rated, and have not received a
brokered deposit waiver, are subject to the special cap. Examiners should determine whether an institution’s
Agent institutions subject to the special cap also can report reciprocal deposits are being reported appropriately on its
and treat the amount of reciprocal deposits that exceed the Call Report and in conformance with the statutory and
general cap as brokered deposits. However, if after an agent regulatory definitions under Section 29(i) of the FDI Act
institution becomes subject to the special cap, it receives an and Section 337.6(e) of the FDIC Rules and Regulations.
amount of reciprocal deposits that causes the total amount
of reciprocal deposits held by it to be greater than its special Network member institutions may receive other deposits
cap, it is no longer an agent institution. If an institution is through a network such as (1) deposits received without the
not an agent institution, all of its reciprocal deposits are to institution placing into the network a deposit of the same
be treated and reported as brokered deposits. maturity and same aggregate amount (sometimes referred to
as “one-way network deposits”) and (2) deposits placed by
Agent institutions that become subject to the special cap the institution into the network where the deposits were
may retain agent status even if their pre-existing reciprocal obtained, directly or indirectly, by or through a deposit
deposits equal or exceed the special cap, as long as they do broker. Such other network deposits meet the definition of
not receive any reciprocal deposits after they have become brokered deposits and would not be eligible for, as
subject to the special cap. Consider the following previously described, the statutory and regulatory exception
illustration: provided for a capped amount of reciprocal deposits.

• 03/31/Y3: Bank A is well rated and well capitalized, The stability of reciprocal deposits may differ depending on
and reports $100 million in total reciprocal deposits on the relationship of the initial customer with the institution.
Call Report Schedule RC-E. Since the general cap is Examiners should consider whether management
$90 million (the lesser of $5 billion or 20 percent of adequately supports their assessments of the stability of
total liabilities), Bank A reports $10 million as reciprocal deposits, or any funding source, for liquidity
brokered reciprocal deposits on Call Report Schedule management and measurement purposes.
RC-O.
Brokered Deposit Restrictions
• 05/15/Y3: Total reciprocal deposits have increased to
$110 million, though the general cap remained at $90 Pursuant to Section 29 of the FDI Act and Section 337.6 of
million. On this date, Bank A receives notice from its the FDIC Rules and Regulations, an institution that is less
primary federal regulator that its composite rating has than well capitalized for the purposes of PCA is restricted
been downgraded to less than well rated (below a 2), from accepting, renewing, or rolling over brokered deposits.
signifying that the institution was no longer in Well capitalized institutions may accept, renew, or roll over
outstanding or good condition; the bank is still Well brokered deposits at any time. An adequately capitalized
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LIQUIDITY AND FUNDS MANAGEMENT Section 6.1

institution may not accept, renew, or roll over any brokered plus 75 basis points. The national rate cap for nonmaturity
deposit unless the institution has applied for and been deposits is the higher of the national rate plus 75 basis points
granted a waiver by the FDIC. An undercapitalized or the federal funds rate plus 75 basis points. The national
institution may not accept, renew, or roll over any brokered rates and national rate caps are published monthly on the
deposit (refer to Section 337.6(b)(3)). If an institution is FDIC’s public website.
under any type of formal agreement pursuant to Section 8
of the FDI Act with a directive to meet or maintain any Section 337.7 provides a simplified process for institutions
specific capital level, it will no longer be considered well that seek to offer a competitive rate when the prevailing rate
capitalized for the purposes of Part 337. in an institution’s local market area exceeds the national rate
cap. The local rate cap for a less than well capitalized
With respect to adequately capitalized institutions that have institution is 90 percent of the highest interest rate paid in
been granted a brokered deposit waiver, any safety and the institution’s local market area on a particular deposit
soundness concerns arising from the acceptance of brokered product by a bank or credit union accepting deposits at a
deposits are ordinarily addressed by the conditions imposed physical location within the institution’s local market area.
in granting the waiver application. In monitoring such The local market area is any readily defined geographic
conditions, examiners should not only verify compliance, market in which the institution accepts or solicits deposits.
but also assess whether the waiver has contributed to an
increasing risk profile. Under Section 337.7(d), a less than well capitalized
institution that seeks to pay a rate of interest up to its local
Deposit Rate Restrictions market rate cap must provide notice to the appropriate FDIC
regional director. The notice must include evidence of the
In addition to the brokered deposit restrictions noted above, highest rate paid on a particular deposit product in the
Section 29 of the FDI Act also places certain restrictions on institution’s local market area. The institution must:
deposit interest rates for institutions that are less than well
capitalized. Deposit rate restrictions prevent an institution • Update its evidence and calculations monthly for both
that is not well capitalized from circumventing the existing and new accounts, unless otherwise instructed
prohibition on brokered deposits by offering rates by the FDIC;
significantly above market in order to attract a large volume • Maintain records of the rate calculations for at least
of deposits quickly. the two most recent examination cycles; and
• Upon the FDIC’s request, provide the documentation
Section 29’s implementing regulation, Section 337.7 of the to the appropriate FDIC regional office and to
FDIC Rules and Regulations, contains two interest rate examination staff during any subsequent
restrictions, one based on when funds are accepted by an examinations.
institution, the other on when an institution solicits deposits.
One restriction provides that an adequately capitalized Additionally, institutions are not permitted to interpolate or
institution accepting reciprocal deposits, or brokered extrapolate interest rates for products with off-tenor
deposits pursuant to a waiver granted under Section 29(c) of maturities. If an institution seeks to offer a product with an
the FDI Act, may not pay a rate of interest that, at the time off-tenor maturity that is not offered by another institution
the funds are accepted, significantly exceeds the following: within its local market area, or for which the FDIC does not
(1) The rate paid on deposits of similar maturity in such publish the national rate cap, the institution is to use the rate
institution’s normal market area for deposits accepted in the offered on the next lower on-tenor maturity for that deposit
institution’s normal market area; or (2) the national rate paid product when determining its applicable national or local
on deposits of comparable maturity, as established by the rate cap, respectively. For example, an institution seeking
FDIC, for deposits accepted outside the institution’s normal to offer a 26-month certificate of deposit (CD), and such
market area. The other interest rate restriction prohibits a product is not offered by other institutions in the trade area,
less than well capitalized institution from soliciting any must use the rate offered for a 24-month CD to determine
deposits by offering a rate of interest that is significantly the applicable national or local rate cap.
higher than the prevailing rate.
An adequately capitalized institution that accepts
The national rate for each deposit product is defined as the nonmaturity brokered deposits subject to waiver, with
average of rates paid by all insured depository institutions respect to a particular deposit broker, is subject to the
and credit unions for which data is available, with rates applicable interest rate cap on:
weighted by each institution’s share of domestic deposits.
The national rate cap is calculated as the higher of: (1) the • Any new nonmaturity accounts opened by or through
national rate plus 75 basis points; or (2) 120 percent of the that particular deposit broker;
current yield on similar maturity U.S. Treasury obligations
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LIQUIDITY AND FUNDS MANAGEMENT Section 6.1

