Risk Management Manual of Examination Policies

LIQUIDITY AND FUNDS MANAGEMENT Section 6.1

RMS Manual of Examination Policies 6.1-1 Liquidity and Funds Management (4/24)

Federal Deposit Insurance Corporation

INTRODUCTION.............................................................. 2

RISK MANAGEMENT PROGRAM ................................ 2

Board and Senior Management Oversight ..................... 2

Liquidity Management Strategies .................................. 3

Collateral Position Management .................................... 3

POLICIES, PROCEDURES, and REPORTING ............... 4

Liquidity Policies and Procedures .................................. 4

Risk Tolerances .............................................................. 5

Liquidity Reporting ........................................................ 5

LIQUIDITY RISK MEASUREMENT .............................. 6

Pro Forma Cash Flow Projections .................................. 6

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

Contingent Funding Events ......................................... 26

Stress Testing Liquidity Risk Exposure ....................... 27

Potential Funding Sources ........................................... 28

Monitoring Framework for Stress Events .................... 28

Testing and Updating Contingency Funding Plans...... 29

Liquidity Event Management Processes ...................... 29

INTERNAL CONTROLS ............................................... 29

Independent Reviews ................................................... 30

EVALUATION OF LIQUIDITY .................................... 30

Liquidity Component Review ...................................... 30

Rating the Liquidity Factor .......................................... 30

LIQUIDITY AND FUNDS MANAGEMENT Section 6.1

Liquidity and Funds Management (4/24) 6.1-2 RMS Manual of Examination Policies

Federal Deposit Insurance Corporation

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INTRODUCTION

Liquidity is the ability to meet cash and collateral

obligations at a reasonable cost. Maintaining an adequate

level of liquidity helps ensure the institution’s ability to

efficiently meet both expected and unexpected cash flow

and collateral needs without adversely affecting the

institution’s operations or financial condition. Liquidity is

essential to meet customer withdrawals, compensate for

balance sheet fluctuations, and provide funds for growth.

Funds management involves estimating liquidity

requirements and meeting those needs in a cost-effective

way. Effective funds management involves management

estimating and planning for liquidity demands over various

periods and considering how funding requirements may

evolve under various scenarios, including adverse

conditions. This planning includes identifying and

maintaining sufficient levels of cash, liquid assets, and

accessible borrowing lines to meet expected and contingent

liquidity demands.

Liquidity risk reflects the possibility an institution will be

unable to obtain funds, such as customer deposits or

borrowed funds, at a reasonable price or within a necessary

period to meet its financial obligations. Failure to

adequately manage liquidity risk can quickly result in

negative consequences, including failure, for an institution

despite strong capital and profitability levels. Therefore, it

is critically important that management implement and

maintain sound policies and procedures to effectively

measure, monitor, and control liquidity risks.

A certain degree of liquidity risk is inherent in banking. An

institution’s challenge is to accurately measure and

prudently manage liquidity demands and funding positions.

To efficiently support daily operations and provide for

contingent liquidity demands, management:

• Establishes an appropriate liquidity risk management

program,

• Ensures adequate resources are available to fund

ongoing liquidity needs,

• Establishes a funding structure commensurate with the

institution’s risk profile,

• Evaluates exposures to contingent liquidity events,

and

• Ensures sufficient resources are available to meet

contingent liquidity needs.

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RISK MANAGEMENT PROGRAM

An institution’s liquidity risk management program

establishes the liquidity management framework.

Comprehensive and effective programs encompass all

elements of an institution’s liquidity, ranging from how

management manages routine liquidity needs to managing

liquidity during a severe stress event. Elements of a sound

liquidity risk management program include:

• Effective management and board oversight;

• Appropriate liquidity management policies,

procedures, strategies, and risk limits;

• Comprehensive liquidity risk measurement and

monitoring systems;

• Adequate levels of marketable assets;

• A diverse mix of existing and potential funding

sources;

• Comprehensive and actionable contingency funding

plans;

• Appropriate plans for potential stress events; and

• Effective internal controls and independent reviews.

The formality and sophistication of effective liquidity

management programs are commensurate with the

institution’s complexity, risk profile, and scope of

operations, and examiners should assess whether programs

meet the institution’s needs. Examiners should consider

whether liquidity risk management activities are integrated

into the institution’s overall risk management program and

address liquidity risks associated with new or existing

business strategies.

Close oversight and sound risk management processes

(particularly when planning for potential stress events) are

especially important if management pursues asset growth

strategies that rely on new or potentially less stable funding

sources.

Board and Senior Management Oversight

Board oversight is critical to effective liquidity risk

management. The board is responsible for establishing the

institution’s liquidity risk tolerance and clearly

communicating it to all levels of management.

Additionally, the board is responsible for reviewing,

approving, and periodically updating liquidity management

strategies, policies, procedures, and risk limits. When

assessing the effectiveness of board oversight, examiners

should consider whether the board:

• Understands and periodically reviews the institution’s

current liquidity position and contingency funding

plans;

• Understands the institution’s liquidity risks and

periodically reviews information necessary to

maintain this understanding;

• Authorizes an asset/liability management level

committee (ALCO), or similar committee, to perform

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RMS Manual of Examination Policies 6.1-3 Liquidity and Funds Management (4/24)

Federal Deposit Insurance Corporation

specific tasks and to oversee liquidity and funds

management, and reviews the minutes of the ALCO;

• Establishes executive-level lines of authority and

responsibility for managing the institution’s liquidity

risk;

• Provides appropriate resources to management for

identifying, measuring, monitoring, and controlling

liquidity risks; and

• Understands the liquidity risk profiles of significant

subsidiaries and affiliates.

Management is responsible for appropriately implementing

board-approved liquidity policies, procedures, and

strategies. This responsibility includes overseeing the

development and implementation of appropriate risk

measurement and reporting systems, contingency funding

plans, and internal controls. Management is also

responsible for regularly reporting the institution’s liquidity

risk profile to the board.

Examiners should evaluate whether the ALCO (or similar

committee) actively monitors the institution’s liquidity

profile. Effective ALCOs have representation across major

functions (e.g., lending, investments, wholesale and retail

funding) that may influence the liquidity risk profile. The

committee is usually responsible for ensuring that liquidity

reports include accurate, timely, and relevant information

on risk exposures.

Examiners should evaluate corporate governance by

reviewing liquidity management processes (including daily,

monthly, and quarterly activities), committee minutes,

liquidity and funds management policies and procedures,

and by holding discussions with management.

Additionally, examiners should consider the findings of

independent reviews and prior reports of examination when

assessing the effectiveness of corrective actions.

Liquidity Management Strategies

Liquidity management involves short- and long-term

strategies that can change over time, especially during times

of stress. Therefore, the institution’s policies often require

management to meet regularly and consider liquidity costs,

benefits, and risks as part of the institution’s overall

strategic planning and budgeting processes. As part of this

process, management:

• Performs periodic liquidity and profitability

evaluations for existing activities and strategies;

• Identifies primary and contingent funding sources

needed to meet daily operations, as well as seasonal

and cyclical cash flow fluctuations;

• Ensures liquidity management strategies are consistent

with the board’s expressed risk tolerance; and

• Evaluates liquidity and profitability risks associated

with new business activities and strategies.

Collateral Position Management

Financial assets are a key funding source, as they can

generate substantial cash inflows through principal and

interest payments. Financial assets can also provide funds

when sold or when used as collateral for borrowings.

Management routinely pledges assets when borrowing

funds or obtaining credit lines from the Federal Home Loan

Bank (FHLB), the Federal Reserve discount window, or

other institutions.

Collateral management is the practice of identifying and

managing the institution’s assets that may be pledged as

collateral to another party. An effective collateral

management program aids in monetizing (i.e. converting to

cash via collateralized borrowing) potentially less liquid

assets for use in conducting payments, funding loans, or

satisfying deposit withdrawals.

Char

acteristics of an effective collateral management

system may include the ability to:

• Identify and track the movement of pledged collateral,

including the entity to which the collateral is pledged,

the entity that has custody of the collateral, and

unencumbered available collateral, at the individual

instrument level.

• Have a centralized view into all pledged collateral,

including the value of collateral pledged relative to the

amount required and the availability of unencumbered

collateral by type and amount.

• Manage collateral positions to avoid accidental double

encumbrance. Typically, each funds provider would

need to release or subordinate its lien before another

counterparty will advance secured credit (examiners

should recognize that providers of funds on a secured

basis, such as the FHLB and Federal Reserve, do not

share collateral or liens on an institution’s pledged

assets).

• Identify all borrowing agreements (contractual or

otherwise) that may require the institution to provide

additional collateral, substitute existing collateral, or

deliver collateral, such as requirements that may be

triggered by changes in an institution’s financial

condition.

• Monitor the change in market value, credit quality,

and performance of collateral instruments so as to be

able to anticipate and meet calls for additional

collateral.

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Federal Deposit Insurance Corporation

Smaller institutions or those with limited amounts of

borrowings may be able to adequately manage collateral

needs through manual processes and monitor collateral

levels by reviewing monthly or quarterly reports. Larger

institutions; those with material payment, settlement, and

clearing activities; or those more active in using secured

financing (e.g. repurchase agreements, public deposits, or

FHLB borrowings) will benefit from actively monitoring

short- (including intraday), medium-, and long-term

collateral positions and may engage in a practice known as

collateral optimization.

During a liquidity stress event, management’s ability to

respond quickly to emergency funding needs is critical and

may depend on the quality and effectiveness of the pledged

collateral reporting and tracking systems. In practice,

demands for collateral must often be met within just a few

hours. In order to meet the timeliness requirements, an

institution may pledge cash or readily available highly

liquid investment securities, such as U.S. Treasuries.

However, given more time, it may be able to substitute less

liquid instruments and return the more liquid instruments to

available inventory. The practice of replacing previously

pledged collateral with less liquid collateral that will still be

deemed acceptable by the secured party is known as

collateral optimization. This activity increases an

institution’s ability to rapidly obtain funding from its more

liquid collateral, but also requires more advanced

management and reporting systems.

Examiners should determine whether the institution has

collateral management and reporting systems that are

commensurate with the institution’s funding structure,

potential borrowing needs, and overall risk profile,

including determining whether reporting systems facilitate

the monitoring and management of assets pledged and of

assets that can be pledged as collateral for borrowed funds.

This determination includes reviewing collateral tracking or

pledged asset reports.

Examiners should also determine whether management:

• Considers potential changes to collateral requirements

in cash flow projections, stress tests, and contingency

funding plans; and

• Understands the operational and timing requirements

associated with accessing collateral (such as at a

custodian institution or a securities settlement location

where the collateral is held).

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POLICIES, PROCEDURES, AND

REPORTING

Liquidity Policies and Procedures

Comprehensive written policies, procedures, and risk limits

form the basis of liquidity risk management programs. All

institutions benefit from board-approved liquidity

management policies and procedures specifically tailored

for their institution.

Even when operating under a holding company with

centralized planning and decision making, each institution’s

board has a legal responsibility to maintain policies,

procedures, and risk limits tailored to its individual

institution’s risk profile. And each institution’s board is

responsible for ensuring that the structure, responsibility,

and controls for managing the institution’s liquidity risk are

clearly documented. To fulfill its oversight responsibilities,

a prudent board regularly monitors reports that highlight

institution-specific liquidity factors.

Boards that review and approve liquidity policies at least

annually ensure such policies remain relevant and

appropriate for the institution’s business model, complexity,

and risk profile. Written policies are important for defining

the scope of the liquidity risk management program and

ensuring that:

• Sufficient resources are devoted to liquidity

management,

• Liquidity risk management is incorporated into the

institution’s overall risk management process, and

• Management and the board share an understanding of

strategic decisions regarding liquidity.

Effective policies and procedures address liquidity matters

(such as legal, regulatory, and operational issues) separately

for legal entities, business lines, and, when appropriate,

individual currencies. Sound liquidity and funds

management policies typically:

• Provide for the effective operation of the ALCO. The

ALCO policies address responsibilities for assessing

current and projected liquidity positions,

implementing board-approved strategies, reviewing

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

LIQUIDITY AND FUNDS MANAGEMENT Section 6.1

RMS Manual of Examination Policies 6.1-5 Liquidity and Funds Management (4/24)

Federal Deposit Insurance Corporation

reviews, when applicable, includes the volume, trend,

and concentration of large deposits, public funds, out-

of-area deposits, uninsured deposits, potentially rate-

sensitive deposits, and wholesale deposits, including

brokered and other deposits received through third-

party arrangements;

• Address permissible funding sources and

concentration limits. Items addressed generally

include funding types with similar rate sensitivity or

volatility, such as brokered or Internet deposits and

deposits generated through promotional offers;

• Provide a method of computing the institution’s cost

of funds;

• Establish procedures for measuring and monitoring

liquidity. Procedures generally include static

measurements and cash flow projections that forecast

base case and a range of stress scenarios;

• Address the type and mix of permitted investments.

Items addressed typically include the maturity

distribution of the portfolio, which investments are

available for liquidity purposes, and the level and

quality of unpledged investments;

• Provide for an adequate system of internal controls.

Controls typically require periodic, independent

reviews of liquidity management processes and

compliance with policies, procedures, and risk limits;

• Include a contingency funding plan (CFP) that

identifies alternate funding sources if liquidity

projections are incorrect or a liquidity crisis arises and

describes potential stress scenarios;

• Require periodic testing of borrowing lines and

consider operational impediments to implementing the

CFP;

• Establish procedures for reviewing and documenting

assumptions used in liquidity projections;

• Define procedures for approving exceptions to

policies, limits, and authorizations;

• Identify permissible wholesale funding sources;

• Define authority levels and procedures for accessing

wholesale funding sources;

• Establish a process for measuring and monitoring

unused borrowing capacity and for verifying, and

positioning, unencumbered collateral;

• Convey the board’s risk tolerance by establishing

target liquidity ratios and parameters under various

time horizons and scenarios; and

• Include other items unique to the institution.

Risk Tolerances

Examiners should consider whether liquidity policies

accurately reflect the board’s risk tolerance and delineate

qualitative and quantitative guidelines commensurate with

the institution’s risk profile and balance sheet complexity.

