Alert September 09, 2008

FDIC Issues Guidance on Liquidity Risk Management

The FDIC issued a Financial Institution Letter (the “Letter,” FIL-84-2008) regarding banks’ liquidity risk management.  The FDIC stated that a bank’s liquidity risk management program is expected to reflect the bank’s complexity, risk profile and scope of operations.  The Letter stresses that banks that use wholesale funding, securitizations, brokered deposits and other high-rate funding strategies “should ensure that their contingency funding plans address relevant stress events.”  Such “stress events” may involve a bank’s sudden inability to securitize assets, tightening of collateral requirements or other restrictive terms associated with secured borrowings, difficulty renewing or replacing funding as it matures, the demise of a business line or the loss of a large depositor or counterparty.  The Letter states that banks that have complex liquidity risk exposures should use pro forma cash flow analyses, among other readily available tools, to measure their liquidity risk.

The Letter reminds banks that the limits set forth at 12 CFR §337.6 on the use of brokered deposits by banks that are less than well capitalized should be reflected in a bank’s Contingency Funding Plan (“CFP”).  The Letter also reminds banks that even when the FDIC grants a less than well-capitalized bank a waiver to accept brokered deposits, restrictions are imposed on the maximum interest rate that can be paid on such deposits.  The FDIC states that a bank’s CFP should provide “practical and realistic” funding alternatives that can be used by a bank as access to funding is reduced.

Moreover, the FDIC states that banks that present high levels of liquidity risk because of dependence on volatile, credit-sensitive or concentrated funding sources, will generally by expected by the FDIC to maintain higher than minimum capital levels.  Furthermore, the FDIC specifically cautions banks in the Letter that they need to set liquidity risk tolerances and/or limits that are “appropriate for the complexity and liquidity risk profile of the institution and…employ both quantitative targets and qualitative guidelines.”