• An amount of funds that exceeds the amount(s) in the When brokered deposits are encountered in an institution,
account(s) that, at the time the institution fell to less examiners should consider the effect on overall funding and
than well capitalized, had been opened by or through investment strategies and, if the institution is less than well
the particular deposit broker; or capitalized, verify compliance with Part 337. Examiners
• For agency or nominee accounts, any funds for a new should also consider the source, stability, and use of
depositor credited to a nonmaturity account or brokered deposits or rate-sensitive funding sources that
accounts. support asset growth or individual loans. Appropriate
supervisory action should be considered if brokered
Refer to the interest rate restrictions in Section 337.7 for deposits or other rate-sensitive funding sources are not
specific information, including the solicitation and appropriately managed as part of an overall, prudent
acceptance of nonmaturity deposits. Examiners should funding strategy. Apparent violations of Part 337 or
review conformance with interest rate restrictions during nonconformance with the Interagency Guidelines
examinations of institutions that are not well capitalized. Establishing Standards for Safety and Soundness (Appendix
While the FDIC may grant a brokered deposit waiver to a A to Part 364) should be discussed with management and
less than well capitalized institution to retain brokered the board and appropriately addressed in the report of
deposits, the FDIC may not waive the interest rate examination.
restrictions under the brokered deposit regulations.
Uninsured Deposits
Brokered Deposits Use
Uninsured deposits can be part of a diversified funding
The FDI Act does not restrict the use of brokered deposits program and, depending on an institution’s funds
for well capitalized institutions, and brokered deposits can management objectives and strategy, these deposits may be
be a suitable funding source when properly managed. gathered from a number of retail, commercial, municipal,
However, some institutions have used brokered deposits to institutional, and wholesale sources. Nevertheless,
fund unsound or rapid expansion of loan and investment uninsured deposits can exhibit sudden instability when an
portfolios, which has contributed to weakened financial and institution experiences financial problems, adverse media
liquidity positions over successive economic cycles. The attention, or curtailment by funding counterparties. The
overuse and failure to properly manage brokered deposits level and characteristics of uninsured deposits, as well as the
by institutions have contributed to failures and losses to the institution’s risk profile, are factors that can affect their
Deposit Insurance Fund. stability and are important for management to understand to
properly assess liquidity risk.
Examiners should consider whether an institution’s policies
adequately describe permissible brokered and rate-sensitive While the duration, number of accounts, or use of multiple
funding types, amounts, and concentration limits. Key services in the deposit relationship may result in more stable
policy considerations include procedures for assessing deposit balances in a business-as-usual scenario, such
potential risks to earnings and capital associated with extended relationships may only have a modest effect in
brokered, reciprocal, and rate-sensitive deposits, and tempering flight risk during a stress event.
monitoring how such funds are used. Examiners should
verify whether management is aware of the restrictions that For institutions facing financial distress, uninsured deposit
may apply if the institution’s PCA capital category falls accounts whose average balances are considerably higher
below well capitalized. than the insurance limit may behave differently (i.e., are
more prone to runoff) than those with average deposit
Examiners should determine whether management balances only marginally above the insurance limit.
performs adequate due diligence before entering any Additionally, non-retail uninsured deposits are likely to be
business relationship with a deposit broker or other third- more sensitive and reactive to signs of serious financial
party business partners that help provide rate-sensitive distress than uninsured retail accounts.
deposits, such as deposit listing services.
An institution’s overall risk profile can also influence the
While the FDI Act does not restrict the use of brokered behavior of customers with uninsured deposits. The
deposits by well-capitalized institutions, the acceptance of uninsured deposits of institutions materially involved in
brokered deposits by well-capitalized institutions is subject activities perceived as riskier (e.g., higher-risk Acquisition,
to the same considerations and concerns applicable to any Development, or Construction lending, or third party
type of special funding. These considerations relate to deposit gathering) may exhibit a greater propensity to runoff
volume, availability, cost, volatility, maturity, and how the during stress. Furthermore, institutions, with a
use of such special funding fits into the institution’s overall concentration in uninsured deposits can be exposed to
liability and liquidity management plans. increased deposit withdrawals during a stress event.
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LIQUIDITY AND FUNDS MANAGEMENT Section 6.1

Prudent management teams consider the degree of exposure obligation. When used judiciously, these standby credit
to uninsured deposits for individual customers and in facilities can complement a diversified funds management
aggregate. Prudent management will also consider potential program and serve as a practical, cost-effective solution for
runoff risk when deriving liquidity stress testing securing an institution’s obligations.
assumptions and when determining an appropriately sized
liquid asset buffer and sources of contingent funding. Some institutions prefer to obtain an SBLC rather than
pledge government securities because of the standby
Public Funds facility’s cost and balance sheet efficiency. FHLBs will
accept a variety of loans and securities as collateral subject
Public funds are deposits of government entities such as to certain collateral requirements or “haircuts.”
states, counties, or local municipalities. In many cases,
public deposits are large and exceed the FDIC’s deposit Similar to FHLB advances or other secured borrowings,
insurance coverage limit. Some states require institutions to SBLCs require collateral. Most institutions depend on
secure only the uninsured portion of public deposits, while eligible loans or securities as collateral. To maximize
others require the entire balance of these accounts to be balance sheet efficiency, institutions frequently secure
secured. State laws typically require funds to be secured by SBLCs with loans, because they would otherwise use
high-quality assets such as securities of U.S. government or unencumbered securities to directly meet pledging
government-sponsored enterprises (GSE), a committed requirements (especially for uninsured public deposits).
standby letter of credit (SBLC) from an FHLB, or a state- While secured borrowings are a widely accepted form of
sponsored pooled collateral program that protects the funding that can be employed in a safe and sound manner,
uninsured portion of public deposits. undiversified reliance on secured borrowings or less stable
funding can sometimes result in strained liquidity. Funding
The stability of public fund accounts can vary significantly diversification is important in the case of large-scale
due to several factors. Account balances may fluctuate due secured borrowing programs, which can encumber assets
to timing differences between tax collections and that would otherwise be eligible for pledging or conversion
expenditures, the funding of significant projects (e.g., to cash. Importantly, funding risk does not arise because of
school or hospital construction), placement requirements, the type of secured borrowing conducted (i.e., FHLB
and economic conditions. Placement requirements may advances or SBLCs); rather, it stems from the volume of
include rotating deposits between institutions in a particular borrowing, leveraging previously unencumbered assets, and
community, obtaining bids and placing funds with the overreliance on non-core sources to achieve growth or
highest bidder, and minimum condition standards for the earnings targets.
institution receiving the deposits (such as specific capital
levels or the absence of formal enforcement actions). SBLCs are generally only exercised by public depositors if
Economic conditions can affect the volatility of public the institution fails to fund a withdrawal. If an institution
deposits, since public entities may experience lower does not have sufficient unencumbered liquid assets to meet
revenues during an economic downturn. a withdrawal request, it may seek a new FHLB advance and
contemporaneously cancel or reduce the SBLC. The assets
Although public deposit accounts often exhibit volatility, used to collateralize the SBLC would secure at least part of
the accounts can be reasonably stable over time, or their the new advance, depending on the FHLB’s revised
fluctuations quite predictable. Therefore, examiners should collateral terms. The FHLB can require additional
review public deposit relationships to make informed collateral, possession of collateral, or limits on availability
judgments as to their stability. if it views an institution as troubled.

Securing Public Funds Some states have adopted pooled collateral programs
through the respective state treasurer to centralize and
In addition to securing public funds with pledged high- streamline collateral management for public deposits.
quality assets, two other common arrangements include Participating institutions allocate high quality securities to a
SBLCs and state pooled collateral programs. Some pool of collateral rather than pledging individual securities
financial institutions obtain SBLCs as a supplemental against a specific public deposit.
funding source to accommodate public depositors,
derivative counterparties, and corporate borrowing needs. The programs facilitate public deposit placement in the
Typically, institutions obtain SBLCs from their district participating states, and some institutions participate in
FHLB to support uninsured public deposits and secure the multiple state programs where they have branches. Similar
SBLCs with eligible loans and securities. The SBLC to the SBLCs used to secure uninsured public deposits, the
guarantees that the issuer will pay the beneficiary on state pool model consumes less of participating institutions’
demand if the institution fails or otherwise defaults on its collateral on a percentage basis than if an individual
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institution were to pledge securities directly. Pledging require institutions to secure public funds, trust accounts,
requirements for each state program vary significantly, with and bankruptcy court funds. In addition to strict regulatory
some programs requiring collateral to cover as little as 25% and bookkeeping controls associated with pledging
of the uninsured deposit placement. Most programs include requirements, institutions often establish monitoring
periodic monitoring of the financial condition of controls to ensure deposits and pledged assets are
participants and increase collateral requirements in the appropriately considered in their liquidity analysis.
event an institution encounters financial stress. Accurate accounting for secured or preferred liabilities is
also important if an institution fails, because secured
Some of the programs include collective liability of depositors and creditors may gain immediate access to some
participating institutions. Collective liability means that if of the institution’s most liquid assets.
a participating member fails and its collateral pledged is
insufficient to make public depositors whole, each Large Depositors and Deposit Concentrations
participating institution is obligated to proportionately share
the cost of the collateral shortfall. For examination purposes, a large depositor is a customer
or entity that owns or controls two percent or more of the
Examiners should recognize that SBLCs and pooled institution’s total deposits. Some large deposits remain
collateral programs may present challenges in times of relatively stable over long periods. However, due to the
stress, particularly when an institution’s borrowing capacity effect the loss of a large deposit account could have on an
may be constrained by a large volume of pledged loans and institution’s overall funding position, these deposits are
securities. SBLCs encumber assets eligible for FHLB considered potentially less stable liabilities.
collateral at the time of commitment and throughout the
instrument’s life, meaning that pledged assets will not be as A large deposit account might be considered stable if the
readily convertible to cash or available to use as collateral customer has ownership in the institution, has maintained a
for additional borrowings. Similarly, assets pledged under long-term relationship with the institution, has numerous
pooled collateral programs will not be as readily convertible accounts, or uses multiple services. Conversely, a large
to cash or available to use as collateral for additional depositor that receives a high deposit rate, but maintains no
borrowings. Further, if an institution’s asset quality or other relationships with the institution, may move the
financial condition deteriorates, the FHLB and state- account quickly if the rate is no longer considered high for
sponsored pooled collateral programs may demand more the market. Therefore, examiners should consider the
rigorous terms or additional collateral. This may occur overall relationship between customers and the institution
precisely when an institution has a heightened need for on- when assessing the stability of large deposits.
balance sheet liquidity.
Examiners should consider whether management actively
Liquidity reviews during examinations should consider the monitors the stability of large deposits and maintains funds
potential impact of standby credit facilities and state- management policies and strategies that reflect
sponsored pooled collateral programs on liquidity and funds consideration of potentially less stable concentrations and
management, asset encumbrance, and the protection of significant deposits that mature simultaneously. Key
uninsured public deposits. Examiners should identify considerations include potential cash flow fluctuations,
SBLCs, other credit facilities, and pooled collateral pledging requirements, affiliated relationships, and the
programs that require pledged collateral and review related narrow interest spreads that may be associated with large
documentation and financial reporting. If an institution deposits.
relies significantly on wholesale borrowings (such as FHLB
advances and SBLCs) to fund its balance sheet, examiners Negotiable Certificates of Deposit
should analyze how asset encumbrances might impair
liquidity in a stress scenario and whether these issues are Negotiable CDs warrant special attention as a component of
appropriately addressed in the CFP. large (uninsured) deposits. These instruments are usually
issued by large regional or money center banks in
Secured and Preferred Deposits denominations of $1 million or more and may be issued at
face value with a stated rate of interest or at a discount
Preferred deposits are deposits of U.S. states and political similar to U.S. Treasury bills. Major bank CDs are widely
subdivisions that are secured or collateralized as required traded, may offer substantial liquidity, and are the
under state law. Only the uninsured amount of such underlying instruments for a market in financial futures.
deposits are considered preferred. Institutions are usually Their cost and availability are closely related to overall
required to pledge securities (or other readily marketable market conditions, and any adverse publicity involving
assets) to cover secured and preferred deposits. Institutions either a particular institution or institutions in general can
must secure U.S. government deposits, and many states
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LIQUIDITY AND FUNDS MANAGEMENT Section 6.1