Typical risk guidelines include:

• Targeted cash flow gaps over discrete and cumulative

periods and under expected and adverse business

conditions;

• Expected levels of unencumbered liquid assets;

• Measures for liquid asset coverage ratios (e.g., liquid

assets to total assets, cash and confirmed borrowing

capacity to uninsured deposits).

• Limits on potentially unstable liabilities;

• Concentration limits on assets that may be difficult to

convert into cash (such as complex financial

instruments, depreciated securities, bank-owned life

insurance, and less-marketable loan portfolios);

• Limits on the level of borrowings, brokered funds, or

exposures to single fund providers or market

segments;

• Funding diversification standards by tenor, source,

and type;

• Limits on contingent liability exposures such as

unfunded loan commitments or lines of credit;

• Collateral requirements for derivative transactions and

secured lending;

• Limits on material exposures in complex activities

(such as securitizations, derivatives, trading, and

international activities).

Examiners should consider whether management and the

board establish meaningful risk limits, periodically evaluate

the appropriateness of established limits, and compare

actual results to approved risk limits. Identified policy

exceptions, as well as the appropriateness and promptness

of corrective actions in response to these exceptions, are

typically noted in board or committee minutes.

Liquidity Reporting

Timely and accurate information is a prerequisite to sound

funds management practices. Institutions benefit from

liquidity risk reports that clearly highlight the institution’s

liquidity position, risk exposures, and level of compliance

with internal risk limits.

Examiners should assess liquidity reporting procedures.

Typically, institution personnel tasked with ongoing

liquidity administration receive liquidity risk reports at least

daily. Senior officers may receive liquidity reports weekly

or monthly, and the board may receive liquidity risk reports

monthly or quarterly. Depending on the complexity of

business activities and the liquidity risk profile, institutions

may need to increase, sometimes on short notice, the

frequency of liquidity reporting.

The format and content of liquidity reports will vary

depending on the characteristics of each institution and its

funds management practices. Examiners should consider

whether an institution’s management information systems

LIQUIDITY AND FUNDS MANAGEMENT Section 6.1

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Federal Deposit Insurance Corporation

and internal reports provide accurate, pertinent information

such as:

• Liquidity needs and the sources of funds available to

meet these needs over various time horizons and

scenarios (reports are often referred to as pro forma

cash flow reports, sources and uses reports, or

scenario analyses);

• Collateral positions and funds providers (lienholders),

including pledged and unpledged assets (and when

necessary, the availability of collateral by legal entity,

jurisdiction, and currency exposure);

• Public funds and other material providers of funds

(including rate and maturity information);

• Funding categories and concentrations;

• Asset yields, liability costs, net interest margins, and

variations from the prior month and budget (beneficial

reports are detailed enough to permit an analysis of

interest margin variations);

• Early warning indicators for contingency funding

events or signs of increasing liquidity pressure;

• Conformance with policy risk limits and the status of

policy exceptions;

• Interest rate projections and economic conditions in

the institution’s trade area;

• Information concerning non-relationship or higher

cost funding programs;

• The stability of deposit customers, providers of

wholesale funds (including brokered deposits), and

other deposits received through third-party

arrangements;

• The level of highly liquid assets;

• Stress test results; and

• Other items unique to the institution.

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LIQUIDITY RISK MEASUREMENT

To identify potential funding gaps, management typically

monitors cash flows, assesses the stability of funding

sources, and projects future funding needs. When assessing

an institution’s liquidity rating, examiners should evaluate

an institution’s liquidity risk measurement and monitoring

procedures.

Pro Forma Cash Flow Projections

Historically, most institutions used single, point-in-time

(static) measurements (such as loan-to-deposit or loan-to-

asset ratios) to assess their liquidity position. Static

liquidity measures provide valuable information and remain

a key part of institutions’ liquidity analysis. However, cash

flow forecasting can enhance an institution’s ability to

monitor and manage liquidity risk.

Cash flow forecasts can be useful for all institutions and

become essential when operational areas (e.g., loans,

deposits, investments) are complex or managed separately

from other areas. Cash flow projections enhance

management’s ability to evaluate and manage these areas

individually and collectively.

The sophistication of cash flow forecasting ranges from the

use of simple spreadsheets to comprehensive liquidity risk

models. Some vendors that offer interest rate risk (IRR)

models also provide options for modeling liquidity cash

flows because the base information is already maintained

for IRR modeling. When reviewing liquidity risk models,

examiners should verify that management compares

funding sources and uses over various periods and that

modeling assumptions are appropriate for evaluating

liquidity risk rather than IRR.

Cash flow projections typically forecast funding sources

and uses over short-, medium-, and long-term time horizons.

Non-complex community institutions that are in sound

condition may forecast short-term positions monthly. More

complex institutions may need to perform weekly or daily

forecasts, and institutions with large payment systems and

settlement activities may need to conduct intraday

measurements. All institutions can benefit from having the

ability to increase the frequency of monitoring and reporting

during a stress event.

Effective cash flow analysis allows management to plan for

tactical (short-term) and strategic (medium- and long-term)

liquidity needs. Examiners should review the institution’s

procedures, assumptions, and information used to develop

cash flow projections. For example, examiners should

consider whether funding sources and uses are adequately

stratified, as excessive account aggregations in liquidity

analysis can mask substantial liquidity risk. Similar to

measuring IRR, there are advantages to using account-level

information. For some institutions, gathering and

measuring information on specific accounts may not be

feasible due to information system limitations. Although

the advantages of using detailed account information may

not be as evident for a non-complex institution, generally,

all institutions can benefit from using more detailed account

information in their liquidity models.

Examiners should carefully assess the assumptions that

management uses when projecting cash flows. Reliability

is enhanced when projections are based on reasonable

assumptions and reliable data. Additionally, the accuracy

and reliability of cash flow projections are enhanced when

projected cash flows consider contractual and expected cash

flows. For example, the accuracy of cash flow projections

for construction loans is enhanced when management

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

maturing time deposits, particularly those obtained through

special rate promotions, can be enhanced if the analysis

considers the probable retention rate of maturing deposits.

Modeling assumptions play a critical role in projecting cash

flows and measuring liquidity risks. Therefore, institutions

benefit from ensuring key assumptions are reasonable, well

documented, and periodically reviewed and approved by the

board. Ensuring the accuracy of assumptions is also

important when assessing the liquidity risk of complex

assets, liabilities, and off-balance sheet positions and can be

critical when evaluating the availability of funding sources

under adverse liquidity scenarios. Accurate and reliable

cash flow forecasting can benefit institutions by identifying

liquidity risks.

Back Testing

The reliability of cash flow projections may also be

enhanced if management evaluates assumptions about

customer behavior, separately estimates gross cash flows on

both sides of the balance sheet, and compares modeling

projections to actual results (back testing). Back testing

allows management to make adjustments to cash flow

models and modeling assumptions, as appropriate, to reflect

changes in cash flow characteristics.

Scenario Analysis

Cash flow projections can also be used in scenario analysis

and to develop CFPs. Management typically starts with

base case projections that assume normal cash flows, market

conditions, and business operations over the selected time

horizon. Management then tests stress scenarios by

changing various cash flow assumptions in the base case

scenario. For example, if the stress scenario assumed a

change in the Prompt Corrective Action (PCA) capital

category that triggered interest rate restrictions and brokered

deposit limitations, it is appropriate for management to

adjust assumptions to reflect the possible limitation or

elimination of access to affected funding sources.

Management typically uses the stress testing results in

developing funding plans to mitigate these risks, including

determining appropriate amounts for – or sizing – the

liquidity buffer and contingent borrowing lines.

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FUNDING SOURCES - ASSETS

The amount of liquid assets that an institution maintains is

generally a function of the stability of its funding structure,

the risk characteristics of its balance sheet, and the adequacy

of its liquidity risk measurement program. Generally, a

lower level of unencumbered liquid assets may be sufficient

if funding sources in base case and in various stress

scenarios remain stable, established borrowing facilities

have been operationalized and are largely unused, and other

risk characteristics are predictable. A higher level of

unencumbered liquid assets may be required if:

• Institution customers have numerous alternative

investment options,

• Recent trends show a substantial reduction in large

liability accounts,

• The institution has a material reliance on potentially

less stable funding sources, such as large, uninsured

deposits,

• The loan portfolio includes a high volume of non-

marketable loans,

• The institution expects several customers to make

material draws on unused lines of credit,

• Deposits include substantial amounts of short-term

municipal accounts,

• A concentration of credits was extended to an industry

with existing or anticipated financial problems,

• A close relationship exists between individual demand

accounts and principal employers in the trade area

who have financial problems,

• A material amount of assets is pledged to support

wholesale borrowings,

• The institution’s access to capital markets is impaired,

• Stress testing results indicate the need for increased

levels of unencumbered, liquid assets, or

• The institution is experiencing financial duress.

An institution’s assets provide varying degrees of liquidity

and can create cash inflows and outflows. Institutions

generally retain a certain level of highly liquid assets to meet

immediate funding needs, and hold other types of

investments to provide liquidity for meeting ongoing

operational needs and responding to contingent funding

events. To balance profitability goals and liquidity

demands, management typically weighs the full benefits

(yield and increased marketability) of holding liquid assets

against the expected higher returns associated with less

liquid assets. Income derived from holding longer-term,

higher-yielding assets may be offset if management is

forced to sell the assets quickly due to adverse balance sheet

fluctuations.

Cash and Due from Accounts

Cash and due from accounts are essential for meeting daily

liquidity needs. Management relies on cash and due from

accounts to fund deposit account withdrawals (particularly

in stress situations), disburse loan proceeds, cover cash

letters, fund operations, meet reserve requirements when

applicable, and facilitate correspondent transactions.

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Loan Portfolio

The loan portfolio is an important factor in liquidity

management. Loan payments provide steady cash flows,

and loans can be used as collateral for secured borrowings

or sold for cash in the secondary loan market. However, the

quality of the loan portfolio can directly impact liquidity.

For example, if an institution encounters asset quality

issues, operational cash flows may be affected by the level

of non-accrual borrowers and late payments.

For many institutions, loans serve as collateral for wholesale

borrowings such as FHLB advances. If asset quality issues

exist, management may find that delinquent loans do not

qualify as collateral. Also, higher amounts of collateral may

be required because of doubts about the overall quality of

the portfolio or because of market volatility that affects the

value of the loan collateral. These “haircuts” can be

substantial and are an important consideration in stress tests.

Comprehensive liquidity analysis considers contractual

requirements and customers’ behavior when forecasting

loan cash flows. Prepayments and renewals can

significantly affect contractual cash flows for many types of

loans. Customer prepayments are a common consideration

for residential mortgage loans (and mortgage-backed

securities) and can be a factor for commercial and

commercial real estate loans (and related securities).

Assumptions related to revolving lines of credit and balloon

loans can also have a material effect on cash flows.

Examiners should determine whether management’s loan

cash flow assumptions are supported by historical data.

Asset Sales and Securitizations

As noted above, assets can be used as collateral for secured

borrowings or sold for cash in the secondary market. Sales

in the secondary market can provide fee income, relief from

interest rate risk, and a funding source for the institution.

However, for an asset to be saleable at a reasonable price in

the secondary market, it will generally have to conform to

market (investor) requirements. Because loans and loan

portfolios may have unique features or defects that hinder

or prevent their sale into the secondary market, management

would benefit from thoroughly reviewing loan

characteristics and documenting assumptions related to loan

portfolios when developing cash flow projections.

Some institutions are able to use securitizations as a funding

vehicle by converting a pool of assets into cash. Asset

securitization typically involves the transfer or sale of on-

balance sheet assets to a third party that issues mortgage-

backed securities (MBS) or asset-backed securities (ABS).

These instruments are then sold to investors. The investors

are paid with the cash flow from the transferred assets.

Assets that are typically securitized include credit card

receivables, automobile receivables, commercial and

residential mortgage loans, commercial loans, home equity

loans, and student loans.

Securitization can be an effective funding method for some

institutions. However, there are several risks associated

with using securitization as a funding source. For example:

• Some securitizations have early amortization clauses

to protect investors if the performance of the

underlying assets does not meet specified criteria. If

an early amortization clause is triggered, the issuing

institution is legally obligated to begin paying

principal to bondholders earlier than originally

anticipated and fund new receivables that would have

otherwise been transferred to the trust. Institutions

involved in securitizations benefit from monitoring

asset performance to better anticipate the cash flow

and funding ramifications of early amortization

clauses.

• If the issuing institution has a large concentration of

residual assets, the institution’s overall cash flow

might be dependent on the residual cash flows from

the performance of the underlying assets. If the

performance of the underlying assets is worse than

projected, the institution’s overall cash flow will be

less than anticipated.

• Residual assets retained by the issuing institution are

typically illiquid assets for which there is no active

market. Additionally, the assets are not acceptable

collateral to pledge for borrowings.

• An issuer’s market reputation can affect its ability to

securitize assets. If the institution’s reputation is

damaged, issuers might not be able to economically

securitize assets and generate cash from future sales of

loans to the trust. This is especially true for

institutions that are relatively new to the securitization

market.

• The timeframe required to securitize loans held for

sale may be considerable, especially if the institution

has limited securitization experience or encounters

unforeseen problems.

Institutions that identify asset sales or securitizations as

contingent liquidity sources, particularly institutions that

rarely sell or securitize loans, benefit from periodically

testing the operational procedures required to access these

funding sources. Market-access testing helps ensure

procedures work as anticipated and helps gauge the time

needed to generate funds; however, testing does not

guarantee the funding sources will be available or on

satisfactory terms during stress events.

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

treatment of financial assets. The standards influence the

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

borrowing with a pledge of collateral. As such,

management must account for, and risk weight, the

transferred financial assets as if the transfer had not

occurred. Accordingly, management should continue to

report the transferred assets in financial statements with no

change in the measurement of the transferred financial

assets.

When financial assets are securitized and accounted for as a

sale, institutions often provide contractual credit

enhancements, which may involve over-collateralization,

retained subordinated interests, asset repurchase

obligations, cash collateral accounts, spread accounts, or

interest-only strips. Part 324 of the FDIC Rules and

Regulations requires the issuing institution to hold capital

against the retained credit risk arising from these contractual

credit enhancements.

There can also be non-contractual support for ABS

transactions that would be considered implicit recourse.

