The Liquidity Spectrum

During my career, I have always heard the following comment: “You only need Liquidity on one day.” Certainly, that is not an accurate statement, banks need Liquidity every day to meet funding needs. However, that need looks different for each institution and changes within a day, week, month, quarter, etc. When 2020 started, Liquidity was on my list of top priorities and issues facing the banking sector. The pandemic arrived with a vengeance, changed the world and through economic conditions and monetary stimulus actions, banks across the country, and in Arkansas, instantly became flush with Liquidity. Reliance on secondary or noncore funding sources quickly diminished and many banks were suddenly faced with the unique issue of excess Liquidity.

Fast forward to mid-2022, we began to see and hear about sizable outflows of deposits which continue in today’s environment. With the rapid and significant increase in interest rates during the same timeframe, and the return to a more normal business cycle with increases in loan demand, the tables have quickly turned, and we once again find Liquidity on the list of significant risks facing the industry. I receive calls daily from bankers, and Liquidity and Funds Management is easily the most common topic of discussion. The rate environment has dramatically impacted the market value of banks’ investment portfolios, thus limiting their ability to serve as a source of Liquidity. To compound that impact, the unrealized losses on investment portfolios and the resulting effect on tangible equity capital is creating a potential issue for a bank’s borrowing authority with the Federal

Home Loan Bank. Furthermore, the need to ensure your bond values adequately meet pledging requirements for public deposits should also be an area of focus in this current cycle. Lastly, as in years past, we are once again receiving inquiries about the regulatory posture on brokered deposits and other alternative funding sources. With that in mind, now is the time for all institutions to evaluate their Contingency Funding Plans and determine the suitability of those options in relation to today’s rate environment and highly competitive market.

From my perspective, you can summarize the conversation about Liquidity in two words: availability and affordability. It is also a story of have and have not. In Arkansas, there has always been a number of banks that remain well supported by a strong deposit base with a lower level of loan demand while some institutions must continually manage and monitor their funding structure to meet needs and opportunities. What will 2023 look like in relation to the availability of diversified funding sources?

In today’s highly competitive market, the number and type of firms competing for consumers’ deposits and investment dollars is significant. Banks are no longer simply competing for funds with other depository institutions, but with a large contingent of financial service providers such as insurance companies, investment, and brokerage firms and fintech companies, just to name a few. As interest rates have risen, so has the ability for the consumer to identify and expect a larger return on their money. Rising interest rates and the overall costs of obtaining adequate funding sources places a significant challenge on institutions to effectively manage costs and spread as it pertains to Liquidity, asset/liability management and earnings.

Examiners’ analysis and evaluation of a bank’s Liquidity and Funds Management position will be highlighted in examinations for the foreseeable future. Institutions that are operating at a higher level of loans-to-deposits, banks that are more reliant on secondary funding sources and banks that operate with a lower level of on-balance sheet Liquidity are encouraged to spend additional time reviewing, developing and updating plans and projections to address the availability and affordability of Liquidity now and in the future. Liquidity risk is at the forefront of concerns as we close out 2022 and I encourage each Board and management team to elevate this discussion within your institution in the near term.