impact the CD market. These CDs have many features • Management may incur relatively high costs to obtain
similar to borrowings and can be quite volatile. funds and may lower credit quality standards in order
to invest in higher-yielding loans and securities to
Borrowings cover the higher costs. If an institution incurs higher-
cost liabilities to support assets already on its books,
Stable deposits are a key funding source for most insured the cost of the borrowings may result in reduced or
depository institutions; however, institutions also use negative net income.
borrowings and other wholesale funding sources to meet • Preoccupation with obtaining funds at the lowest
their funding needs. Borrowings include debt instruments possible cost, without proper consideration given to
or loans that institutions obtain from other entities such as diversification and maturity distribution, intensifies an
correspondent lines of credit, federal funds purchased, and institution’s exposure to funding concentrations and
FHLB and Federal Reserve Bank advances. interest rate fluctuations.
• Some borrowings have embedded options that make
Generally, borrowings are viewed as a supplemental their maturity or future interest rate uncertain. This
funding source rather than as a replacement for deposits. If uncertainty can increase the complexity of liquidity
an institution is using borrowed funds to meet contingent management and may increase future funding costs.
liquidity needs, examiners should determine whether
management understands the associated risks and has Common borrowing sources include:
commensurate risk management practices. Effective
practices typically include a comprehensive CFP that • Federal Reserve Bank facilities,
specifically addresses funding plans if the institution’s • Federal Home Loan Bank advances,
financial condition or the economy deteriorates. Active and • Federal funds purchased,
effective risk management, including funding concentration • Repurchase agreements,
management by size and source, can mitigate some of the • Dollar repurchase agreements,
risks associated with borrowings. • Commercial paper, and
• International funding sources.
To make effective use of borrowing facilities,
knowledgeable risk managers seek to understand the
Federal Reserve Bank Facilities
conditions, limitations, and potential drawbacks of
borrowing from different sources and facilities. The Federal Reserve Banks provide short-term
Additionally, effective managers understand and monitor collateralized credit to institutions through the Federal
borrowing capacity, terms, acceptable collateral, and Reserve’s discount window. The discount window is
collateral borrowing values (e.g., collateral haircuts). They available to any insured depository institution that maintains
maintain a detailed inventory of pledged assets posted to deposits subject to reserve requirements. The most common
various funds providers and know their remaining capacity types of collateral are U.S. Treasury securities; agency,
to post additional unencumbered assets to execute GSE, mortgage-backed, asset-backed, municipal, and
borrowings quickly. Effective managers are also aware of corporate securities; and commercial, agricultural,
the execution constraints that may arise when attempting to consumer, residential real estate, and commercial real estate
borrow at the end of a business day or week and ensure loans. Depending on the collateral type and the condition
CFPs acknowledge these constraints. of the institution, collateral may be transferred to the
Federal Reserve, held by the borrower in custody, held by a
Key considerations when assessing liquidity risks third party, or reflected by book entry. Collateral pledged
associated with borrowed funds include the following: to the discount window cannot be shared with other funding
providers. Therefore, an important consideration for
• Pledging assets to secure borrowings can negatively management is whether collateral is pre-positioned or pre-
affect an institution’s liquidity profile by reducing the pledged to another entity and the operational requirements,
amount of securities available for sale during periods including timeframes, to transfer the pledging to the Federal
of stress. Reserve in a timely manner to obtain funding when needed.
• Unexpected changes in market conditions can make it
difficult for management to secure funds and manage Types of discount window credit include primary credit
its funding maturity structure. (generally overnight credit to meet temporary liquidity
• It may be more difficult to borrow funds if the needs), secondary credit (available to institutions that do not
institution’s condition or the general economy qualify for primary credit), seasonal credit (available to
deteriorates. institutions that demonstrate a clear seasonal pattern to

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LIQUIDITY AND FUNDS MANAGEMENT Section 6.1

deposits and assets), and emergency credit (rare Federal Home Loan Bank (FHLB) Advances
circumstances).
The FHLBs provide secured loans or “advances” to their
The Federal Reserve’s primary credit program was designed members, which include insured depository institutions.
to ensure adequate liquidity in the banking system and is Many well-performing institutions use FHLB advances to
intended as a backup, short-term credit facility for eligible prudently address funds management needs, facilitate credit
institutions. In general, depository institutions are eligible intermediation, and supplement contingent funding sources.
for primary credit if they have a composite CAMELS rating FHLB borrowings are secured by eligible collateral
of 1, 2, or 3 and are at least adequately capitalized under the according to each FHLB district’s credit policy and
PCA framework. generally include certain real estate-related loans and
securities. Institutions can borrow from the FHLBs on a
Since primary credit can serve as a viable source of backup, short- and longer-term basis, with maturities ranging from
short-term funds, examiners should not automatically overnight to 30 years on various repayment, amortization,
criticize the occasional use of primary credit. At the same and interest rate terms.
time, overreliance on primary credit borrowings or any one
source of short-term contingency funds may indicate Each FHLB establishes credit and collateral policies that set
operational or financial difficulties. Examiners should the terms for member advances. Interest rates and collateral
consider whether institutions that use primary credit requirements may be subject to a member institution’s
facilities maintain viable exit strategies. financial condition or other prudential considerations.
Although the FHLBs serve as a reliable source of funding
Secondary credit is available to institutions that do not for members, certain eligibility requirements for advances
qualify for primary credit and is extended on a very short- have been set by the Federal Housing Finance Agency
term basis at a rate above the primary credit rate. This (FHFA), the FHLB System’s supervisor. For example, the
program entails a higher level of Reserve Bank FHFA regulations (12 CFR 1266.4) prohibit FHLBs from
administration and oversight than primary credit. making new advances to members without positive tangible
capital, among other requirements. Therefore, effectively
If an institution’s borrowing becomes a regular occurrence, managed FHLB members consider their continuing
Federal Reserve Bank officials will review the purpose of eligibility to borrow as part of funds management and
the borrowing and encourage management to initiate a contingency funding strategies.
program to eliminate the need for such borrowings.
Appropriate reasons for borrowing include preventing Examiners should analyze several factors when reviewing
overnight overdrafts, loss of deposits or borrowed funds, an institution’s use of FHLB advances. Foremost among
unexpected loan demand, liquidity and cash flow needs, these factors, FHLBs may impose strict collateral and
operational or computer problems, or a tightened federal borrowing capacity requirements for the quality of pledged
funds market. Accordingly, well-managed financial assets, collateral margins, loan documentation, and
institutions develop longer-term funding or take-out maximum advance levels. Changes in a member
alternatives to transition from reliance on the discount institution’s financial condition can also impact its ability
window. These alternatives can include FHLB advances, and cost to borrow. In addition, collateral pledged to an
deposit gathering strategies, and other contingency funding FHLB cannot be readily shared with other funds providers,
options. such as the Federal Reserve’s discount window, and it could
take time to reassign that collateral to another lender.
Examiners should be aware that the Federal Reserve will not Examiners should assess whether institutions have
permit institutions that are not viable to borrow at the considered these requirements as part of their overall funds
discount window. Section 10B(b) of the Federal Reserve management process and CFP.
Act limits Reserve Bank advances to not more than 60 days
in any 120-day period for undercapitalized institutions or Examiners should also consider an institution’s use of
institutions with a composite CAMELS rating of 5. This FHLB advances in terms of overall wholesale funding usage
limit may be overridden only if the primary federal banking (versus stable deposit funding), leverage, and balance sheet
agency supervisor certifies the borrower’s viability or if, management. In certain circumstances, an institution can
following an examination of the borrower by the Federal become over-leveraged with wholesale funds or collateral
Reserve, the Chairman of the Board of Governors of the encumbrance, which could impact liquidity, earnings, and
Federal Reserve certifies in writing to the Reserve Bank that other measureable areas of performance.
the borrower is viable. These certifications may be renewed
for additional 60-day periods. Examiners should review the institution’s analysis of FHLB
borrowing capacity in the event of severe market stress.
“The role of the FHLBanks in providing secured advances
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LIQUIDITY AND FUNDS MANAGEMENT Section 6.1