This implicit recourse may create credit, liquidity, and

regulatory capital implications for issuers that provide

support for ABS transactions. Institutions typically provide

implicit recourse in situations where management perceives

that the failure to provide support, even though not

contractually required, would damage the institution’s

future access to the ABS market. For risk-based capital

purposes, institutions deemed to be providing implicit

recourse are generally required to hold capital against the

entire outstanding amount of assets sold, as though they

remained on the books.

Investment Portfolio

An institution’s investment portfolio can provide liquidity

through regular cash flows, maturing securities, the sale of

securities for cash, or by pledging securities as collateral for

borrowings, repurchase agreements, or other transactions.

Institutions can benefit from periodically assessing the

quality and marketability of the investment portfolio to

determine:

• The level of unencumbered securities available to

pledge for borrowings,

• The financial impact of unrealized holding gains and

losses,

• The effect of changes in asset quality, and

• The potential need to provide additional collateral

should rapid changes in market rates significantly

reduce the value of longer-duration investments

pledged to secured borrowings.

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FUNDING SOURCES - LIABILITIES

Deposits are the most common funding source for most

institutions; however, other liability sources, such as

borrowings, can also provide funding for daily business

activities, or as alternatives to using assets to satisfy

liquidity needs. Deposits and other liability sources are

often differentiated by their stability and customer profile

characteristics.

Core Deposits

Core deposits are generally stable, lower-cost funding

sources that typically lag behind other funding sources in

repricing during a period of rising interest rates. The

deposits are typically funds of local customers that also have

a borrowing or other relationship with the institution.

Convenient branch locations, superior customer service,

extensive ATM networks, and low- or no-fee accounts are

factors that contribute to the stability of the deposits. Other

factors include the insured status of the account and the type

of depositor (e.g., retail, commercial, and municipal).

Examiners should assess the stability of deposit accounts

when reviewing liquidity and funds management practices.

Generally, higher-cost, non-relationship deposits, such as

Internet deposits or deposits obtained through special-rate

promotions, may be considered less-stable funding sources.

Brokered deposits are not considered core deposits or a

stable funding source due to their brokered status and

wholesale characteristics.

Core deposits are defined in the Uniform Bank Performance

Report (UBPR) User’s Guide as the sum of all transaction

accounts, money market deposit accounts (MMDAs), non-

transaction other savings deposits (excluding MMDAs), and

time deposits of $250,000 and below, less fully insured

brokered deposits of $250,000 and less. However,

examiners should not assume that all deposits meeting the

UBPR definition of core are necessarily stable or that all

deposits defined as non-core are automatically volatile.

In some instances, core deposits included in the UPBR’s

core deposit definition might exhibit characteristics

associated with less stable funding sources. For example,

out-of-area certificates of deposit (CDs) of $250,000 or less

that are obtained from a listing service may have less

stability although they are included in core deposits under

the UBPR definition, given the lack of direct relationship

and motivation of such depositors seeking competitive

rates. As another example, transactional account deposits

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brought to the institution through an arrangement with a

third party (whether a broker-dealer, financial technology

firm, reciprocal network, or other third party) and which

may qualify for an exception from brokered deposit

treatment, may also be less stable as movement of such

deposits is often controlled by a third party. Management

and examiners should not automatically view “core”

deposits as a stable funding source without additional

analysis.

Alternatively, some deposit accounts generally viewed as

volatile, non-core funds by UBPR definitions (for example,

CDs larger than $250,000) might be considered relatively

stable after a closer analysis. For instance, a local depositor

might have CDs larger than $250,000 that may be

considered stable because the depositor has maintained

those deposits with the institution for several years.

However, while some deposit relationships over $250,000

remain stable when the institution is in good condition, such

relationships, because of their uninsured status, might

become less stable if the institution experiences financial

problems. Additionally, deposits identified as stable during

good economic conditions may not be reliable funding

sources during stress events. Therefore, examiners should

consider whether management identifies deposit accounts

likely to be unstable in times of stress and appropriately

evaluates these deposits in its liquidity stress testing and in

determining the adequacy of the liquidity buffer.

Deposit Management Programs

The critical role deposits play in an institution’s successful

operation demonstrates the importance of implementing

programs for retaining or expanding the deposit base.

Strong competition for depositors’ funds and customers’

preference to receive market deposit rates also highlight the

benefit of deposit management programs. Effective deposit

management programs generally include:

• Regular reports detailing existing deposit types and

levels,

• Projections for asset and deposit growth,

• Associated cost and interest-rate scenarios,

• Clearly defined marketing strategies,

• Procedures to compare results against projections, and

• Steps to revise the plans when needed.

Deposit management programs generally take into account

the make-up of the market-area economy, local and national

economic conditions, and the potential for investing

deposits at acceptable margins. Other considerations

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

monetary and fiscal policies on the institution’s service area

and capital markets in general.

Effective deposit management programs are monitored and

adjusted as necessary. The long-term success of such

programs is closely related to management’s ability to

identify the need for changes quickly. Effective programs

include procedures for accurately projecting deposit trends

and carefully monitoring the potential volatility of accounts

(e.g., stable, fluctuating, seasonal, brokered).

Wholesale Funds

Wholesale funds include, but are not limited to, brokered

deposits, deposits obtained through programs marketed by

third parties (such as a broker-dealer, financial technology

firm, reciprocal network, or other third party) even though

not defined or reported as brokered deposits, Internet

deposits, deposits obtained through listing services, foreign

deposits, public funds, federal funds purchased, FHLB

advances, correspondent line of credit advances, and other

borrowings.

Providers of wholesale funds closely track institutions’

financial condition and may cease or curtail funding,

increase interest rates, or increase collateral requirements if

they determine an institution’s financial condition is

deteriorating. As a result, some institutions may experience

liquidity problems due to a lack of wholesale funding

availability when funding needs increase.

The Internet, listing services, and other automated services

enable investors who focus on yield to easily identify high-

yield deposits. Customers who focus primarily on yield are

a less stable source of funding than customers with typical

deposit relationships. If more attractive returns become

available, these customers may rapidly transfer funds to new

institutions or investments in a manner similar to that of

wholesale investors.

It is important to measure the impact of the loss of wholesale

funding sources on the institution’s liquidity position. The

challenge of measuring, monitoring, and managing liquidity

risk typically increases as the use of wholesale and

nontraditional funding sources increases. Institutions that

rely more heavily on wholesale funding will often need

enhanced funds management and measurement processes

and may require more comprehensive scenario modeling.

In addition, contingency planning and capital management

take on added significance for institutions that rely heavily

on wholesale funding.

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Brokered and Higher Rate Deposits

Section 29 of the FDI Act establishes certain brokered

deposit restrictions on institutions that are not well

capitalized. Section 337.6 of the FDIC Rules and

Regulations implements Section 29 and defines a brokered

deposit as a deposit obtained through or with assistance of a

deposit broker. The term deposit broker is generally defined

by Section 29 as any person engaged in the business of

placing deposits, or facilitating the placement of deposits,

of third parties with institutions or the business of placing

deposits with insured depository institutions for the purpose

of selling interests in those deposits to third parties; and an

agent or trustee who establishes a deposit account to

facilitate a business arrangement with an insured depository

institution to use the proceeds of the account to fund a

prearranged loan.

Section 337.6 exempts from the deposit broker definition

third parties that have exclusive deposit relationships with

only one institution and defines relevant terms, including

“placing,” “facilitating,” “engaged in the business of

placing deposits,” “engaged in the business of facilitating

the placement of deposits,” and “engaged in the business.”

Refer to section 337.6(a)(5)(i)-(iv) for these definitions.

The rule excludes an entity with a “primary purpose

exception” from the deposit broker definition.

Even if a third party would otherwise fit the definition of a

“deposit broker,” the brokered deposit statute and regulation

provide nine statutory exceptions and one additional

regulatory exception to this definition of deposit broker

(refer to section 337.6(a)(5)(v)). Certain business

relationships are designated as meeting the primary purpose

exception (PPE). Institutions and non-bank third parties

may also request a PPE for a particular business line that

does not meet one of the designated exceptions by filing an

application with the FDIC under Section 303.243(b) of the

FDIC Rules and Regulations.

Primary Purpose Exceptions (PPE)

The PPE applies when, with respect to a particular business

line, the primary purpose of the agent’s or nominee’s

business relationship with its customers is not the placement

of funds with insured depository institutions.

The revised rule designates 14 business relationships as

meeting the PPE. In December 2021, the FDIC designated

an additional business line as qualifying for a PPE (refer to

87 FR 1065). Whether an agent or nominee qualifies for the

PPE is based on analysis of the agent’s or nominee’s

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.

relationship with those customers, most of which an

institution may rely upon without notice to the FDIC.

However, as discussed below, a third party, or an institution

filing on behalf of a third party, must provide the FDIC with

a written notice that the third party will rely on a designated

business exception described in Section

337.6(a)(5)(v)(I)(1)(i)-(ii) of the FDIC Rules and

Regulations. In addition, for business relationships that are

not identified as a designated business exception, an agent

or nominee (or an institution on its behalf) may submit a

written application and receive approval from the FDIC to

qualify for a PPE as described in Section

337.6(a)(5)(v)(I)(2). Specific requirements related to PPE

filings are addressed in Section 303.243(b).

The two designated business relationship PPEs requiring a

notice to the FDIC are:

• The “25 percent test,” where less than 25 percent of

the total assets that the agent or nominee has under

administration for its customers is placed at depository

institutions; and

• “Enabling transactions,” where 100 percent of funds

that the agent or nominee places, or assists in placing,

at depository institutions are placed into transactional

accounts that do not pay any fees, interest, or other

remuneration to the underlying depositor.

The FDIC may, with notice, revoke a PPE of a third party

if:

• The third party no longer meets the criteria for a

designated exception;

• The notice or subsequent reporting is inaccurate; or

• The notice filer fails to submit required reports.

Involvement of Additional Third Parties

An institution that receives deposits from an unaffiliated

third party with a PPE for a particular business line must

determine whether there are any additional third parties

involved in the deposit placement arrangement that qualify

as a deposit broker, because the institution is responsible for

accurately reporting the deposits on its Call Report. If an

additional third party is involved that would qualify as a

“deposit broker” under 12 CFR § 337.6(a)(5), for example

if the additional third party is engaging in “matchmaking

activities” under 12 CFR § 337.6(a)(5)(iii)(C), then the

deposits received from that arrangement must be reported

as a brokered deposit by the institution, even if the

unaffiliated third party has a primary purpose exception for

the relevant business line. Note that even when the sweep

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deposits are placed by the third party directly, the IDI must

consider whether an additional third party may be

“facilitating the placement of the deposits.”

For example, the FDIC has received PPE notice filings from

broker dealers asserting that an additional third party

involved in the unaffiliated sweep program provides the

broker dealers with “administrative services.” It has been

the FDIC’s experience that such services include activities

that meet the facilitation part of the deposit broker

definition, for example by engaging in matchmaking

activities. When receiving sweep deposits under such an

arrangement, it is the institution’s responsibility to evaluate

the third party’s role and determine whether that role

constitutes facilitating the placement of deposits, including

by engaging in matchmaking activities, when it files its Call

Report.

During examinations, examiners should determine whether

institutions are relying upon PPEs to except certain deposits

involving third parties and assess the institution’s Call

Report filing documentation supporting the institution’s

reliance on the PPE.

Listing Services

A listing service is a company that compiles information

about the interest rates offered by institutions on deposit

products. A particular company can be a listing service

(compiler of information) as well as a deposit broker

(facilitating the placement of deposits). Whether a listing

service, or a similar service that posts information about

deposit rates, is a deposit broker will likely depend on

whether the service meets the criteria under the

“facilitation” part of the deposit broker definition. Based on

the “facilitation” definition, a listing service that passively

posts rate information and sends trade confirmations

between the depositor and the institution is unlikely to be a

deposit broker. However, if a listing service provides

services that meet one of the three prongs of the

“facilitation” definition, then it would be considered a

deposit broker.

Sweep Accounts

Some brokerage firms and investment companies that invest

money in stocks, bonds, and other investments on behalf of

clients operate sweep programs in which customers are

given the option to sweep uninvested cash into a bank

deposit. This arrangement provides the brokerage customer

with additional yield and insurance coverage on swept

funds. These swept funds are generally considered

As noted under “Brokered Deposit Restrictions,” if an institution

is under any type of formal agreement pursuant to Section 8 of the

FDI Act with a directive to meet or maintain any specific capital

brokered deposits unless the third-party brokerage firm

meets the PPE.

Sweep accounts that rely on the PPE must fit a designated

exception from the definition of deposit broker. The entity

will qualify for the “25 percent test” designated exception if

it is in a business relationship where, with respect to a

particular business line, less than 25 percent of the total

assets that the entity has under administration for its

customers is placed at depository institutions and where the

entity has filed a notice with the FDIC. The entity may also

rely on another exception from the definition of deposit

broker for which it qualifies.

Network and Reciprocal Deposits

Institutions sometimes participate in networks established

for the purpose of sharing deposits. In such a network, a

participating institution places funds, either directly or

through a third-party network sponsor, at other participating

network institutions in order for its customer to receive full

deposit insurance coverage.

Some networks establish reciprocal agreements allowing

participating institutions to send and receive deposits with

the same maturity (if any) and in the same aggregate amount

simultaneously. This reciprocal agreement allows

institutions to maintain the same volume of funds they had

when the customer made the initial deposit, while providing

participating customers with deposits in excess of the

$250,000 deposit insurance limit additional deposit

insurance through placement at other insured depository

institutions. While reciprocal deposits meet the definition

of a brokered deposit, under certain conditions a limited

amount of reciprocal deposits may be excluded from

treatment and reporting as brokered deposits.

Section 29(i) of the FDI Act (implemented through Section

337.6(e) of the FDIC Rules and Regulations) excludes a

capped amount of reciprocal deposits from treatment as

brokered deposits for those insured depository institutions

that qualify as an “agent institution.” The amount of

reciprocal deposits that an agent institution may except from

treatment as brokered deposits may not exceed the lesser of

$5 billion or 20 percent of total liabilities (referred to as the

“general cap”). To qualify as an “agent institution,” the

institution must meet one of the following:

• When most recently examined, under section 10(d) of

the FDI Act, was found to have a composite condition

of outstanding or good, and is well capitalized

; or

level, it will no longer be considered well capitalized for the

purposes of Part 337.

