Category: Financial Institutions and Banking

In an uncertain economy, with rampant inflation and other significant economic headwinds, it’s a good idea for community banks to ensure their loans are based on sound funding sources and that the degree of liquidity risk they’re carrying is reasonable and manageable for the foreseeable future. This means your bank needs to have adequate procedures in place to mitigate risk and stay solvent through tough times.

What are the problems?

The recent economic downturn is just one reason for the increase in liquidity risk. It’s also tied to loan growth accompanied by shrinking liquid asset holdings and increasing reliance on noncore and wholesale sources — such as borrowings, brokered deposits, internet deposits, deposits obtained through listing services and uninsured deposits — to fund loan growth.

Typically, these alternative funding sources are more expensive and volatile than insured core deposits. And they’re subject to legal, regulatory, and counterparty requirements that can create liquidity stress, particularly if a bank has credit quality issues or deteriorating capital levels.

The Federal Deposit Insurance Corporation (FDIC) recognizes that alternative funding sources can be an important component of a well-managed bank’s liquidity and funding strategy. But these sources can be problematic if a bank relies on them too heavily. Incorporating a balanced funding strategy into a comprehensive liquidity risk management plan is key to success.

How can you manage liquidity risk?

The FDIC urges banks to consult the federal banking regulators’ Interagency Policy Statement on Funding and Liquidity Risk Management, which outlines the essential elements of sound liquidity risk management. The statement notes that banks should balance the use of alternative funding sources “with prudent capital, earnings, and liquidity considerations through the prism of the institution’s approved risk tolerance.” Specifically, they should:

• Ensure effective board and management oversight,
• Adopt appropriate strategies, policies, procedures, and limits to manage and mitigate liquidity risk,
• Implement appropriate liquidity risk measurement and monitoring systems,
• Actively manage intraday liquidity and collateral,
• Have a diverse mix of existing and potential future funding sources, and
• Hold adequate levels of highly liquid marketable securities that are free of legal, regulatory, or operational impediments.

What’s the backup plan?

Banks also should design a comprehensive contingency funding plan (CFP) that sufficiently addresses potential adverse liquidity events and emergency cash flow requirements. Finally, they need to set up appropriate internal controls and internal audit processes.

For banks that rely heavily on volatile funding sources, it’s important to ensure that the banks’ risk tolerances and recovery strategies are reflected in their asset-liability management programs and CFPs. A well-developed CFP should help a bank manage a range of liquidity stress scenarios by establishing clear lines of responsibility and articulating implementation, escalation, and communication procedures. It also needs to address triggering mechanisms, early warning indicators, and remediation steps that cover the use of contingent funding sources.

CFPs should identify alternative liquidity sources and ensure ready access to contingent funding because liquidity pressures can spread during a period of significant stress. Examples of backup funds providers include federal home loan banks, correspondent institutions, and others that facilitate repurchase agreements or money market transactions.

An independent party should regularly review and evaluate the various components of a bank’s liquidity management process. The review should match the process against regulatory guidance and industry best practices as adjusted for the bank’s liquidity risk profile. The reviewer then should report the results to management and the board of directors.

How do you stay afloat?

Clearly, for community banks, managing liquidity risk is key to staying solvent and profitable. Without appropriate strategies in place for dealing with potential funding source issues, your bank could be left to flounder in an ocean of problems. Help your bank stay afloat by ensuring you have robust practices in place.

Contact one of our experts if you need help staying on top of liquidity risk.

8 tips for a successful succession plan

One of the biggest challenges community banks face today is a shortage of banking talent. So, it’s critical for banks to develop a solid succession plan to manage transition risk. When key management personnel retire or leave unexpectedly, a succession plan helps ensure that the bank is prepared for the change and proactively addresses the vacancy.

Tailor your plan

Keep in mind that your succession plan must be tailored to your bank’s size, complexity, location, culture, risk profile, product and service mix, management “bench strength,” and other characteristics. With that in mind, here are eight tips to get you started:

• Look within. There are many advantages to identifying internal candidates to succeed the CEO and other key management personnel. They’re already immersed in your bank’s culture and are familiar with its operations, goals, and strategies. Another big advantage of promoting from within is that your board of directors is likely already familiar with internal candidates’ work and personalities.

• Have a leadership development program. A formal program for developing potential successors improves your chances of identifying internal successors. By providing training, mentoring, and coaching, you help candidates develop the skills they need to succeed in a management role — and you have an opportunity to evaluate their performance over time. In addition, your investment in employees may help with retention.

• Consider external candidates. Although promoting from within has significant advantages, in some cases considering external candidates may be necessary or desirable. For example, if a CEO or other executive departs unexpectedly, you might not have a suitable internal candidate. Or perhaps the board feels that your bank would benefit from an outsider’s fresh perspective or experience at other types of institutions.

• Look beyond the CEO. Many banks’ succession plans are limited to the top role. But it can be equally important to plan for the departure of other key positions — such as the CFO, chief risk officer or chief technology officer — as well as division or department heads who are critical to the bank’s operations and success. As you review your bank’s organizational chart, examine each position, consider the potential impact of a sudden vacancy and plan accordingly.

• Think both short- and long-term. It’s important to have a short-term plan in the event someone leaves unexpectedly. This may involve designating interim successors who can fill in until a permanent replacement is found (which, in some cases, may be the interim successor). To minimize disruptions, a bank can use cross-training to ensure the availability of backup staff who can assume management responsibilities on an interim basis.

• Make implementation part of your plan. Outlining your succession goals and strategies isn’t enough. Your plan should also include a “playbook” that sets forth processes for implementing the plan. For example, if you plan to hire from outside the bank, the playbook should specify where you’ll look for candidates, where you’ll post job listings and how you’ll identify the right people for the job. It might include checklists or other tools for evaluating candidates.

• Communicate your plan. Transparency is key. It’s important to communicate your plans to all involved and manage candidates’ expectations to avoid losing people when one person is selected as successor. Make sure participants view the process as a career development opportunity, not a competition, and that you have a clear career path for those who aren’t chosen.

• Revisit your plan regularly. A succession plan isn’t something you can put on a shelf and forget about until it’s time to implement it. To ensure that your plan continues to make sense for your institution, review it periodically and update it if necessary to reflect changes in your bank’s strategies, size, product and service offerings, regulatory environment, or other circumstances. Suppose, for example, that three years after developing a succession plan, a bank implements mobile banking applications and other digital technologies and hires a CTO. Unless the plan is updated, the bank’s operations could be disrupted if the CTO leaves.

Start early

Ideally, succession planning should start several years before potential succession events. You’ll need to give yourself plenty of time to define the qualifications you’re looking for, draft job descriptions, and evaluate internal and external candidates. You’ll also need backup plans for unexpected departures. By planning for management transitions, you’ll head off transition problems before they have a chance to derail your bank.

Sidebar: Regulatory expectations regarding succession planning

Federal banking agencies view succession planning as a key governance and risk management tool. In a recently published Q&A on succession planning, Federal Reserve representatives note that “management capabilities and succession prospects are considered throughout the examination process” and that these factors influence the “assessment of the bank’s viability.”

The Q&A also says that “given the importance of maintaining qualified bank leadership, any significant disruption in the bank’s operations can have far-reaching, negative ramifications for a bank’s safety and soundness. Hence, an effective succession plan is nimble enough to respond to changes in bank leadership in a timely fashion.”

Contact one of our experts with any questions about managing transition risk.