must be distinguished from the Federal Reserve’s financing usually short-term, highly credit sensitive instruments that
facilities, which are set up to provide emergency financing may not be available if the institution’s financial condition
for troubled financial institutions confronted with deteriorates.
immediate liquidity challenges. Due to operational and
financing limitations of the market intermediation process, Repurchase Agreements
the FHLBanks cannot functionally serve as the lender of last
resort, particularly for large, troubled members that can In a securities repurchase agreement (repo), an institution
have significant borrowing needs over a short period of agrees to sell a security to a counterparty and
time.” 3 In certain instances, the FHLBs may have their own simultaneously commits to repurchase the security at a
liquidity capacity limitation on a given business day if mutually agreed upon date and price. In economic terms, a
unexpectedly large advance requests are made from repo is a form of secured borrowing. The amount borrowed
multiple members. Therefore, institutions should have an against the security is generally the full market value less a
appropriate level of unencumbered on-balance liquid assets reasonable discount. Typically, the security does not
and CFP strategies that enable borrowing from other physically change locations or accounting ownership;
sources such as the Federal Reserve’s discount window. instead, the selling institution’s safekeeping agent makes
entries to recognize the purchasing institution’s interest in
Federal Funds Purchased the security.

Federal funds are reserves held in an institution’s Federal From an accounting standpoint, repos involving securities
Reserve Bank account (during periods when Federal are either reported as secured borrowings or as sales and a
Reserve requirements are warranted) that can be lent (sold) forward repurchase commitment based on whether the
by institutions with excess reserves to other institutions with selling institution maintains control over the transferred
an account at a Federal Reserve Bank. Institutions borrow financial asset. Generally, if the repo both entitles and
(purchase) federal funds to meet their reserve requirements obligates the selling institution to repurchase or redeem the
or other funding needs. Institutions rely on the Federal transferred assets from the transferee (i.e., the purchaser) the
Reserve Bank or a correspondent institution to facilitate selling institution may report the transaction as a secured
federal funds transactions. State nonmember institutions borrowing if various other conditions outlined in U.S.
that do not maintain balances at the Federal Reserve Generally Accepted Accounting Principles (GAAP) have
purchase or sell federal funds through a correspondent been met. If the selling institution does not maintain
institution. effective control of the transferred assets according to the
repurchase agreement, the transaction would be reported as
In most instances, federal funds transactions take the form a sale of the securities and a forward repurchase
of overnight or short-term unsecured transfers of commitment. For further information, see the Call Report
immediately available funds between institutions. Glossary entries pertaining to Repurchase/Resale
However, institutions also enter into continuing contracts Agreements and Transfers of Financial Assets.
that have no set maturity but are subject to cancellation upon
notice by either party to the transaction. Institutions also Bilateral repos involve only two parties, and are most
engage in federal funds transactions of a set maturity, but commonly conducted with either a primary dealer bank or a
these include only a small percentage of all federal funds central counterparty. In a tri-party repo, an agent is involved
transactions. In any event, these transactions can be in matching counterparties, holding the collateral, and
supported with written verification from the lending ensuring the transactions are executed properly. Like
institution. bilateral repos, the terms of tri-party repos are negotiated by
the collateral provider and the cash investor. Once the terms
Some institutions may access federal funds as a liability are established, the settlement details are transmitted to the
management technique to fund a rapid expansion of loan or clearing institution, which confirms the terms and settles the
investment portfolios and enhance profits. In these transaction on its books for the two parties. In deep stress,
situations, examiners should determine whether appropriate the traditional tri-party repo market may close to the cash
board approvals, limits, and policies are in place and should borrower as counterparties may no longer negotiate with the
discuss with management and the board their plans for cash borrower and may not roll maturing contracts or enter
developing appropriate long-term funding solutions. into new contracts.
Liquidity risks typically decline if management avoids
overreliance on federal funds purchased, as the funds are

3 See FHLBank System at 100: Focusing on the Future, at

https://www.fhfa.gov/AboutUs/Reports/ReportDocuments/FHLB
ank-System-at-100-Report.pdf.
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LIQUIDITY AND FUNDS MANAGEMENT Section 6.1

The General Collateral Finance (GCF) Repo market decline significantly in a stress event, creating an
removes for cash lenders the counterparty credit exposure undesirable amount of exposure. Reverse repos/cash
present in the bilateral and triparty repo markets. The GCF lending programs that are inadequately managed can expose
market is a brokered and centrally cleared market – with the an institution to risk of loss and may be regarded as an
Fixed Income Clearing Corporation (FICC) being the unsuitable investment practice.
central counterparty. GCF trades are negotiated through
interdealer brokers (IDBs) on a blind basis. In other words, Since the fair value of the underlying security may change
participants provide an IDB the terms under which they are during the term of the transaction, both parties to a repo may
willing to borrow or lend cash. The IDB then tries to broker experience credit exposure. Although repo market
a trade while maintaining each participant’s anonymity. participants normally limit credit exposures by maintaining
Once a trade has been brokered, the IDB submits the details a cushion between the amount lent and the value of the
to FICC, which substitutes itself as the counterparty to each underlying collateral and by keeping terms short to allow
side of the repo transaction. for redemption as necessary, credit reviews of repo
counterparties prior to the initiation of transactions remains
The majority of repurchase agreements mature in three a critical step. Properly administered repurchase
months or less. One-day transactions are known as agreements conducted within a comprehensive
overnight repos, while transactions longer in duration are asset/liability management program are not normally
referred to as term repos. Institutions typically use repos as subject to regulatory criticism. The Policy Statement on
short-term, relatively low cost funding mechanisms. The Repurchase Agreements of Depository Institutions with
interest rate paid on a repurchase agreement depends on the Securities Dealers and Others, dated February 10, 1998,
type of underlying collateral. In general, the higher the provides additional information on repos, associated
credit quality of the collateral and the easier the security is policies and procedures, credit risk management practices,
to deliver and hold, the lower the repo rate. Supply and and collateral management practices.
demand factors for the underlying collateral also influence
the repo rate. Dollar Repurchase Agreements

There are also timing considerations in settling repo Dollar repurchase agreements, also known as dollar repos
transactions. The centrally cleared contracts, including and dollar rolls, provide financial institutions with an
GCF transactions, clear earlier in the day and the tri-party alternative method of borrowing against securities owned.
market clears later in the day. The quality of collateral also Unlike standard repurchase agreements, dollar repos require
affects the timing of tri-party repos. Since riskier collateral the buyer to return substantially similar, versus identical,
can only be accepted by some subset of all market securities to the seller. Dealers typically offer dollar roll
participants, cash borrowers offering lower quality financing to institutions as a means of covering short
collateral tend to arrange trades earlier in the day to allow positions in particular securities. Short positions arise when
for ample market participation. Repo borrowing programs a dealer sells securities that it does not currently own for
that are inadequately managed may result in a loss of forward delivery. To compensate for potential costs
essential funding at a critical time. associated with failing on a delivery, dealers are willing to
offer attractive financing rates in exchange for the use of the
The opposite side of a repo transaction, is sometimes called institution’s securities in covering a short position. Savings
a reverse repo. A reverse repo that requires the buying associations, which are the primary participants among
institution to sell back the same asset purchased is treated as financial institutions in dollar roll transactions, typically use
a loan for Call Report purposes. If the reverse repurchase mortgage pass-through securities as collateral for the
agreement does not require the institution to resell the same, transactions.
or a substantially similar, security purchased, it is reported
as a purchase of the security and a commitment to sell the Supervisory authorities do not normally take exception to
security. dollar repos if the transactions are conducted for legitimate
purposes and the institution has appropriate controls.
Reverse repos can involve unique risks and complex
accounting and recordkeeping challenges, and institutions International Funding Sources
benefit from establishing appropriate risk management
policies, procedures, and controls. In particular, institutions International funding sources exist in various forms. The
can benefit from controls when relying on reverse repos that most common source of funds is the Eurodollar market.
are secured with high-risk assets. Reverse repo activity Eurodollar deposits are U.S. dollar-denominated deposits
exposes the institution to a risk of loss if the cash lent taken by an institution’s overseas branch or its international
exceeds the market value of the security received as banking facility. Reserve requirements and deposit
collateral, and the value of the underlying assets may insurance assessments do not apply to Eurodollar deposits.
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LIQUIDITY AND FUNDS MANAGEMENT Section 6.1