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• Has obtained a brokered deposit waiver from the

FDIC; or

• Does not receive an amount of reciprocal deposits that

causes the total amount of reciprocal deposits held by

the agent institution to be greater than the average of

the total amount of reciprocal deposits held by the

agent institution on the last day of each of the four

calendar quarters preceding the calendar quarter in

which the agent institution was found not to have a

composite condition of outstanding or good or was

determined to be not well capitalized (also referred to

as the “special cap”).

Treatment and reporting may be impacted if an institution

receives reciprocal deposits that exceed its applicable cap

(general cap or special cap). Agent institutions that are in

outstanding or good composite condition (i.e., well rated)

and are well capitalized, or are adequately capitalized and

have obtained a brokered deposit waiver, are subject to the

general cap, and therefore would report and treat the amount

of reciprocals deposits that exceed the general cap as

brokered deposits. Agent institutions that are not well

capitalized or not well rated, and have not received a

brokered deposit waiver, are subject to the special cap.

Agent institutions subject to the special cap also can report

and treat the amount of reciprocal deposits that exceed the

general cap as brokered deposits. However, if after an agent

institution becomes subject to the special cap, it receives an

amount of reciprocal deposits that causes the total amount

of reciprocal deposits held by it to be greater than its special

cap, it is no longer an agent institution. If an institution is

not an agent institution, all of its reciprocal deposits are to

be treated and reported as brokered deposits.

Agent institutions that become subject to the special cap

may retain agent status even if their pre-existing reciprocal

deposits equal or exceed the special cap, as long as they do

not receive any reciprocal deposits after they have become

subject to the special cap. Consider the following

illustration:

• 03/31/Y3: Bank A is well rated and well capitalized,

and reports $100 million in total reciprocal deposits on

Call Report Schedule RC-E. Since the general cap is

$90 million (the lesser of $5 billion or 20 percent of

total liabilities), Bank A reports $10 million as

brokered reciprocal deposits on Call Report Schedule

RC-O.

• 05/15/Y3: Total reciprocal deposits have increased to

$110 million, though the general cap remained at $90

million. On this date, Bank A receives notice from its

primary federal regulator that its composite rating has

been downgraded to less than well rated (below a 2),

signifying that the institution was no longer in

outstanding or good condition; the bank is still Well

Capitalized for PCA purposes. As of this date, Bank

A becomes subject to the special cap, which is $80

million (the average of total reciprocal deposits

reported on the Call Reports for the quarters ending

03/31/Y3, 12/31/Y2, 09/30/Y2, and 06/30/Y2).

• 06/30/Y3 Call Report scenarios (assume that the

special cap is lower than the general cap):

o If Bank A does not receive additional reciprocal

deposits after 05/15/Y3, the institution retains

agent status and may treat $90 million as non-

brokered under the general cap. Bank A reports

total reciprocal deposits of $110 million on

Schedule RC-E, and $20 million as brokered

reciprocal deposits on Schedule RC-O.

o If Bank A receives additional reciprocal deposits

in any amount after 05/15/Y3, it loses agent

status, and all of its reciprocal deposits ($110

million) must be reported as brokered on

Schedules RC-E and RC-O.

Examiners should determine whether an institution’s

reciprocal deposits are being reported appropriately on its

Call Report and in conformance with the statutory and

regulatory definitions under Section 29(i) of the FDI Act

and Section 337.6(e) of the FDIC Rules and Regulations.

Network member institutions may receive other deposits

through a network such as (1) deposits received without the

institution placing into the network a deposit of the same

maturity and same aggregate amount (sometimes referred to

as “one-way network deposits”) and (2) deposits placed by

the institution into the network where the deposits were

obtained, directly or indirectly, by or through a deposit

broker. Such other network deposits meet the definition of

brokered deposits and would not be eligible for, as

previously described, the statutory and regulatory exception

provided for a capped amount of reciprocal deposits.

The stability of reciprocal deposits may differ depending on

the relationship of the initial customer with the institution.

Examiners should consider whether management

adequately supports their assessments of the stability of

reciprocal deposits, or any funding source, for liquidity

management and measurement purposes.

Brokered Deposit Restrictions

Pursuant to Section 29 of the FDI Act and Section 337.6 of

the FDIC Rules and Regulations, an institution that is less

than well capitalized for the purposes of PCA is restricted

from accepting, renewing, or rolling over brokered deposits.

Well capitalized institutions may accept, renew, or roll over

brokered deposits at any time. An adequately capitalized

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institution may not accept, renew, or roll over any brokered

deposit unless the institution has applied for and been

granted a waiver by the FDIC. An undercapitalized

institution may not accept, renew, or roll over any brokered

deposit (refer to Section 337.6(b)(3)). If an institution is

under any type of formal agreement pursuant to Section 8

of the FDI Act with a directive to meet or maintain any

specific capital level, it will no longer be considered well

capitalized for the purposes of Part 337.

With respect to adequately capitalized institutions that have

been granted a brokered deposit waiver, any safety and

soundness concerns arising from the acceptance of brokered

deposits are ordinarily addressed by the conditions imposed

in granting the waiver application. In monitoring such

conditions, examiners should not only verify compliance,

but also assess whether the waiver has contributed to an

increasing risk profile.

Deposit Rate Restrictions

In addition to the brokered deposit restrictions noted above,

Section 29 of the FDI Act also places certain restrictions on

deposit interest rates for institutions that are less than well

capitalized. Deposit rate restrictions prevent an institution

that is not well capitalized from circumventing the

prohibition on brokered deposits by offering rates

significantly above market in order to attract a large volume

of deposits quickly.

Section 29’s implementing regulation, Section 337.7 of the

FDIC Rules and Regulations, contains two interest rate

restrictions, one based on when funds are accepted by an

institution, the other on when an institution solicits deposits.

One restriction provides that an adequately capitalized

institution accepting reciprocal deposits, or brokered

deposits pursuant to a waiver granted under Section 29(c) of

the FDI Act, may not pay a rate of interest that, at the time

the funds are accepted, significantly exceeds the following:

(1) The rate paid on deposits of similar maturity in such

institution’s normal market area for deposits accepted in the

institution’s normal market area; or (2) the national rate paid

on deposits of comparable maturity, as established by the

FDIC, for deposits accepted outside the institution’s normal

market area. The other interest rate restriction prohibits a

less than well capitalized institution from soliciting any

deposits by offering a rate of interest that is significantly

higher than the prevailing rate.

The national rate for each deposit product is defined as the

average of rates paid by all insured depository institutions

and credit unions for which data is available, with rates

weighted by each institution’s share of domestic deposits.

The national rate cap is calculated as the higher of: (1) the

national rate plus 75 basis points; or (2) 120 percent of the

current yield on similar maturity U.S. Treasury obligations

plus 75 basis points. The national rate cap for nonmaturity

deposits is the higher of the national rate plus 75 basis points

or the federal funds rate plus 75 basis points. The national

rates and national rate caps are published monthly on the

FDIC’s public website.

Section 337.7 provides a simplified process for institutions

that seek to offer a competitive rate when the prevailing rate

in an institution’s local market area exceeds the national rate

cap. The local rate cap for a less than well capitalized

institution is 90 percent of the highest interest rate paid in

the institution’s local market area on a particular deposit

product by a bank or credit union accepting deposits at a

physical location within the institution’s local market area.

The local market area is any readily defined geographic

market in which the institution accepts or solicits deposits.

Under Section 337.7(d), a less than well capitalized

institution that seeks to pay a rate of interest up to its local

market rate cap must provide notice to the appropriate FDIC

regional director. The notice must include evidence of the

highest rate paid on a particular deposit product in the

institution’s local market area. The institution must:

• Update its evidence and calculations monthly for both

existing and new accounts, unless otherwise instructed

by the FDIC;

• Maintain records of the rate calculations for at least

the two most recent examination cycles; and

• Upon the FDIC’s request, provide the documentation

to the appropriate FDIC regional office and to

examination staff during any subsequent

examinations.

Additionally, institutions are not permitted to interpolate or

extrapolate interest rates for products with off-tenor

maturities. If an institution seeks to offer a product with an

off-tenor maturity that is not offered by another institution

within its local market area, or for which the FDIC does not

publish the national rate cap, the institution is to use the rate

offered on the next lower on-tenor maturity for that deposit

product when determining its applicable national or local

rate cap, respectively. For example, an institution seeking

to offer a 26-month certificate of deposit (CD), and such

product is not offered by other institutions in the trade area,

must use the rate offered for a 24-month CD to determine

the applicable national or local rate cap.

An adequately capitalized institution that accepts

nonmaturity brokered deposits subject to waiver, with

respect to a particular deposit broker, is subject to the

applicable interest rate cap on:

• Any new nonmaturity accounts opened by or through

that particular deposit broker;

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• An amount of funds that exceeds the amount(s) in the

account(s) that, at the time the institution fell to less

than well capitalized, had been opened by or through

the particular deposit broker; or

• For agency or nominee accounts, any funds for a new

depositor credited to a nonmaturity account or

accounts.

Refer to the interest rate restrictions in Section 337.7 for

specific information, including the solicitation and

acceptance of nonmaturity deposits. Examiners should

review conformance with interest rate restrictions during

examinations of institutions that are not well capitalized.

While the FDIC may grant a brokered deposit waiver to a

less than well capitalized institution to retain brokered

deposits, the FDIC may not waive the interest rate

restrictions under the brokered deposit regulations.

Brokered Deposits Use

The FDI Act does not restrict the use of brokered deposits

for well capitalized institutions, and brokered deposits can

be a suitable funding source when properly managed.

However, some institutions have used brokered deposits to

fund unsound or rapid expansion of loan and investment

portfolios, which has contributed to weakened financial and

liquidity positions over successive economic cycles. The

overuse and failure to properly manage brokered deposits

by institutions have contributed to failures and losses to the

Deposit Insurance Fund.

Examiners should consider whether an institution’s policies

adequately describe permissible brokered and rate-sensitive

funding types, amounts, and concentration limits. Key

policy considerations include procedures for assessing

potential risks to earnings and capital associated with

brokered, reciprocal, and rate-sensitive deposits, and

monitoring how such funds are used. Examiners should

verify whether management is aware of the restrictions that

may apply if the institution’s PCA capital category falls

below well capitalized.

Examiners should determine whether management

performs adequate due diligence before entering any

business relationship with a deposit broker or other third-

party business partners that help provide rate-sensitive

deposits, such as deposit listing services.

While the FDI Act does not restrict the use of brokered

deposits by well-capitalized institutions, the acceptance of

brokered deposits by well-capitalized institutions is subject

to the same considerations and concerns applicable to any

type of special funding. These considerations relate to

volume, availability, cost, volatility, maturity, and how the

use of such special funding fits into the institution’s overall

liability and liquidity management plans.

When brokered deposits are encountered in an institution,

examiners should consider the effect on overall funding and

investment strategies and, if the institution is less than well

capitalized, verify compliance with Part 337. Examiners

should also consider the source, stability, and use of

brokered deposits or rate-sensitive funding sources that

support asset growth or individual loans. Appropriate

supervisory action should be considered if brokered

deposits or other rate-sensitive funding sources are not

appropriately managed as part of an overall, prudent

funding strategy. Apparent violations of Part 337 or

nonconformance with the Interagency Guidelines

Establishing Standards for Safety and Soundness (Appendix

A to Part 364) should be discussed with management and

the board and appropriately addressed in the report of

examination.

Uninsured Deposits

Uninsured deposits can be part of a diversified funding

program and, depending on an institution’s funds

management objectives and strategy, these deposits may be

gathered from a number of retail, commercial, municipal,

institutional, and wholesale sources. Nevertheless,

uninsured deposits can exhibit sudden instability when an

institution experiences financial problems, adverse media

attention, or curtailment by funding counterparties. The

level and characteristics of uninsured deposits, as well as the

institution’s risk profile, are factors that can affect their

stability and are important for management to understand to

properly assess liquidity risk.

While the duration, number of accounts, or use of multiple

services in the deposit relationship may result in more stable

deposit balances in a business-as-usual scenario, such

extended relationships may only have a modest effect in

tempering flight risk during a stress event.

For institutions facing financial distress, uninsured deposit

accounts whose average balances are considerably higher

than the insurance limit may behave differently (i.e., are

more prone to runoff) than those with average deposit

balances only marginally above the insurance limit.

Additionally, non-retail uninsured deposits are likely to be

more sensitive and reactive to signs of serious financial

distress than uninsured retail accounts.

An institution’s overall risk profile can also influence the

behavior of customers with uninsured deposits. The

uninsured deposits of institutions materially involved in

activities perceived as riskier (e.g., higher-risk Acquisition,

Development, or Construction lending, or third party

deposit gathering) may exhibit a greater propensity to runoff

during stress. Furthermore, institutions, with a

concentration in uninsured deposits can be exposed to

increased deposit withdrawals during a stress event.

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Prudent management teams consider the degree of exposure

to uninsured deposits for individual customers and in

aggregate. Prudent management will also consider potential

runoff risk when deriving liquidity stress testing

assumptions and when determining an appropriately sized

liquid asset buffer and sources of contingent funding.

Public Funds

Public funds are deposits of government entities such as

states, counties, or local municipalities. In many cases,

public deposits are large and exceed the FDIC’s deposit

insurance coverage limit. Some states require institutions to

secure only the uninsured portion of public deposits, while

others require the entire balance of these accounts to be

secured. State laws typically require funds to be secured by

high-quality assets such as securities of U.S. government or

government-sponsored enterprises (GSE), a committed

standby letter of credit (SBLC) from an FHLB, or a state-

sponsored pooled collateral program that protects the

uninsured portion of public deposits.

The stability of public fund accounts can vary significantly

due to several factors. Account balances may fluctuate due

to timing differences between tax collections and

expenditures, the funding of significant projects (e.g.,

school or hospital construction), placement requirements,

and economic conditions. Placement requirements may

include rotating deposits between institutions in a particular

community, obtaining bids and placing funds with the

highest bidder, and minimum condition standards for the

institution receiving the deposits (such as specific capital

levels or the absence of formal enforcement actions).

Economic conditions can affect the volatility of public

deposits, since public entities may experience lower

revenues during an economic downturn.

Although public deposit accounts often exhibit volatility,

the accounts can be reasonably stable over time, or their

fluctuations quite predictable. Therefore, examiners should

review public deposit relationships to make informed

judgments as to their stability.

Securing Public Funds

In addition to securing public funds with pledged high-

quality assets, two other common arrangements include

SBLCs and state pooled collateral programs. Some

financial institutions obtain SBLCs as a supplemental

funding source to accommodate public depositors,

derivative counterparties, and corporate borrowing needs.

Typically, institutions obtain SBLCs from their district

FHLB to support uninsured public deposits and secure the

SBLCs with eligible loans and securities. The SBLC

guarantees that the issuer will pay the beneficiary on

demand if the institution fails or otherwise defaults on its

obligation. When used judiciously, these standby credit

facilities can complement a diversified funds management

program and serve as a practical, cost-effective solution for

securing an institution’s obligations.

Some institutions prefer to obtain an SBLC rather than

pledge government securities because of the standby

facility’s cost and balance sheet efficiency. FHLBs will

accept a variety of loans and securities as collateral subject

to certain collateral requirements or “haircuts.”

Similar to FHLB advances or other secured borrowings,

SBLCs require collateral. Most institutions depend on

eligible loans or securities as collateral. To maximize

balance sheet efficiency, institutions frequently secure

SBLCs with loans, because they would otherwise use

unencumbered securities to directly meet pledging

requirements (especially for uninsured public deposits).

While secured borrowings are a widely accepted form of

funding that can be employed in a safe and sound manner,

undiversified reliance on secured borrowings or less stable

funding can sometimes result in strained liquidity. Funding

diversification is important in the case of large-scale

secured borrowing programs, which can encumber assets

that would otherwise be eligible for pledging or conversion

to cash. Importantly, funding risk does not arise because of

the type of secured borrowing conducted (i.e., FHLB

advances or SBLCs); rather, it stems from the volume of

borrowing, leveraging previously unencumbered assets, and

overreliance on non-core sources to achieve growth or

earnings targets.

SBLCs are generally only exercised by public depositors if

the institution fails to fund a withdrawal. If an institution

does not have sufficient unencumbered liquid assets to meet

a withdrawal request, it may seek a new FHLB advance and

contemporaneously cancel or reduce the SBLC. The assets

used to collateralize the SBLC would secure at least part of

the new advance, depending on the FHLB’s revised

collateral terms. The FHLB can require additional

collateral, possession of collateral, or limits on availability

if it views an institution as troubled.

Some states have adopted pooled collateral programs

through the respective state treasurer to centralize and

streamline collateral management for public deposits.

Participating institutions allocate high quality securities to a

pool of collateral rather than pledging individual securities

against a specific public deposit.

The programs facilitate public deposit placement in the

participating states, and some institutions participate in

multiple state programs where they have branches. Similar

to the SBLCs used to secure uninsured public deposits, the

state pool model consumes less of participating institutions’

collateral on a percentage basis than if an individual

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institution were to pledge securities directly. Pledging

requirements for each state program vary significantly, with

some programs requiring collateral to cover as little as 25%

of the uninsured deposit placement. Most programs include

periodic monitoring of the financial condition of

participants and increase collateral requirements in the

event an institution encounters financial stress.

Some of the programs include collective liability of

participating institutions. Collective liability means that if

a participating member fails and its collateral pledged is

insufficient to make public depositors whole, each

participating institution is obligated to proportionately share

the cost of the collateral shortfall.

Examiners should recognize that SBLCs and pooled

collateral programs may present challenges in times of

stress, particularly when an institution’s borrowing capacity

may be constrained by a large volume of pledged loans and

securities. SBLCs encumber assets eligible for FHLB

collateral at the time of commitment and throughout the

instrument’s life, meaning that pledged assets will not be as

readily convertible to cash or available to use as collateral

for additional borrowings. Similarly, assets pledged under

pooled collateral programs will not be as readily convertible

to cash or available to use as collateral for additional

borrowings. Further, if an institution’s asset quality or

financial condition deteriorates, the FHLB and state-

sponsored pooled collateral programs may demand more

rigorous terms or additional collateral. This may occur

precisely when an institution has a heightened need for on-

balance sheet liquidity.

Liquidity reviews during examinations should consider the

potential impact of standby credit facilities and state-

sponsored pooled collateral programs on liquidity and funds

management, asset encumbrance, and the protection of

uninsured public deposits. Examiners should identify

SBLCs, other credit facilities, and pooled collateral

programs that require pledged collateral and review related

documentation and financial reporting. If an institution

relies significantly on wholesale borrowings (such as FHLB

advances and SBLCs) to fund its balance sheet, examiners

should analyze how asset encumbrances might impair

liquidity in a stress scenario and whether these issues are

appropriately addressed in the CFP.

Secured and Preferred Deposits

Preferred deposits are deposits of U.S. states and political

subdivisions that are secured or collateralized as required

under state law. Only the uninsured amount of such

deposits are considered preferred. Institutions are usually

required to pledge securities (or other readily marketable

assets) to cover secured and preferred deposits. Institutions

must secure U.S. government deposits, and many states

require institutions to secure public funds, trust accounts,

and bankruptcy court funds. In addition to strict regulatory

and bookkeeping controls associated with pledging

requirements, institutions often establish monitoring

controls to ensure deposits and pledged assets are

appropriately considered in their liquidity analysis.

Accurate accounting for secured or preferred liabilities is

also important if an institution fails, because secured

depositors and creditors may gain immediate access to some

of the institution’s most liquid assets.

Large Depositors and Deposit Concentrations

For examination purposes, a large depositor is a customer

or entity that owns or controls two percent or more of the

institution’s total deposits. Some large deposits remain

relatively stable over long periods. However, due to the

effect the loss of a large deposit account could have on an

institution’s overall funding position, these deposits are

considered potentially less stable liabilities.

A large deposit account might be considered stable if the

customer has ownership in the institution, has maintained a

long-term relationship with the institution, has numerous

accounts, or uses multiple services. Conversely, a large

depositor that receives a high deposit rate, but maintains no

other relationships with the institution, may move the

account quickly if the rate is no longer considered high for

the market. Therefore, examiners should consider the

overall relationship between customers and the institution

when assessing the stability of large deposits.

Examiners should consider whether management actively

monitors the stability of large deposits and maintains funds

management policies and strategies that reflect

consideration of potentially less stable concentrations and

significant deposits that mature simultaneously. Key

considerations include potential cash flow fluctuations,

pledging requirements, affiliated relationships, and the

narrow interest spreads that may be associated with large

deposits.

Negotiable Certificates of Deposit

Negotiable CDs warrant special attention as a component of

large (uninsured) deposits. These instruments are usually

issued by large regional or money center banks in

denominations of $1 million or more and may be issued at

face value with a stated rate of interest or at a discount

similar to U.S. Treasury bills. Major bank CDs are widely

traded, may offer substantial liquidity, and are the

underlying instruments for a market in financial futures.

Their cost and availability are closely related to overall

market conditions, and any adverse publicity involving

either a particular institution or institutions in general can

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impact the CD market. These CDs have many features

similar to borrowings and can be quite volatile.

Borrowings

Stable deposits are a key funding source for most insured

depository institutions; however, institutions also use

borrowings and other wholesale funding sources to meet

their funding needs. Borrowings include debt instruments

or loans that institutions obtain from other entities such as

correspondent lines of credit, federal funds purchased, and

FHLB and Federal Reserve Bank advances.

Generally, borrowings are viewed as a supplemental

funding source rather than as a replacement for deposits. If

an institution is using borrowed funds to meet contingent

liquidity needs, examiners should determine whether

management understands the associated risks and has

commensurate risk management practices. Effective

practices typically include a comprehensive CFP that

specifically addresses funding plans if the institution’s

financial condition or the economy deteriorates. Active and

effective risk management, including funding concentration

management by size and source, can mitigate some of the

risks associated with borrowings.

To make effective use of borrowing facilities,

knowledgeable risk managers seek to understand the

conditions, limitations, and potential drawbacks of

borrowing from different sources and facilities.

Additionally, effective managers understand and monitor

borrowing capacity, terms, acceptable collateral, and

collateral borrowing values (e.g., collateral haircuts). They

maintain a detailed inventory of pledged assets posted to

various funds providers and know their remaining capacity

to post additional unencumbered assets to execute

borrowings quickly. Effective managers are also aware of

the execution constraints that may arise when attempting to

borrow at the end of a business day or week and ensure

CFPs acknowledge these constraints.

Key considerations when assessing liquidity risks

associated with borrowed funds include the following:

• Pledging assets to secure borrowings can negatively

affect an institution’s liquidity profile by reducing the

amount of securities available for sale during periods

of stress.

• Unexpected changes in market conditions can make it

difficult for management to secure funds and manage

its funding maturity structure.

• It may be more difficult to borrow funds if the

institution’s condition or the general economy

deteriorates.

• Management may incur relatively high costs to obtain

funds and may lower credit quality standards in order

to invest in higher-yielding loans and securities to

cover the higher costs. If an institution incurs higher-

cost liabilities to support assets already on its books,

the cost of the borrowings may result in reduced or

negative net income.

• Preoccupation with obtaining funds at the lowest

possible cost, without proper consideration given to

diversification and maturity distribution, intensifies an

institution’s exposure to funding concentrations and

interest rate fluctuations.

• Some borrowings have embedded options that make

their maturity or future interest rate uncertain. This

uncertainty can increase the complexity of liquidity

management and may increase future funding costs.

Common borrowing sources include:

• Federal Reserve Bank facilities,

• Federal Home Loan Bank advances,

• Federal funds purchased,

• Repurchase agreements,

• Dollar repurchase agreements,

• Commercial paper, and

• International funding sources.

Federal Reserve Bank Facilities

The Federal Reserve Banks provide short-term

collateralized credit to institutions through the Federal

Reserve’s discount window. The discount window is

available to any insured depository institution that maintains

deposits subject to reserve requirements. The most common

types of collateral are U.S. Treasury securities; agency,

GSE, mortgage-backed, asset-backed, municipal, and

corporate securities; and commercial, agricultural,

consumer, residential real estate, and commercial real estate

loans. Depending on the collateral type and the condition

of the institution, collateral may be transferred to the

Federal Reserve, held by the borrower in custody, held by a

third party, or reflected by book entry. Collateral pledged

to the discount window cannot be shared with other funding

providers. Therefore, an important consideration for

management is whether collateral is pre-positioned or pre-

pledged to another entity and the operational requirements,

including timeframes, to transfer the pledging to the Federal

Reserve in a timely manner to obtain funding when needed.

Types of discount window credit include primary credit

(generally overnight credit to meet temporary liquidity

needs), secondary credit (available to institutions that do not

qualify for primary credit), seasonal credit (available to

institutions that demonstrate a clear seasonal pattern to

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Federal Deposit Insurance Corporation

deposits and assets), and emergency credit (rare

circumstances).

The Federal Reserve’s primary credit program was designed

to ensure adequate liquidity in the banking system and is

intended as a backup, short-term credit facility for eligible

institutions. In general, depository institutions are eligible

for primary credit if they have a composite CAMELS rating

of 1, 2, or 3 and are at least adequately capitalized under the

PCA framework.

Since primary credit can serve as a viable source of backup,

short-term funds, examiners should not automatically

criticize the occasional use of primary credit. At the same

time, overreliance on primary credit borrowings or any one

source of short-term contingency funds may indicate

operational or financial difficulties. Examiners should

consider whether institutions that use primary credit

facilities maintain viable exit strategies.

Secondary credit is available to institutions that do not

qualify for primary credit and is extended on a very short-

term basis at a rate above the primary credit rate. This

program entails a higher level of Reserve Bank

administration and oversight than primary credit.

If an institution’s borrowing becomes a regular occurrence,

Federal Reserve Bank officials will review the purpose of

the borrowing and encourage management to initiate a

program to eliminate the need for such borrowings.

Appropriate reasons for borrowing include preventing

overnight overdrafts, loss of deposits or borrowed funds,

unexpected loan demand, liquidity and cash flow needs,

operational or computer problems, or a tightened federal

funds market. Accordingly, well-managed financial

institutions develop longer-term funding or take-out

alternatives to transition from reliance on the discount

window. These alternatives can include FHLB advances,

deposit gathering strategies, and other contingency funding

options.

Examiners should be aware that the Federal Reserve will not

permit institutions that are not viable to borrow at the

discount window. Section 10B(b) of the Federal Reserve

Act limits Reserve Bank advances to not more than 60 days

in any 120-day period for undercapitalized institutions or

institutions with a composite CAMELS rating of 5. This

limit may be overridden only if the primary federal banking

agency supervisor certifies the borrower’s viability or if,

following an examination of the borrower by the Federal

Reserve, the Chairman of the Board of Governors of the

Federal Reserve certifies in writing to the Reserve Bank that

the borrower is viable. These certifications may be renewed

for additional 60-day periods.

Federal Home Loan Bank (FHLB) Advances

The FHLBs provide secured loans or “advances” to their

members, which include insured depository institutions.

Many well-performing institutions use FHLB advances to

prudently address funds management needs, facilitate credit

intermediation, and supplement contingent funding sources.

FHLB borrowings are secured by eligible collateral

according to each FHLB district’s credit policy and

generally include certain real estate-related loans and

securities. Institutions can borrow from the FHLBs on a

short- and longer-term basis, with maturities ranging from

overnight to 30 years on various repayment, amortization,

and interest rate terms.

Each FHLB establishes credit and collateral policies that set

the terms for member advances. Interest rates and collateral

requirements may be subject to a member institution’s

financial condition or other prudential considerations.

Although the FHLBs serve as a reliable source of funding

for members, certain eligibility requirements for advances

have been set by the Federal Housing Finance Agency

(FHFA), the FHLB System’s supervisor. For example, the

FHFA regulations (12 CFR 1266.4) prohibit FHLBs from

making new advances to members without positive tangible

capital, among other requirements. Therefore, effectively

managed FHLB members consider their continuing

eligibility to borrow as part of funds management and

contingency funding strategies.