The interbank market is highly volatile, and management Derivatives

typically benefits from analyzing Eurodollar deposit
activities within the same context as all other potentially less Management can use derivative instruments (financial
stable funding sources. contracts that generally obtain their value from underlying
assets, interest rates, or financial indexes) to reduce business
Commercial Paper risks. However, like all financial instruments, derivatives
contain risks that must be properly managed. For example,
Institutions can issue commercial paper to quickly raise interest rate swaps typically involve the periodic net
funds from the capital markets. Commercial paper is settlement of swap payments that can substantially affect an
generally a short-term, negotiable promissory note issued institution’s cash flows. Additionally, derivative contracts
for short-term funding needs by a bank holding company, may have initial margin requirements that require an
large commercial institution, or other large commercial institution to pledge cash or investment securities that
business. Commercial paper usually matures in 270 days or reflect a specified percentage of the contract’s notional
less, is not collateralized, and is purchased by institutional value. Variation margin requirements (which may require
investors. daily or intraday settlements to reflect changes in market
value) can also affect an institution’s cash flows and
Some commercial paper programs are backed by assets and investment security levels. Examiners should consider the
are referred to as asset-backed commercial paper. Some extent to which management engaging in derivative
programs also involve multi-seller conduits where a special- activities understands and manages the liquidity, interest
purpose entity is established to buy interests in pools of rate, and price risks of these instruments.
financial assets (from one or more sellers). Entities fund
such purchases by selling commercial paper notes, Other Contingent Liabilities
primarily to institutional investors.
Legal risks can have a significant financial impact on
Institutions that provide liquidity lines or other forms of institutions that may affect liquidity positions. Examiners
credit enhancement to their own or outside commercial should consider whether institutions identify these
paper programs face the risk that the facilities could be contingencies when measuring and reporting liquidity risks
drawn upon during a crisis situation. Prudent institutions as exposures become more certain.
plan for such events and include such events in stress
scenario analysis and contingency plans. In addition,
←
institutions benefit from addressing the institution’s ability
to continue using commercial paper conduits as a funding LIQUIDITY RISK ANALYSIS AND
source in the institution’s CFP. MITIGATION

← There are many ways management can analyze and mitigate

OFF-BALANCE SHEET ITEMS liquidity risk and maintain the institution’s current and
future liquidity positions within the risk tolerance targets
Off-balance sheet items, such as those described below, can established by the board. For managing routine and stressed
be a source or use of funds. liquidity needs, institutions typically establish diversified
funding sources and maintain a cushion of high-quality
liquid assets. Examiners should consider whether CFPs
Loan Commitments identify backup funding sources, action steps to address
acute liquidity needs, and whether management tests
Loan commitments are common off-balance sheet items. various stress scenarios to identify risks to mitigate and
Typical commitments include unfunded commercial, address in CFPs.
residential, and consumer loans; unfunded lines of credit for
commercial and retail customers; and fee-paid, commercial
letters of credit. Sound risk management practices include Cushion of Highly Liquid Assets
closely monitoring the amount of unfunded commitments
that require funding over various periods and detailing One of the most important components of an institution’s
anticipated demands against unfunded commitments in ability to effectively respond to liquidity stress is the
internal reports and contingency plans. Examiners should availability of unencumbered, highly liquid assets (i.e.,
consider the nature, volume, and anticipated use of the assets free from legal, regulatory, or operational
institution’s loan commitments when assessing and rating impediments). Unencumbered liquid assets can be sold or
the liquidity position. pledged to obtain funds under a range of stress scenarios.
The quality of the assets is a critical consideration, as it

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LIQUIDITY AND FUNDS MANAGEMENT Section 6.1

significantly affects management’s ability to sell or pledge Occasionally, it may be appropriate for examiners to
the assets in times of stress. consider pledged assets as part of the highly liquid cushion,
such as when management pledges Treasury notes as part of
When determining what type of assets to hold for contingent an unfunded line of credit. In other instances, it may be
liquidity purposes, management typically considers factors appropriate for examiners to consider an asset that has not
such as: been explicitly pledged as illiquid. For example, if an
institution is required to deposit funds at a correspondent
• Level of credit and market risk: Assets with lower institution to facilitate operational services, these funds
levels of credit and market risk tend to have higher should generally be excluded from its liquidity reports or
liquidity profiles. denoted as unavailable.
• Liquidity during stress events: High-quality liquid
assets are generally not subject to significantly Examiners assess whether the size of the institution’s liquid
increased risk during stress events such as credit or asset cushion is aligned with its risk tolerance and profile
market risk. Conversely, certain assets, such as and supported by documented analysis and stress test
specialty assets with small markets or assets from results. Factors that may indicate a need to maintain a larger
industries experiencing stress, are often less liquid in liquid asset buffer include:
times of stress in the banking sector.
• Ease and certainty of valuation: Prices based on • Easy customer access to alternative investments,
trades in sizeable and active markets tend to be more • Recent trends showing substantial reductions in large
reliable, and an asset’s liquidity increases if market liability accounts,
participants are more likely to agree on its valuation. • Significant volumes of less-stable funding,
Formula-based pricing is less desirable than data from • High levels of assets with limited marketability (due
recent trades. to credit quality issues or other factors),
• Expectations of elevated draws on unused lines of
Institutions with high-quality liquid assets are generally able credit or loan commitments,
to monetize the assets through the sale of the assets or the • A concentration of credit to an industry with existing
use of secured borrowings. This generally means an or anticipated financial problems,
institution’s cushion of liquid assets is concentrated in cash • Close ties between deposit accounts and employers
and due from accounts, federal funds sold, and high-quality experiencing financial problems,
assets, such as U.S. Treasury securities or GSE bonds. • A significant volume of assets are pledged to
However, with digital banking and social media, severe wholesale borrowings, and
liquidity stress can transpire in as little as a few hours. • Impaired access to funds from capital markets.
Because severe stress can occur so rapidly, cash and cash
equivalents are an essential component of the liquidity
cushion.
Evaluation of Asset Encumbrance

Cash remains the most liquid asset. Hence, appropriate cash Asset encumbrance is another important consideration of
cushions can help to meet liquidity requirements until asset liquidity risk management. Assets typically become
encumbered when they are pledged against borrowings,
sales or borrowings can be executed. If institutions change
SBLCs, or public deposits or could be considered restricted
the mix of their pool of liquid assets by substituting out cash
even though there is no explicit pledge agreement as
for other types of liquid assets (e.g., during a period of rising
described earlier. Examiners should understand, and assess
interest rates when the opportunity cost of holding cash
increases), effective management will be able to management’s understanding of, the dynamics of asset
encumbrance and the triggers and requirements of the
demonstrate that it can readily monetize these assets to meet
products and programs that are used to manage liquidity and
stressed needs for liquidity without undue losses that impact
collateral positions.
the institution’s financial condition.
In a favorable economic environment, profitable, well-
The ability of management to monetize marketable
securities or access secured borrowing lines without delay capitalized institutions generally have a wide capacity to
borrow and can obtain secured borrowings with a pledge of
can be critical in times of stress. Access to unencumbered
loans or securities. In some cases, management provides a
liquid assets is critical, where such assets are easy to sell or
blanket lien on the institution’s mortgage loans and other
pledge with little or no discount throughout an interest rate
assets to secure credit. When asset quality and on-balance
or credit cycle. Unrealized holding losses in liquid
sheet liquidity are strong, secured borrowings and other
securities portfolios, however, reduce amounts that can be
monetized by means of sale or pledging as collateral against arrangements can be reliable and cost-effective.
borrowings.
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LIQUIDITY AND FUNDS MANAGEMENT Section 6.1

In the event of asset quality or other financial deterioration, whether alternative sources are identified in formal CFPs
secured creditors often seek to protect their position by and periodically tested.
increasing collateral requirements. These collateral calls
typically lead to increases in asset encumbrance at a time To reduce risks associated with funding concentrations,
when the institution has elevated funding needs to address management generally benefits from considering the
losses and other outflows. Therefore, asset encumbrance is correlations between sources of funds and market
a critical consideration for examiners when assessing an conditions and having available a variety of short-, medium-
institution’s scenario testing and CFP. and long-term funding sources. The board is responsible for
setting and clearly articulating an institution’s risk tolerance
In addition to traditional secured borrowings, two examples in this area through policy guidelines and limits for funding
of arrangements that could lead to elevated collateral diversification.
requirements during financial stress include SBLCs and
state pooled collateral programs. Management can use Although management uses diversified funding sources to
SBLCs for a variety of purposes, such as securing public reduce funding concentration risks, management also
deposits, accommodating derivative counterparties, and considers other factors when selecting funding sources. For
corporate borrowing needs. Typically SBLCs are secured example, the cost of a particular funding source is a critical
with eligible loans and securities. If asset quality declines consideration when developing profitability strategies.
or the institution’s financial condition deteriorates, the Additionally, the stability and availability of a funding
SBLC could be exercised and effectively convert to a source are important factors when planning for asset
borrowing, thereby increasing collateral encumbrance at a growth. Examiners should assess strategies that rely on
time when the institution may have identified FHLB less-stable funding sources, particularly strategies that fund
borrowings as a contingent source to address other funding significant growth in new business lines.
gaps.
When assessing the diversification of funding sources,
Under the state-sponsored pooled collateral model, important factors for examiners to consider include:
participating institutions pledge securities to a pool that is
coordinated by state finance officials to collateralize • Internal evaluations of risks associated with funding
multiple public deposits. In these programs, the states sources (e.g., stress tests and diversification limits)
monitor the financial condition of participants and increase and whether the evaluations are reasonable and well-
collateral requirements if the institution’s financial documented,
condition deteriorates. • Potential curtailment of funding or significantly higher
funding costs during periods of stress,
For institutions that pledge assets for secured borrowings • Time required to access funding in stressed and
and for those that use SBLCs or pooled collateral systems normal periods,
for managing uninsured public deposits, examiners should • Sources and uses of funds during significant growth
assess whether stress testing scenarios consider the potential periods, and
for increased collateral requirements. Examiners should • Available alternatives to volatile funding sources.
also determine whether the analysis includes assets that may
be restricted but not explicitly pledged. Potential asset Maintaining market access to funds is also an essential
encumbrances under a stress scenario (to cover heightened component of ensuring funding diversity. Market access
collateral calls for borrowings and any public deposit can be critical, as it affects an institution’s ability to raise
arrangements or similar agreements) are typically new funds and to liquidate assets. Examiners should
incorporated into the CFP. consider whether management actively manages, monitors,
and tests the institution’s market access to funds. Such
Diversified Funding Sources efforts are typically consistent with the institution’s
liquidity risk profile and sources of funding. For example,
An important component of liquidity management is the access to the capital markets is an important consideration
diversification of funding sources. Undue reliance on any for most large or complex institutions, whereas the
one source of funding can have adverse consequences in a availability of correspondent lines and other sources of
period of liquidity stress. Management typically diversifies wholesale funds are critical for community institutions.
funding across a range of retail sources and, if used, across Market perceptions play a critical role in an institution’s
a range of wholesale sources, consistent with the ability to access funds readily and at reasonable terms. For
institution’s sophistication and complexity. Institutions that this reason, examiners should determine whether liquidity
rely primarily on directly gathered retail deposit accounts risk managers are aware of any information (such as an
are generally not criticized for relying on one primary announcement of a decline in earnings or a downgrade by a
funding source. However, examiners should consider
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LIQUIDITY AND FUNDS MANAGEMENT Section 6.1

rating agency) that could affect perceptions of an collateral that can be pledged. Well-performing
institution’s financial condition. institutions can often obtain secured credit from the
Federal Reserve’s discount window, the FHLB, or
Assessing the Stability of Funding Sources other providers by pledging eligible loans and
securities.
Assessing the stability of funding sources is an essential part • The current rate environment: Depositors may be
of liquidity risk measurement and liquidity management. less rate sensitive in a low-rate environment due to the
Institutions may rely on a variety of funding sources, and a limited benefits (only marginally higher rates)
wide array of factors may impact the stability of those obtained by shifting deposits into longer-term
funding sources. Some of the primary factors that investments.
examiners should consider when assessing the stability of • The current business cycle: If the national or local
funding sources include: economy is in a downward cycle, individuals and
businesses may decide to keep more cash on hand
• The cost of the institution’s funding sources rather than spending or investing.
compared to market costs and alternative funding • Contractual terms and conditions: Terms and
sources: If an institution pays significantly above requirements related to the institution’s condition,
local or national rates to obtain or retain deposits, the such as its PCA category, credit ratings, or capital
institution’s deposit base may be highly cost sensitive, levels, can materially affect liquidity. Specific
and depositors may be more likely to move deposits if contractual terms and conditions are often associated
terms become more favorable elsewhere. Examiners with brokered deposits, funds from deposit listing
should determine whether management uses rate services, correspondent institution accounts,
specials or one-time promotional offerings to obtain repurchase agreements, and FHLB advances.
deposits or to retain rate-sensitive customers. • The relationship with the funding source: Large
Examiners should also assess how much of the deposit deposits might be more stable if the deposit is difficult
base consists of rate specials and determine whether to move (e.g., the deposit is in a transaction account
management measures and reports the level of such used by a payroll provider), if the depositor is an
deposits. insider in the institution, or if the depositor has a long
• Large deposit growth or significant changes in history with the institution. However, examiners
deposit composition: Examiners should carefully should consider that depositors may withdraw funds
consider strategies that rely on less stable funding during stress periods regardless of administrative
sources to fund significant growth in new business difficulties or the effect on the institution.
lines. The level of risk in new strategies can be
misjudged and could be compounded by the use of Intraday Liquidity Monitoring
less stable funding sources.
• Stability of insured deposits: Insured deposits can Intraday liquidity monitoring is an important component of
be a stable, low-cost form of funding depending on an liquidity risk management. It is important for an institution
institution’s depositor base; client relationships across to manage, and understand its potential intraday liquidity
credit, deposit, and other financial products; the tenure needs associated with wholesale payments and trading
of the deposit relationship; and the sensitivity of activity, including derivative positions. While most
depositors to interest rates, the institution’s condition, community institutions do not experience significant
adverse media attention, and counterparty and market wholesale payments inflows and outflows, operate trading
participants’ views toward the institution. accounts, or have large derivative positions and settlement
• Stability of uninsured deposits: Uninsured deposits risk, some use derivatives to hedge interest rate risk
are not automatically considered volatile; however, in exposure that can require an intraday use of liquidity to
times of stress or when an institution’s condition collateralize a position.
deteriorates, uninsured depositors are more likely to
withdraw their funds. Therefore, examiners should For example, as part of a derivatives transaction, an
closely review large volumes of uninsured deposits, institution may be required to submit either initial or
along with their risk characteristics, including maintenance/variation margin associated with the contract
concentrations of large individual depositors, as well on a given business day by a specific time. Even though the
as depositors’ potential behavior in stressed institution could be “in the money” (meaning it has a net
environments. positive exposure to the dealer counterparty) and expect a
• Secured borrowings and asset encumbrance: net liquidity inflow, the derivative contract could require a
Secured borrowing can be a stable source of funding short-term or intraday cash payment. The institution’s
depending on the institution’s condition and quality of payment could occur before the counterparty remits its