Examiners should analyze several factors when reviewing

an institution’s use of FHLB advances. Foremost among

these factors, FHLBs may impose strict collateral and

borrowing capacity requirements for the quality of pledged

assets, collateral margins, loan documentation, and

maximum advance levels. Changes in a member

institution’s financial condition can also impact its ability

and cost to borrow. In addition, collateral pledged to an

FHLB cannot be readily shared with other funds providers,

such as the Federal Reserve’s discount window, and it could

take time to reassign that collateral to another lender.

Examiners should assess whether institutions have

considered these requirements as part of their overall funds

management process and CFP.

Examiners should also consider an institution’s use of

FHLB advances in terms of overall wholesale funding usage

(versus stable deposit funding), leverage, and balance sheet

management. In certain circumstances, an institution can

become over-leveraged with wholesale funds or collateral

encumbrance, which could impact liquidity, earnings, and

other measureable areas of performance.

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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must be distinguished from the Federal Reserve’s financing

facilities, which are set up to provide emergency financing

for troubled financial institutions confronted with

immediate liquidity challenges. Due to operational and

financing limitations of the market intermediation process,

the FHLBanks cannot functionally serve as the lender of last

resort, particularly for large, troubled members that can

have significant borrowing needs over a short period of

time.”

In certain instances, the FHLBs may have their own

liquidity capacity limitation on a given business day if

unexpectedly large advance requests are made from

multiple members. Therefore, institutions should have an

appropriate level of unencumbered on-balance liquid assets

and CFP strategies that enable borrowing from other

sources such as the Federal Reserve’s discount window.

Federal Funds Purchased

Federal funds are reserves held in an institution’s Federal

Reserve Bank account (during periods when Federal

Reserve requirements are warranted) that can be lent (sold)

by institutions with excess reserves to other institutions with

an account at a Federal Reserve Bank. Institutions borrow

(purchase) federal funds to meet their reserve requirements

or other funding needs. Institutions rely on the Federal

Reserve Bank or a correspondent institution to facilitate

federal funds transactions. State nonmember institutions

that do not maintain balances at the Federal Reserve

purchase or sell federal funds through a correspondent

institution.

In most instances, federal funds transactions take the form

of overnight or short-term unsecured transfers of

immediately available funds between institutions.

However, institutions also enter into continuing contracts

that have no set maturity but are subject to cancellation upon

notice by either party to the transaction. Institutions also

engage in federal funds transactions of a set maturity, but

these include only a small percentage of all federal funds

transactions. In any event, these transactions can be

supported with written verification from the lending

institution.

Some institutions may access federal funds as a liability

management technique to fund a rapid expansion of loan or

investment portfolios and enhance profits. In these

situations, examiners should determine whether appropriate

board approvals, limits, and policies are in place and should

discuss with management and the board their plans for

developing appropriate long-term funding solutions.

Liquidity risks typically decline if management avoids

overreliance on federal funds purchased, as the funds are

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

https://www.fhfa.gov/AboutUs/Reports/ReportDocuments/FHLB

ank-System-at-100-Report.pdf.

usually short-term, highly credit sensitive instruments that

may not be available if the institution’s financial condition

deteriorates.

Repurchase Agreements

In a securities repurchase agreement (repo), an institution

agrees to sell a security to a counterparty and

simultaneously commits to repurchase the security at a

mutually agreed upon date and price. In economic terms, a

repo is a form of secured borrowing. The amount borrowed

against the security is generally the full market value less a

reasonable discount. Typically, the security does not

physically change locations or accounting ownership;

instead, the selling institution’s safekeeping agent makes

entries to recognize the purchasing institution’s interest in

the security.

From an accounting standpoint, repos involving securities

are either reported as secured borrowings or as sales and a

forward repurchase commitment based on whether the

selling institution maintains control over the transferred

financial asset. Generally, if the repo both entitles and

obligates the selling institution to repurchase or redeem the

transferred assets from the transferee (i.e., the purchaser) the

selling institution may report the transaction as a secured

borrowing if various other conditions outlined in U.S.

Generally Accepted Accounting Principles (GAAP) have

been met. If the selling institution does not maintain

effective control of the transferred assets according to the

repurchase agreement, the transaction would be reported as

a sale of the securities and a forward repurchase

commitment. For further information, see the Call Report

Glossary entries pertaining to Repurchase/Resale

Agreements and Transfers of Financial Assets.

Bilateral repos involve only two parties, and are most

commonly conducted with either a primary dealer bank or a

central counterparty. In a tri-party repo, an agent is involved

in matching counterparties, holding the collateral, and

ensuring the transactions are executed properly. Like

bilateral repos, the terms of tri-party repos are negotiated by

the collateral provider and the cash investor. Once the terms

are established, the settlement details are transmitted to the

clearing institution, which confirms the terms and settles the

transaction on its books for the two parties. In deep stress,

the traditional tri-party repo market may close to the cash

borrower as counterparties may no longer negotiate with the

cash borrower and may not roll maturing contracts or enter

into new contracts.

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The General Collateral Finance (GCF) Repo market

removes for cash lenders the counterparty credit exposure

present in the bilateral and triparty repo markets. The GCF

market is a brokered and centrally cleared market – with the

Fixed Income Clearing Corporation (FICC) being the

central counterparty. GCF trades are negotiated through

interdealer brokers (IDBs) on a blind basis. In other words,

participants provide an IDB the terms under which they are

willing to borrow or lend cash. The IDB then tries to broker

a trade while maintaining each participant’s anonymity.

Once a trade has been brokered, the IDB submits the details

to FICC, which substitutes itself as the counterparty to each

side of the repo transaction.

The majority of repurchase agreements mature in three

months or less. One-day transactions are known as

overnight repos, while transactions longer in duration are

referred to as term repos. Institutions typically use repos as

short-term, relatively low cost funding mechanisms. The

interest rate paid on a repurchase agreement depends on the

type of underlying collateral. In general, the higher the

credit quality of the collateral and the easier the security is

to deliver and hold, the lower the repo rate. Supply and

demand factors for the underlying collateral also influence

the repo rate.

There are also timing considerations in settling repo

transactions. The centrally cleared contracts, including

GCF transactions, clear earlier in the day and the tri-party

market clears later in the day. The quality of collateral also

affects the timing of tri-party repos. Since riskier collateral

can only be accepted by some subset of all market

participants, cash borrowers offering lower quality

collateral tend to arrange trades earlier in the day to allow

for ample market participation. Repo borrowing programs

that are inadequately managed may result in a loss of

essential funding at a critical time.

The opposite side of a repo transaction, is sometimes called

a reverse repo. A reverse repo that requires the buying

institution to sell back the same asset purchased is treated as

a loan for Call Report purposes. If the reverse repurchase

agreement does not require the institution to resell the same,

or a substantially similar, security purchased, it is reported

as a purchase of the security and a commitment to sell the

security.

Reverse repos can involve unique risks and complex

accounting and recordkeeping challenges, and institutions

benefit from establishing appropriate risk management

policies, procedures, and controls. In particular, institutions

can benefit from controls when relying on reverse repos that

are secured with high-risk assets. Reverse repo activity

exposes the institution to a risk of loss if the cash lent

exceeds the market value of the security received as

collateral, and the value of the underlying assets may

decline significantly in a stress event, creating an

undesirable amount of exposure. Reverse repos/cash

lending programs that are inadequately managed can expose

an institution to risk of loss and may be regarded as an

unsuitable investment practice.

Since the fair value of the underlying security may change

during the term of the transaction, both parties to a repo may

experience credit exposure. Although repo market

participants normally limit credit exposures by maintaining

a cushion between the amount lent and the value of the

underlying collateral and by keeping terms short to allow

for redemption as necessary, credit reviews of repo

counterparties prior to the initiation of transactions remains

a critical step. Properly administered repurchase

agreements conducted within a comprehensive

asset/liability management program are not normally

subject to regulatory criticism. The Policy Statement on

Repurchase Agreements of Depository Institutions with

Securities Dealers and Others, dated February 10, 1998,

provides additional information on repos, associated

policies and procedures, credit risk management practices,

and collateral management practices.

Dollar Repurchase Agreements

Dollar repurchase agreements, also known as dollar repos

and dollar rolls, provide financial institutions with an

alternative method of borrowing against securities owned.

Unlike standard repurchase agreements, dollar repos require

the buyer to return substantially similar, versus identical,

securities to the seller. Dealers typically offer dollar roll

financing to institutions as a means of covering short

positions in particular securities. Short positions arise when

a dealer sells securities that it does not currently own for

forward delivery. To compensate for potential costs

associated with failing on a delivery, dealers are willing to

offer attractive financing rates in exchange for the use of the

institution’s securities in covering a short position. Savings

associations, which are the primary participants among

financial institutions in dollar roll transactions, typically use

mortgage pass-through securities as collateral for the

transactions.

Supervisory authorities do not normally take exception to

dollar repos if the transactions are conducted for legitimate

purposes and the institution has appropriate controls.

International Funding Sources

International funding sources exist in various forms. The

most common source of funds is the Eurodollar market.

Eurodollar deposits are U.S. dollar-denominated deposits

taken by an institution’s overseas branch or its international

banking facility. Reserve requirements and deposit

insurance assessments do not apply to Eurodollar deposits.

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The interbank market is highly volatile, and management

typically benefits from analyzing Eurodollar deposit

activities within the same context as all other potentially less

stable funding sources.

Commercial Paper

Institutions can issue commercial paper to quickly raise

funds from the capital markets. Commercial paper is

generally a short-term, negotiable promissory note issued

for short-term funding needs by a bank holding company,

large commercial institution, or other large commercial

business. Commercial paper usually matures in 270 days or

less, is not collateralized, and is purchased by institutional

investors.

Some commercial paper programs are backed by assets and

are referred to as asset-backed commercial paper. Some

programs also involve multi-seller conduits where a special-

purpose entity is established to buy interests in pools of

financial assets (from one or more sellers). Entities fund

such purchases by selling commercial paper notes,

primarily to institutional investors.

Institutions that provide liquidity lines or other forms of

credit enhancement to their own or outside commercial

paper programs face the risk that the facilities could be

drawn upon during a crisis situation. Prudent institutions

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

source in the institution’s CFP.

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OFF-BALANCE SHEET ITEMS

Off-balance sheet items, such as those described below, can

be a source or use of funds.

Loan Commitments

Loan commitments are common off-balance sheet items.

Typical commitments include unfunded commercial,

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

closely monitoring the amount of unfunded commitments

that require funding over various periods and detailing

anticipated demands against unfunded commitments in

internal reports and contingency plans. Examiners should

consider the nature, volume, and anticipated use of the

institution’s loan commitments when assessing and rating

the liquidity position.

Derivatives

Management can use derivative instruments (financial

contracts that generally obtain their value from underlying

assets, interest rates, or financial indexes) to reduce business

risks. However, like all financial instruments, derivatives

contain risks that must be properly managed. For example,

interest rate swaps typically involve the periodic net

settlement of swap payments that can substantially affect an

institution’s cash flows. Additionally, derivative contracts

may have initial margin requirements that require an

institution to pledge cash or investment securities that

reflect a specified percentage of the contract’s notional

value. Variation margin requirements (which may require

daily or intraday settlements to reflect changes in market

value) can also affect an institution’s cash flows and

investment security levels. Examiners should consider the

extent to which management engaging in derivative

activities understands and manages the liquidity, interest

rate, and price risks of these instruments.

Other Contingent Liabilities

Legal risks can have a significant financial impact on

institutions that may affect liquidity positions. Examiners

should consider whether institutions identify these

contingencies when measuring and reporting liquidity risks

as exposures become more certain.

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LIQUIDITY RISK ANALYSIS AND

MITIGATION

There are many ways management can analyze and mitigate

liquidity risk and maintain the institution’s current and

future liquidity positions within the risk tolerance targets

established by the board. For managing routine and stressed

liquidity needs, institutions typically establish diversified

funding sources and maintain a cushion of high-quality

liquid assets. Examiners should consider whether CFPs

identify backup funding sources, action steps to address

acute liquidity needs, and whether management tests

various stress scenarios to identify risks to mitigate and

address in CFPs.

Cushion of Highly Liquid Assets

One of the most important components of an institution’s

ability to effectively respond to liquidity stress is the

availability of unencumbered, highly liquid assets (i.e.,

assets free from legal, regulatory, or operational

impediments). Unencumbered liquid assets can be sold or

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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significantly affects management’s ability to sell or pledge

the assets in times of stress.

When determining what type of assets to hold for contingent

liquidity purposes, management typically considers factors

such as:

• Level of credit and market risk: Assets with lower

levels of credit and market risk tend to have higher

liquidity profiles.

• Liquidity during stress events: High-quality liquid

assets are generally not subject to significantly

increased risk during stress events such as credit or

market risk. Conversely, certain assets, such as

specialty assets with small markets or assets from

industries experiencing stress, are often less liquid in

times of stress in the banking sector.

• Ease and certainty of valuation: Prices based on

trades in sizeable and active markets tend to be more

reliable, and an asset’s liquidity increases if market

participants are more likely to agree on its valuation.

Formula-based pricing is less desirable than data from

recent trades.

Institutions with high-quality liquid assets are generally able

to monetize the assets through the sale of the assets or the

use of secured borrowings. This generally means an

institution’s cushion of liquid assets is concentrated in cash

and due from accounts, federal funds sold, and high-quality

assets, such as U.S. Treasury securities or GSE bonds.

However, with digital banking and social media, severe

liquidity stress can transpire in as little as a few hours.

Because severe stress can occur so rapidly, cash and cash

equivalents are an essential component of the liquidity

cushion.

Cash remains the most liquid asset. Hence, appropriate cash

cushions can help to meet liquidity requirements until asset

sales or borrowings can be executed. If institutions change

the mix of their pool of liquid assets by substituting out cash

for other types of liquid assets (e.g., during a period of rising

interest rates when the opportunity cost of holding cash

increases), effective management will be able to

demonstrate that it can readily monetize these assets to meet

stressed needs for liquidity without undue losses that impact

the institution’s financial condition.

The ability of management to monetize marketable

securities or access secured borrowing lines without delay

can be critical in times of stress. Access to unencumbered

liquid assets is critical, where such assets are easy to sell or

pledge with little or no discount throughout an interest rate

or credit cycle. Unrealized holding losses in liquid

securities portfolios, however, reduce amounts that can be

monetized by means of sale or pledging as collateral against

borrowings.

Occasionally, it may be appropriate for examiners to

consider pledged assets as part of the highly liquid cushion,

such as when management pledges Treasury notes as part of

an unfunded line of credit. In other instances, it may be

appropriate for examiners to consider an asset that has not

been explicitly pledged as illiquid. For example, if an

institution is required to deposit funds at a correspondent

institution to facilitate operational services, these funds

should generally be excluded from its liquidity reports or

denoted as unavailable.

Examiners assess whether the size of the institution’s liquid

asset cushion is aligned with its risk tolerance and profile

and supported by documented analysis and stress test

results. Factors that may indicate a need to maintain a larger

liquid asset buffer include:

• Easy customer access to alternative investments,

• Recent trends showing substantial reductions in large

liability accounts,

• Significant volumes of less-stable funding,

• High levels of assets with limited marketability (due

to credit quality issues or other factors),

• Expectations of elevated draws on unused lines of

credit or loan commitments,

• A concentration of credit to an industry with existing

or anticipated financial problems,

• Close ties between deposit accounts and employers

experiencing financial problems,

• A significant volume of assets are pledged to

wholesale borrowings, and

• Impaired access to funds from capital markets.

Evaluation of Asset Encumbrance

Asset encumbrance is another important consideration of

liquidity risk management. Assets typically become

encumbered when they are pledged against borrowings,

SBLCs, or public deposits or could be considered restricted

even though there is no explicit pledge agreement as

described earlier. Examiners should understand, and assess

management’s understanding of, the dynamics of asset

encumbrance and the triggers and requirements of the

products and programs that are used to manage liquidity and

collateral positions.

In a favorable economic environment, profitable, well-

capitalized institutions generally have a wide capacity to

borrow and can obtain secured borrowings with a pledge of

loans or securities. In some cases, management provides a

blanket lien on the institution’s mortgage loans and other

assets to secure credit. When asset quality and on-balance

sheet liquidity are strong, secured borrowings and other

arrangements can be reliable and cost-effective.

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In the event of asset quality or other financial deterioration,

secured creditors often seek to protect their position by

increasing collateral requirements. These collateral calls

typically lead to increases in asset encumbrance at a time

when the institution has elevated funding needs to address

losses and other outflows. Therefore, asset encumbrance is

a critical consideration for examiners when assessing an

institution’s scenario testing and CFP.

In addition to traditional secured borrowings, two examples

of arrangements that could lead to elevated collateral

requirements during financial stress include SBLCs and

state pooled collateral programs. Management can use

SBLCs for a variety of purposes, such as securing public

deposits, accommodating derivative counterparties, and

corporate borrowing needs. Typically SBLCs are secured

with eligible loans and securities. If asset quality declines

or the institution’s financial condition deteriorates, the

SBLC could be exercised and effectively convert to a

borrowing, thereby increasing collateral encumbrance at a

time when the institution may have identified FHLB

borrowings as a contingent source to address other funding

gaps.

Under the state-sponsored pooled collateral model,

participating institutions pledge securities to a pool that is

coordinated by state finance officials to collateralize

multiple public deposits. In these programs, the states

monitor the financial condition of participants and increase

collateral requirements if the institution’s financial

condition deteriorates.

For institutions that pledge assets for secured borrowings

and for those that use SBLCs or pooled collateral systems

for managing uninsured public deposits, examiners should

assess whether stress testing scenarios consider the potential

for increased collateral requirements. Examiners should

also determine whether the analysis includes assets that may

be restricted but not explicitly pledged. Potential asset

encumbrances under a stress scenario (to cover heightened

collateral calls for borrowings and any public deposit

arrangements or similar agreements) are typically

incorporated into the CFP.

Diversified Funding Sources

An important component of liquidity management is the

diversification of funding sources. Undue reliance on any

one source of funding can have adverse consequences in a

period of liquidity stress. Management typically diversifies

funding across a range of retail sources and, if used, across

a range of wholesale sources, consistent with the

institution’s sophistication and complexity. Institutions that

rely primarily on directly gathered retail deposit accounts

are generally not criticized for relying on one primary

funding source. However, examiners should consider

whether alternative sources are identified in formal CFPs

and periodically tested.

To reduce risks associated with funding concentrations,

management generally benefits from considering the

correlations between sources of funds and market

conditions and having available a variety of short-, medium-

and long-term funding sources. The board is responsible for

setting and clearly articulating an institution’s risk tolerance

in this area through policy guidelines and limits for funding

diversification.

Although management uses diversified funding sources to

reduce funding concentration risks, management also

considers other factors when selecting funding sources. For

example, the cost of a particular funding source is a critical

consideration when developing profitability strategies.

Additionally, the stability and availability of a funding

source are important factors when planning for asset

growth. Examiners should assess strategies that rely on

less-stable funding sources, particularly strategies that fund

significant growth in new business lines.

When assessing the diversification of funding sources,

important factors for examiners to consider include:

• Internal evaluations of risks associated with funding

sources (e.g., stress tests and diversification limits)

and whether the evaluations are reasonable and well-

documented,

• Potential curtailment of funding or significantly higher

funding costs during periods of stress,

• Time required to access funding in stressed and

normal periods,

• Sources and uses of funds during significant growth

periods, and

• Available alternatives to volatile funding sources.

Maintaining market access to funds is also an essential

component of ensuring funding diversity. Market access

can be critical, as it affects an institution’s ability to raise

new funds and to liquidate assets. Examiners should

consider whether management actively manages, monitors,

and tests the institution’s market access to funds. Such

efforts are typically consistent with the institution’s

liquidity risk profile and sources of funding. For example,

access to the capital markets is an important consideration

for most large or complex institutions, whereas the

availability of correspondent lines and other sources of

wholesale funds are critical for community institutions.

Market perceptions play a critical role in an institution’s

ability to access funds readily and at reasonable terms. For

this reason, examiners should determine whether liquidity

risk managers are aware of any information (such as an

announcement of a decline in earnings or a downgrade by a

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rating agency) that could affect perceptions of an

institution’s financial condition.

Assessing the Stability of Funding Sources

Assessing the stability of funding sources is an essential part

of liquidity risk measurement and liquidity management.

Institutions may rely on a variety of funding sources, and a

wide array of factors may impact the stability of those

funding sources. Some of the primary factors that

examiners should consider when assessing the stability of

funding sources include:

• The cost of the institution’s funding sources

compared to market costs and alternative funding

sources: If an institution pays significantly above

local or national rates to obtain or retain deposits, the

institution’s deposit base may be highly cost sensitive,

and depositors may be more likely to move deposits if

terms become more favorable elsewhere. Examiners

should determine whether management uses rate

specials or one-time promotional offerings to obtain

deposits or to retain rate-sensitive customers.

Examiners should also assess how much of the deposit

base consists of rate specials and determine whether

management measures and reports the level of such

deposits.

• Large deposit growth or significant changes in

deposit composition: Examiners should carefully

consider strategies that rely on less stable funding

sources to fund significant growth in new business

lines. The level of risk in new strategies can be

misjudged and could be compounded by the use of

less stable funding sources.

• Stability of insured deposits: Insured deposits can

be a stable, low-cost form of funding depending on an

institution’s depositor base; client relationships across

credit, deposit, and other financial products; the tenure

of the deposit relationship; and the sensitivity of

depositors to interest rates, the institution’s condition,

adverse media attention, and counterparty and market

participants’ views toward the institution.

• Stability of uninsured deposits: Uninsured deposits

are not automatically considered volatile; however, in

times of stress or when an institution’s condition

deteriorates, uninsured depositors are more likely to

withdraw their funds. Therefore, examiners should

closely review large volumes of uninsured deposits,

along with their risk characteristics, including

concentrations of large individual depositors, as well

as depositors’ potential behavior in stressed

environments.

• Secured borrowings and asset encumbrance:

Secured borrowing can be a stable source of funding

depending on the institution’s condition and quality of

collateral that can be pledged. Well-performing

institutions can often obtain secured credit from the

Federal Reserve’s discount window, the FHLB, or

other providers by pledging eligible loans and

securities.

• The current rate environment: Depositors may be

less rate sensitive in a low-rate environment due to the

limited benefits (only marginally higher rates)

obtained by shifting deposits into longer-term

investments.

• The current business cycle: If the national or local

economy is in a downward cycle, individuals and

businesses may decide to keep more cash on hand

rather than spending or investing.

• Contractual terms and conditions: Terms and

requirements related to the institution’s condition,

such as its PCA category, credit ratings, or capital

levels, can materially affect liquidity. Specific

contractual terms and conditions are often associated

with brokered deposits, funds from deposit listing

services, correspondent institution accounts,

repurchase agreements, and FHLB advances.

• The relationship with the funding source: Large

deposits might be more stable if the deposit is difficult

to move (e.g., the deposit is in a transaction account

used by a payroll provider), if the depositor is an

insider in the institution, or if the depositor has a long

history with the institution. However, examiners

should consider that depositors may withdraw funds

during stress periods regardless of administrative

difficulties or the effect on the institution.

Intraday Liquidity Monitoring

Intraday liquidity monitoring is an important component of

liquidity risk management. It is important for an institution

to manage, and understand its potential intraday liquidity

needs associated with wholesale payments and trading

activity, including derivative positions. While most

community institutions do not experience significant

wholesale payments inflows and outflows, operate trading

accounts, or have large derivative positions and settlement

risk, some use derivatives to hedge interest rate risk

exposure that can require an intraday use of liquidity to

collateralize a position.

For example, as part of a derivatives transaction, an

institution may be required to submit either initial or

maintenance/variation margin associated with the contract

on a given business day by a specific time. Even though the

institution could be “in the money” (meaning it has a net

positive exposure to the dealer counterparty) and expect a

net liquidity inflow, the derivative contract could require a

short-term or intraday cash payment. The institution’s

payment could occur before the counterparty remits its

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payment, creating a timing difference and potential short-

term or intraday liquidity need. Also, institutions that

conduct wholesale payments over a large value payment

system

could encounter situations that result in intraday

cash deficits, such as if expected payments receipts are

throttled/slowed by senders concerned about the

institution’s financial condition (and the risk of having a

large intraday loan to the institution) but the institution is

unable to throttle outgoing payments in a similar manner, in

turn potentially causing daylight overdrafts

in excess of the

regular net debit cap. The Federal Reserve may provide

credit to support potential intraday mismatches, but there

may also be limits on the institution’s ability to access this

support.

The Role of Equity

Issuing new equity is often a relatively slow and costly way

to raise funds and is not viewed as an immediate or direct

source of liquidity. However, to the extent that a strong

capital position helps an institution quickly obtain funds at

a reasonable cost, issuing equity can be considered a

liquidity facilitator. For institutions with a holding

company, cash can be injected from the parent in the form

of equity, ideally tier 1 capital.

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CONTINGENCY FUNDING

Contingency Funding Plans

All institutions, regardless of size or complexity, benefit

from a formal CFP that clearly defines strategies for

addressing liquidity shortfalls in emergency situations.

Comprehensive CFPs delineate policies to manage a range

of stress environments, establish clear lines of

responsibility, and articulate clear implementation and

escalation procedures. The reliability of a CFP improves if

it is regularly tested and updated to ensure that it is

operationally sound. Often, management coordinates

liquidity risk management plans with disaster, contingency,

and business planning efforts and aligns them with business

line and risk management objectives, strategies, and tactics.

CFPs are tailored to the business model, risk, and

complexity of the individual institution. Such CFPs:

Retail payments often are not time sensitive and commonly occur

within batch processing cycles through the ACH payments system.

Wholesale payments conducted via wire transfers over Fedwire or

CHIPS are more likely to be pre-scheduled and time-sensitive.

A daylight overdraft occurs when funds in an institution’s Federal

Reserve account balance is insufficient to cover outgoing

• Establish a liquidity event management framework

(including points of contact and public relations

plans),

• Establish a monitoring framework,

• Identify potential contingent funding events,

• Identify potential funding sources,

• Require stress testing, and

• Require periodic testing of the CFP framework.

Contingent Funding Events

The primary goals of most CFPs are to identify risks from

contingent funding events and establish an operational

framework to deal with those risks. Contingent funding

events are often managed based on their probability of

occurrence and potential effect. CFPs generally focus on

events that, while relatively infrequent, could have a high

impact on the institution’s operations. Appropriate plans

typically set a course of action to identify, manage, and

control significant contingent funding risks.

Stress factors that may provide early warning signs for

identifying potential funding risks can be institution-

specific or systemic and may involve one or more of the

following:

• Deterioration in asset quality,

• Downgrades in credit ratings,

• Downgrades in PCA capital category,

• Deterioration in the liquidity management function,

• Widening of credit default spreads,

• Declining institution or holding company stock prices,

• High put-call ratios (i.e., high put volume relative to

call volume) or increases in the volume of short

selling,

• Operating losses,

• Rapid growth,

• Inability to fund asset growth,

• Inability to renew or replace maturing liabilities,

• Price volatility or changes in the market value of

various assets,

• Negative press coverage, including social media

channels,

• Anticipation of a significant negative reaction to an

investor earnings call,

• Deterioration in economic conditions or market

perceptions,

• Disruptions in the financial markets,

transactions, for example, Fedwire funds transfers or incoming

securities or other payment activity processed by a Federal Reserve

Bank, such as check or automated clearinghouse (ACH)

transactions. For more information, refer to the “Guide to the

Federal Reserve’s Payment System Risk Policy on Intraday

Credit” effective January 20, 2022

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• General or sector-specific market disruptions (e.g.,

payment systems or capital markets), and

• Competitor or peer institutions experiencing liquidity

duress with the potential for spillover effects or

contagion risk spreading to the subject institution.

Counterparties can also cause stress events (both credit and

non-credit exposures). For example, if an institution sells

financial assets to correspondent institutions for

securitization, and its primary correspondent exits the

market, the institution may need to use a contingent funding

source.