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LIQUIDITY AND FUNDS MANAGEMENT Section 6.1

payment, creating a timing difference and potential short- • Establish a liquidity event management framework
term or intraday liquidity need. Also, institutions that (including points of contact and public relations
conduct wholesale payments over a large value payment plans),
system 4 could encounter situations that result in intraday • Establish a monitoring framework,
cash deficits, such as if expected payments receipts are • Identify potential contingent funding events,
throttled/slowed by senders concerned about the • Identify potential funding sources,
institution’s financial condition (and the risk of having a • Require stress testing, and
large intraday loan to the institution) but the institution is • Require periodic testing of the CFP framework.
unable to throttle outgoing payments in a similar manner, in
turn potentially causing daylight overdrafts 5 in excess of the
regular net debit cap. The Federal Reserve may provide
Contingent Funding Events
credit to support potential intraday mismatches, but there
may also be limits on the institution’s ability to access this The primary goals of most CFPs are to identify risks from
support. contingent funding events and establish an operational
framework to deal with those risks. Contingent funding
events are often managed based on their probability of
The Role of Equity occurrence and potential effect. CFPs generally focus on
events that, while relatively infrequent, could have a high
Issuing new equity is often a relatively slow and costly way impact on the institution’s operations. Appropriate plans
to raise funds and is not viewed as an immediate or direct typically set a course of action to identify, manage, and
source of liquidity. However, to the extent that a strong control significant contingent funding risks.
capital position helps an institution quickly obtain funds at
a reasonable cost, issuing equity can be considered a Stress factors that may provide early warning signs for
liquidity facilitator. For institutions with a holding identifying potential funding risks can be institution-
company, cash can be injected from the parent in the form specific or systemic and may involve one or more of the
of equity, ideally tier 1 capital. following:
← • Deterioration in asset quality,
CONTINGENCY FUNDING • Downgrades in credit ratings,
• Downgrades in PCA capital category,
Contingency Funding Plans • Deterioration in the liquidity management function,
• Widening of credit default spreads,
All institutions, regardless of size or complexity, benefit • Declining institution or holding company stock prices,
from a formal CFP that clearly defines strategies for • High put-call ratios (i.e., high put volume relative to
addressing liquidity shortfalls in emergency situations. call volume) or increases in the volume of short
Comprehensive CFPs delineate policies to manage a range selling,
of stress environments, establish clear lines of • Operating losses,
responsibility, and articulate clear implementation and
• Rapid growth,
escalation procedures. The reliability of a CFP improves if
• Inability to fund asset growth,
it is regularly tested and updated to ensure that it is
operationally sound. Often, management coordinates • Inability to renew or replace maturing liabilities,
liquidity risk management plans with disaster, contingency, • Price volatility or changes in the market value of
and business planning efforts and aligns them with business various assets,
line and risk management objectives, strategies, and tactics. • Negative press coverage, including social media
channels,
CFPs are tailored to the business model, risk, and • Anticipation of a significant negative reaction to an
complexity of the individual institution. Such CFPs: investor earnings call,
• Deterioration in economic conditions or market
perceptions,
• Disruptions in the financial markets,

4 Retail payments often are not time sensitive and commonly occur transactions, for example, Fedwire funds transfers or incoming
within batch processing cycles through the ACH payments system. securities or other payment activity processed by a Federal Reserve
Wholesale payments conducted via wire transfers over Fedwire or Bank, such as check or automated clearinghouse (ACH)
CHIPS are more likely to be pre-scheduled and time-sensitive. transactions. For more information, refer to the “Guide to the
5 A daylight overdraft occurs when funds in an institution’s Federal
Federal Reserve’s Payment System Risk Policy on Intraday
Reserve account balance is insufficient to cover outgoing Credit” effective January 20, 2022
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LIQUIDITY AND FUNDS MANAGEMENT Section 6.1

• General or sector-specific market disruptions (e.g., Generally, the magnitude and frequency of stress testing is
payment systems or capital markets), and commensurate with the complexity of the institution, as well
• Competitor or peer institutions experiencing liquidity as the level and trend of its liquidity risk. If liquidity risk
duress with the potential for spillover effects or becomes elevated, management could benefit from
contagion risk spreading to the subject institution. conducting more frequent stress testing, while large or
complex institutions may also benefit from daily liquidity
Counterparties can also cause stress events (both credit and stress testing to inform, in part, day-to-day liquidity
non-credit exposures). For example, if an institution sells management.
financial assets to correspondent institutions for
securitization, and its primary correspondent exits the The growing prevalence of digital banking and online
market, the institution may need to use a contingent funding banking applications has facilitated 24/7 banking. These
source. innovations, in addition to the influence of social media, can
accelerate and intensify liquidity risk due to deposit runs
Institutions with unrealized holding losses on debt securities and contagion. A comprehensive CFP reflects this risk and
should fully understand potential restrictions that could be could include within the suite of stress scenarios an end-of-
imposed by the FHLB and other institutional counterparties day or end-of-week stress scenario with severe deposit run-
(e.g., public depositors, deposit brokers, and listing and off occurring in hours or minutes as opposed to days or
registry services) should the unrealized losses affect certain weeks. For example, the modeling and testing of a severe
capital measures, such as GAAP equity. These restrictions stress event that begins on a Friday afternoon may expose
may include a curtailment of new advances or placements vulnerabilities in the ability to execute a CFP (e.g., the
(based on law or policy) at institutions that report a low or ability to quickly monetize unencumbered collateral and
negative GAAP equity position. execute on borrowing lines) that would not be identified in
longer-duration scenarios.
Comprehensive CFPs identify institution-specific events
that may impact on- and off-balance sheet cash flows given Liquidity stress tests are typically based on existing cash-
the specific balance-sheet structure, business lines, and flow projections that are appropriately modified to reflect
organizational structure. For example, institutions that potential stress events (institution-specific or market-wide)
securitize loans have CFPs that consider a stress event across multiple time horizons. Stress tests are used to
where the institution loses access to the market but still has identify and quantify potential risks and to analyze possible
to honor its commitments to customers to extend loans. effects on the institution’s cash flows, liquidity position,
profitability, and solvency. For instance, during a crisis, an
Comprehensive CFPs also delineate various stages and institution’s liquidity needs can quickly escalate while
severity levels for each potential contingent liquidity event. liquidity sources can decline (e.g., customers may withdraw
For example, asset quality can deteriorate incrementally and uninsured deposits or draw down borrowing lines, or the
have various levels of severity, such as less than institution’s lines of credit may be reduced or canceled).
satisfactory, deficient, and critically deficient. CFPs also Stress testing allows an institution to evaluate the possible
address the timing and severity levels of temporary, impact of these events and to plan accordingly.
intermediate-term, and long-term disruptions. For example,
a natural disaster may cause temporary disruptions to Examiners should review documented assumptions
payment systems, while deficient asset quality may occur regarding the cash flows used in stress test scenarios and
over a longer term. Institutions can then use the stages or consider whether they incorporate:
severity levels identified to establish various stress test
scenarios and early-warning indicators. • Customer behaviors (early deposit withdrawals,
renewal and run-off of loans, exercising options);
Stress Testing Liquidity Risk Exposure • Significant runoff of surge, uninsured, or volatile
deposits;
After identifying potential stress events, management often • Prepayments on loans and mortgage-backed
implements quantitative projections, such as stress tests, to securities;
assess the liquidity risk posed by the potential events. Stress • Curtailment of committed borrowing lines;
testing helps management understand the vulnerability of • Material reduction in asset values;
certain funding sources to various risks and to determine • Regulatory restrictions on brokered deposits or
when and how to access alternative funding sources. Stress interest rates paid on deposits;
testing also helps management identify methods for rapid • Significant changes in market interest rates;
and effective responses, guide crisis management planning, • Seasonality (public fund fluctuations, agricultural
and determine an appropriate liquidity buffer. credits, construction lending); and

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LIQUIDITY AND FUNDS MANAGEMENT Section 6.1