Institutions with unrealized holding losses on debt securities

should fully understand potential restrictions that could be

imposed by the FHLB and other institutional counterparties

(e.g., public depositors, deposit brokers, and listing and

registry services) should the unrealized losses affect certain

capital measures, such as GAAP equity. These restrictions

may include a curtailment of new advances or placements

(based on law or policy) at institutions that report a low or

negative GAAP equity position.

Comprehensive CFPs identify institution-specific events

that may impact on- and off-balance sheet cash flows given

the specific balance-sheet structure, business lines, and

organizational structure. For example, institutions that

securitize loans have CFPs that consider a stress event

where the institution loses access to the market but still has

to honor its commitments to customers to extend loans.

Comprehensive CFPs also delineate various stages and

severity levels for each potential contingent liquidity event.

For example, asset quality can deteriorate incrementally and

have various levels of severity, such as less than

satisfactory, deficient, and critically deficient. CFPs also

address the timing and severity levels of temporary,

intermediate-term, and long-term disruptions. For example,

a natural disaster may cause temporary disruptions to

payment systems, while deficient asset quality may occur

over a longer term. Institutions can then use the stages or

severity levels identified to establish various stress test

scenarios and early-warning indicators.

Stress Testing Liquidity Risk Exposure

After identifying potential stress events, management often

implements quantitative projections, such as stress tests, to

assess the liquidity risk posed by the potential events. Stress

testing helps management understand the vulnerability of

certain funding sources to various risks and to determine

when and how to access alternative funding sources. Stress

testing also helps management identify methods for rapid

and effective responses, guide crisis management planning,

and determine an appropriate liquidity buffer.

Generally, the magnitude and frequency of stress testing is

commensurate with the complexity of the institution, as well

as the level and trend of its liquidity risk. If liquidity risk

becomes elevated, management could benefit from

conducting more frequent stress testing, while large or

complex institutions may also benefit from daily liquidity

stress testing to inform, in part, day-to-day liquidity

management.

The growing prevalence of digital banking and online

banking applications has facilitated 24/7 banking. These

innovations, in addition to the influence of social media, can

accelerate and intensify liquidity risk due to deposit runs

and contagion. A comprehensive CFP reflects this risk and

could include within the suite of stress scenarios an end-of-

day or end-of-week stress scenario with severe deposit run-

off occurring in hours or minutes as opposed to days or

weeks. For example, the modeling and testing of a severe

stress event that begins on a Friday afternoon may expose

vulnerabilities in the ability to execute a CFP (e.g., the

ability to quickly monetize unencumbered collateral and

execute on borrowing lines) that would not be identified in

longer-duration scenarios.

Liquidity stress tests are typically based on existing cash-

flow projections that are appropriately modified to reflect

potential stress events (institution-specific or market-wide)

across multiple time horizons. Stress tests are used to

identify and quantify potential risks and to analyze possible

effects on the institution’s cash flows, liquidity position,

profitability, and solvency. For instance, during a crisis, an

institution’s liquidity needs can quickly escalate while

liquidity sources can decline (e.g., customers may withdraw

uninsured deposits or draw down borrowing lines, or the

institution’s lines of credit may be reduced or canceled).

Stress testing allows an institution to evaluate the possible

impact of these events and to plan accordingly.

Examiners should review documented assumptions

regarding the cash flows used in stress test scenarios and

consider whether they incorporate:

• Customer behaviors (early deposit withdrawals,

renewal and run-off of loans, exercising options);

• Significant runoff of surge, uninsured, or volatile

deposits;

• Prepayments on loans and mortgage-backed

securities;

• Curtailment of committed borrowing lines;

• Material reduction in asset values;

• Regulatory restrictions on brokered deposits or

interest rates paid on deposits;

• Significant changes in market interest rates;

• Seasonality (public fund fluctuations, agricultural

credits, construction lending); and

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• Various time horizons.

Effective assumptions generally incorporate both

contractual and non-contractual behavioral cash flows,

including the possibility of funds being withdrawn.

Examples of non-contractual funding requirements that may

occur during a financial crisis include supporting auction

rate securities, money market funds, commercial paper

programs, special purpose vehicles, and structured

investment vehicles. Institutions may be compelled to

financially support shortfalls in money market funds or

asset-backed paper that does not sell or roll due to market

stress, and assets may be taken on-balance sheet from

sponsored off-balance sheet vehicles. While this financial

support is not contractually required, management may

determine that the negative press and reputation risks

outweigh the costs of providing the financial support.

Effective stress testing generally assesses various stress

levels and stages ranging from low- to severe-stress

scenarios. To establish appropriate stress scenarios,

management may use the different stages and severity levels

that the institution assigns to stress events. For example, a

low-stress scenario may include several events identified as

low severity, while a severe-stress scenario may combine

several high-severity events. A severe stress scenario may

tie a sharp change in interest rates with asset quality

deterioration or combine severe declines in asset quality,

financial condition, and PCA category.

Management’s active involvement and support is critical to

the effectiveness of the stress testing process. Stress test

results are typically discussed with the board, and when

appropriate, management takes actions to limit the

institution’s exposures, build up a liquidity cushion, or

adjust the institution’s liquidity profile to fit its risk

tolerance. In some situations, management may adjust the

institution’s business strategy to mitigate a contingent

funding exposure.

Potential Funding Sources

Identification of potential funding sources for shortfalls

resulting from stress scenarios is a key component of CFPs.

Management generally identifies alternative funding

sources and ensures ready access to the funds.

The most important and reliable funding source is a cushion

of highly liquid assets. Other common contingent funding

sources include the sale or securitization of assets,

repurchase agreements, FHLB borrowings, or borrowings

through the Federal Reserve discount window. However, in

a stress event, many of these liquidity sources may become

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

contingent funding sources. For example, cash and cash

equivalents are typically placed at the top of the hierarchy

(e.g., reserve balances at the Federal Reserve, interest-

bearing balances, federal funds sold, and due from

accounts), followed by operationalized borrowing lines with

the Federal Reserve discount window, unencumbered

highly liquid securities, FHLB borrowing lines, etc. The

use of these sources can depend on the nature and duration

of a prospective liquidity or market stress event, as well as

the ability to sell liquid assets or draw on contingent lines of

credit.

Institutions that rely on unsecured borrowings for

contingency funding normally consider how borrowing

capacity may be affected by an institution-specific or

market-wide disruption. Management that relies on secured

funding sources for contingency funding generally also

consider whether the institution may be subject to higher

margin or collateral requirements in certain stress scenarios.

Higher margin or collateral requirements may be triggered

by deterioration in the institution’s overall financial

condition or in a specific portfolio. Potential collateral

values are also normally subjected to stress tests, because

devaluations or market uncertainties could reduce the

amount of contingent funding available from a pledged

asset. Similarly, stress tests often consider correlation risk

when evaluating margin and collateral requirements. For

example, if an institution relies on its loan portfolio for

contingent liquidity, a stress test may assess the effects of

poor asset quality. If loans previously securitized were of

poor credit quality, the market value and collateral value of

current and future loans originated by the institution could

be significantly reduced.

Institutions also benefit by operationalizing other secured

funding lines, giving management the ability to draw on

these lines immediately. Effective management will

generally determine an appropriate contingent borrowing

capacity and pledge collateral to funds providers as

appropriate.

Monitoring Framework for Stress Events

Early identification of liquidity stress events is critical to

implementing an effective response. The early recognition

of potential events allows the institution to position itself

into progressive states of readiness as an event evolves,

while providing a framework to report or communicate

within the institution and to outside parties. As a result,

effective CFPs typically identify early warning signs that

are tailored to the institution’s specific risk profile. The

CFPs also establish a monitoring framework and

responsibilities for monitoring identified risk factors.

LIQUIDITY AND FUNDS MANAGEMENT Section 6.1

RMS Manual of Examination Policies 6.1-29 Liquidity and Funds Management (4/24)

Federal Deposit Insurance Corporation

Early warning indicators may be classified by management

as early-stage, low-severity, or moderate-severity stress

events and include factors such as:

• Decreased credit-line availability from correspondent

institutions,

• Demands for collateral or higher collateral

requirements from counterparties that provide credit to

the institution,

• Cancellation of loan commitments or the non-renewal

of maturing loans from counterparties that provide

credit to the institution,

• Decreased availability of warehouse financing for

mortgage banking operations,

• Increased trading of the institution’s debt, or

• Unwillingness of counterparties or brokers to

participate in unsecured or long-term transactions.

Testing and Updating Contingency Funding

Plans

Management periodically tests and updates the CFP to

assess its reliability under times of stress. Generally,

management tests contingent funding sources at least

annually. Testing may include both drawing on a

contingent borrowing line and operational testing.

Operational testing is often designed to ensure that:

• Roles and responsibilities are up to date and

appropriate,

• Legal and operational documents are current and

appropriate,

• Cash and collateral can be moved where and when

needed, and

• Contingent liquidity lines are available.

Effective CFP testing typically includes periodically testing

the operational elements associated with accessing

contingent funding sources. The tests help ensure funds are

available when needed. For example, there may be

extended time constraints for establishing lines with the

Federal Reserve or FHLB. Often, the lines are set up in

advance to establish availability and to limit the time

required to pledge assets and draw on lines. However,

establishing lines in advance and testing the lines does not

guarantee funding sources will be available within the same

time frames or on the same terms during stress events.

In addition, institutions can benefit by employing

operational CFP simulations to test communications,

coordination, and decision-making involving managers

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

new funds at a time when the capital markets may be less

active. The complexity of these tests can range from a

simple communication and access test for a non-complex

institution or can include multiple tests throughout the day

to assess the timing of funds access.

Liquidity Event Management Processes

In a contingent liquidity event, it is critical that

management’s response be timely, effective, and

coordinated. Therefore, comprehensive CFPs typically

provide for a dedicated crisis management team and

administrative structure and include realistic action plans to

execute the plan elements for various levels of stress. CFPs

establish clear lines of authority and reporting by defining

responsibilities and decision-making authority. CFPs also

address the need for more frequent communication and

reporting among team members, the board, and other

affected parties. Critical liquidity events may also require

daily computation of liquidity risk reports and supplemental

information, and comprehensive CFPs provide for more

frequent and more detailed reporting as the stress situation

intensifies.

The reputation of an institution is a critical asset when a

liquidity crisis occurs, and proactive management maintains

plans (including public relations plans) to help preserve the

institution’s reputation in periods of perceived stress.

Failure to appropriately manage reputation risk could cause

severe damage to an institution.

And finally, comprehensive CFPs also address effective

communication with key stakeholders, such as

counterparties, credit-rating agencies, and customers.

Smaller institutions that rarely interact with the media may

benefit from having plans in place for how they will manage

press inquiries and training front-line employees on how to

respond to customer questions.

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INTERNAL CONTROLS

Adequate internal controls are integral to ensuring the

integrity of an institution’s liquidity risk management

process. An effective system of internal controls promotes

effective operations, reliable financial and regulatory

reporting, and compliance with relevant laws and

institutional policies. Effective internal control systems are

designed to ensure that approval processes and board limits

are followed and any exceptions to policies are quickly

reported to, and promptly addressed by, senior management

and the board.

LIQUIDITY AND FUNDS MANAGEMENT Section 6.1

Liquidity and Funds Management (4/24) 6.1-30 RMS Manual of Examination Policies

Federal Deposit Insurance Corporation

Independent Reviews

A key internal control involves having an independent party

regularly evaluate the various components of the liquidity

risk management process. A review typically assesses the

effectiveness of liquidity risk management programs,

considering the complexity of the institution’s liquidity risk

profile. Institutions may achieve independence by

assigning this responsibility to the audit function or other

qualified individuals independent of the liquidity risk

management process. To facilitate the independence of the

review process, reviewers typically report key issues

requiring attention (including instances of noncompliance

with laws and regulations or the institution’s policies) to the

ALCO and audit committee for prompt action. Independent

reviews are typically performed at least annually.

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EVALUATION OF LIQUIDITY

Liquidity Component Review

Under the Uniform Financial Institutions Rating System, in

evaluating the adequacy of a financial institution’s liquidity

position, consideration should be given to the current level

and prospective sources of liquidity compared to funding

needs, as well as the adequacy of funds management

practices relative to the institution’s size, complexity, and

risk profile.

In general, funds management practices should ensure that

an institution is able to maintain a level of liquidity

sufficient to meet its financial obligations in a timely

manner and to fulfill the legitimate banking needs of its

community. Practices should reflect the ability of the

institution to manage unplanned changes in funding

sources, as well as react to changes in market conditions that

affect the ability to quickly liquidate assets with minimal

loss.

In addition, funds management practices should ensure that

liquidity is not maintained at a high cost or through undue

reliance on funding sources that may not be available in

times of financial stress or adverse changes in market

conditions.

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.

• Access to money markets and other sources of

funding.

• The level of diversification of funding sources, both

on- and off-balance sheet.

• The degree of reliance on short-term volatile funding

sources (including borrowings and brokered deposits)

to fund longer-term assets.

• The trend and stability of deposits.

• The ability to securitize and sell certain pools of

assets.

• The capability of management to properly identify,

measure, monitor, and control the institution’s

liquidity position, including the effectiveness of funds

management strategies, liquidity policies,

management information systems, and contingency

funding plans.

Rating the Liquidity Factor

A rating of 1 indicates strong liquidity levels and well-

developed funds management practices. The institution has

reliable access to sufficient sources of funds on favorable

terms to meet present and anticipated liquidity needs.

A rating of 2 indicates satisfactory liquidity levels and funds

management practices. The institution has access to

sufficient sources of funds on acceptable terms to meet

present and anticipated liquidity needs. Modest weaknesses

may be evident in funds management practices.

A rating of 3 indicates liquidity levels or funds management

practices in need of improvement. Institutions rated 3 may

lack ready access to funds on reasonable terms or may

evidence significant weaknesses in funds management

practices.

A rating of 4 indicates deficient liquidity levels or

inadequate funds management practices. Institutions rated

4 may not have or be able to obtain a sufficient volume of

funds on reasonable terms to meet liquidity needs.

A rating of 5 indicates liquidity levels or funds management

practices so critically deficient that the continued viability

of the institution is threatened. Institutions rated 5 require

immediate external financial assistance to meet maturing

obligations or other liquidity needs.