• Various time horizons. contingent funding sources. For example, cash and cash
equivalents are typically placed at the top of the hierarchy
Effective assumptions generally incorporate both (e.g., reserve balances at the Federal Reserve, interest-
contractual and non-contractual behavioral cash flows, bearing balances, federal funds sold, and due from
including the possibility of funds being withdrawn. accounts), followed by operationalized borrowing lines with
Examples of non-contractual funding requirements that may the Federal Reserve discount window, unencumbered
occur during a financial crisis include supporting auction highly liquid securities, FHLB borrowing lines, etc. The
rate securities, money market funds, commercial paper use of these sources can depend on the nature and duration
programs, special purpose vehicles, and structured of a prospective liquidity or market stress event, as well as
investment vehicles. Institutions may be compelled to the ability to sell liquid assets or draw on contingent lines of
financially support shortfalls in money market funds or credit.
asset-backed paper that does not sell or roll due to market
stress, and assets may be taken on-balance sheet from Institutions that rely on unsecured borrowings for
sponsored off-balance sheet vehicles. While this financial contingency funding normally consider how borrowing
support is not contractually required, management may capacity may be affected by an institution-specific or
determine that the negative press and reputation risks market-wide disruption. Management that relies on secured
outweigh the costs of providing the financial support. funding sources for contingency funding generally also
consider whether the institution may be subject to higher
Effective stress testing generally assesses various stress margin or collateral requirements in certain stress scenarios.
levels and stages ranging from low- to severe-stress Higher margin or collateral requirements may be triggered
scenarios. To establish appropriate stress scenarios, by deterioration in the institution’s overall financial
management may use the different stages and severity levels condition or in a specific portfolio. Potential collateral
that the institution assigns to stress events. For example, a values are also normally subjected to stress tests, because
low-stress scenario may include several events identified as devaluations or market uncertainties could reduce the
low severity, while a severe-stress scenario may combine amount of contingent funding available from a pledged
several high-severity events. A severe stress scenario may asset. Similarly, stress tests often consider correlation risk
tie a sharp change in interest rates with asset quality when evaluating margin and collateral requirements. For
deterioration or combine severe declines in asset quality, example, if an institution relies on its loan portfolio for
financial condition, and PCA category. contingent liquidity, a stress test may assess the effects of
poor asset quality. If loans previously securitized were of
Management’s active involvement and support is critical to poor credit quality, the market value and collateral value of
the effectiveness of the stress testing process. Stress test current and future loans originated by the institution could
results are typically discussed with the board, and when be significantly reduced.
appropriate, management takes actions to limit the
institution’s exposures, build up a liquidity cushion, or Institutions also benefit by operationalizing other secured
adjust the institution’s liquidity profile to fit its risk funding lines, giving management the ability to draw on
tolerance. In some situations, management may adjust the these lines immediately. Effective management will
institution’s business strategy to mitigate a contingent generally determine an appropriate contingent borrowing
funding exposure. capacity and pledge collateral to funds providers as
appropriate.
Potential Funding Sources
Monitoring Framework for Stress Events
Identification of potential funding sources for shortfalls
resulting from stress scenarios is a key component of CFPs. Early identification of liquidity stress events is critical to
Management generally identifies alternative funding implementing an effective response. The early recognition
sources and ensures ready access to the funds. of potential events allows the institution to position itself
into progressive states of readiness as an event evolves,
The most important and reliable funding source is a cushion while providing a framework to report or communicate
of highly liquid assets. Other common contingent funding within the institution and to outside parties. As a result,
sources include the sale or securitization of assets, effective CFPs typically identify early warning signs that
repurchase agreements, FHLB borrowings, or borrowings are tailored to the institution’s specific risk profile. The
through the Federal Reserve discount window. However, in CFPs also establish a monitoring framework and
a stress event, many of these liquidity sources may become responsibilities for monitoring identified risk factors.
unavailable or cost prohibitive. Therefore, effective stress
tests typically assess the availability of contingent funding
in stress scenarios. CFPs can also establish a hierarchy for
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LIQUIDITY AND FUNDS MANAGEMENT Section 6.1

Early warning indicators may be classified by management new funds at a time when the capital markets may be less
as early-stage, low-severity, or moderate-severity stress active. The complexity of these tests can range from a
events and include factors such as: simple communication and access test for a non-complex
institution or can include multiple tests throughout the day
• Decreased credit-line availability from correspondent to assess the timing of funds access.
institutions,
• Demands for collateral or higher collateral Liquidity Event Management Processes
requirements from counterparties that provide credit to
the institution, In a contingent liquidity event, it is critical that
• Cancellation of loan commitments or the non-renewal management’s response be timely, effective, and
of maturing loans from counterparties that provide coordinated. Therefore, comprehensive CFPs typically
credit to the institution, provide for a dedicated crisis management team and
• Decreased availability of warehouse financing for administrative structure and include realistic action plans to
mortgage banking operations, execute the plan elements for various levels of stress. CFPs
• Increased trading of the institution’s debt, or establish clear lines of authority and reporting by defining
• Unwillingness of counterparties or brokers to responsibilities and decision-making authority. CFPs also
participate in unsecured or long-term transactions. address the need for more frequent communication and
reporting among team members, the board, and other
Testing and Updating Contingency Funding affected parties. Critical liquidity events may also require
daily computation of liquidity risk reports and supplemental
Plans information, and comprehensive CFPs provide for more
frequent and more detailed reporting as the stress situation
Management periodically tests and updates the CFP to intensifies.
assess its reliability under times of stress. Generally,
management tests contingent funding sources at least The reputation of an institution is a critical asset when a
annually. Testing may include both drawing on a liquidity crisis occurs, and proactive management maintains
contingent borrowing line and operational testing. plans (including public relations plans) to help preserve the
Operational testing is often designed to ensure that: institution’s reputation in periods of perceived stress.
Failure to appropriately manage reputation risk could cause
• Roles and responsibilities are up to date and severe damage to an institution.
appropriate,
• Legal and operational documents are current and And finally, comprehensive CFPs also address effective
appropriate, communication with key stakeholders, such as
• Cash and collateral can be moved where and when counterparties, credit-rating agencies, and customers.
needed, and Smaller institutions that rarely interact with the media may
• Contingent liquidity lines are available. benefit from having plans in place for how they will manage
press inquiries and training front-line employees on how to
Effective CFP testing typically includes periodically testing respond to customer questions.
the operational elements associated with accessing
contingent funding sources. The tests help ensure funds are ←
available when needed. For example, there may be INTERNAL CONTROLS
extended time constraints for establishing lines with the
Federal Reserve or FHLB. Often, the lines are set up in Adequate internal controls are integral to ensuring the
advance to establish availability and to limit the time integrity of an institution’s liquidity risk management
required to pledge assets and draw on lines. However,
process. An effective system of internal controls promotes
establishing lines in advance and testing the lines does not
effective operations, reliable financial and regulatory
guarantee funding sources will be available within the same reporting, and compliance with relevant laws and
time frames or on the same terms during stress events. institutional policies. Effective internal control systems are
designed to ensure that approval processes and board limits
In addition, institutions can benefit by employing are followed and any exceptions to policies are quickly
operational CFP simulations to test communications,
reported to, and promptly addressed by, senior management
coordination, and decision-making involving managers
and the board.
with different responsibilities, in different geographic
locations, or at different operating subsidiaries. Simulations
or tests performed late in the day can highlight specific
problems such as difficulty in selling assets or borrowing
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LIQUIDITY AND FUNDS MANAGEMENT Section 6.1

Independent Reviews • Access to money markets and other sources of

funding.
A key internal control involves having an independent party • The level of diversification of funding sources, both
regularly evaluate the various components of the liquidity on- and off-balance sheet.
risk management process. A review typically assesses the • The degree of reliance on short-term volatile funding
effectiveness of liquidity risk management programs, sources (including borrowings and brokered deposits)
considering the complexity of the institution’s liquidity risk to fund longer-term assets.
profile. Institutions may achieve independence by • The trend and stability of deposits.
assigning this responsibility to the audit function or other • The ability to securitize and sell certain pools of
qualified individuals independent of the liquidity risk assets.
management process. To facilitate the independence of the • The capability of management to properly identify,
review process, reviewers typically report key issues measure, monitor, and control the institution’s
requiring attention (including instances of noncompliance liquidity position, including the effectiveness of funds
with laws and regulations or the institution’s policies) to the management strategies, liquidity policies,
ALCO and audit committee for prompt action. Independent management information systems, and contingency
reviews are typically performed at least annually. funding plans.

← Rating the Liquidity Factor

EVALUATION OF LIQUIDITY
A rating of 1 indicates strong liquidity levels and well-
Liquidity Component Review developed funds management practices. The institution has
reliable access to sufficient sources of funds on favorable
Under the Uniform Financial Institutions Rating System, in terms to meet present and anticipated liquidity needs.
evaluating the adequacy of a financial institution’s liquidity
position, consideration should be given to the current level A rating of 2 indicates satisfactory liquidity levels and funds
and prospective sources of liquidity compared to funding management practices. The institution has access to
needs, as well as the adequacy of funds management sufficient sources of funds on acceptable terms to meet
practices relative to the institution’s size, complexity, and present and anticipated liquidity needs. Modest weaknesses
risk profile. may be evident in funds management practices.

In general, funds management practices should ensure that A rating of 3 indicates liquidity levels or funds management
an institution is able to maintain a level of liquidity practices in need of improvement. Institutions rated 3 may
sufficient to meet its financial obligations in a timely lack ready access to funds on reasonable terms or may
manner and to fulfill the legitimate banking needs of its evidence significant weaknesses in funds management
community. Practices should reflect the ability of the practices.
institution to manage unplanned changes in funding
sources, as well as react to changes in market conditions that A rating of 4 indicates deficient liquidity levels or
affect the ability to quickly liquidate assets with minimal inadequate funds management practices. Institutions rated
loss. 4 may not have or be able to obtain a sufficient volume of
funds on reasonable terms to meet liquidity needs.
In addition, funds management practices should ensure that
liquidity is not maintained at a high cost or through undue A rating of 5 indicates liquidity levels or funds management
reliance on funding sources that may not be available in practices so critically deficient that the continued viability
times of financial stress or adverse changes in market of the institution is threatened. Institutions rated 5 require
conditions. immediate external financial assistance to meet maturing
obligations or other liquidity needs.
Liquidity is rated based upon, but not limited to, an
assessment of the following evaluation factors:

• The adequacy of liquidity sources compared to present

and future needs and the ability of the institution to
meet liquidity needs without adversely affecting its
operations or condition.
• The availability of assets readily convertible to cash
without undue loss.

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