Each institution's liquidity policy should have a contingency plan that addresses alternative funding if initial projections of funding sources and uses are incorrect or if a liquidity crisis arises, such as when an institution is having trouble meeting its cash letter. A liquidity contingency plan helps ensure that a bank or consolidated company can prudently and efficiently manage routine and extraordinary fluctuations in liquidity. Such a plan also helps management to monitor liquidity risk, ensure that an appropriate amount of liquid assets is maintained, measure and project funding requirements during various scenarios, and manage access to funding sources. In a crisis situation, management has little time to plan its strategy, so it is important to have a well-developed contingency liquidity plan prior to a crisis occurring. The need for contingency plans is even more critical for banks that have an increasing reliance on alternative funding sources.
The contingency plan should be updated on a regular basis and:
- Define responsibilities and decision-making authority so that all personnel understand their role during a problem-funding situation.
- Include an assessment of the possible liquidity events that an institution might encounter. The types of potential liquidity events considered should range from high-probability/low-impact events that can occur in day-to-day operations, to low-probability/high impact events that can arise through institution-specific, systemic market, or operational circumstances. As an example: Consider the impact that a credit rating downgrade or the general perception of a loss of creditworthiness would have on liquidity .
- Assess the potential for erosion (magnitude and rate of outflow) by funding source under optimistic, pessimistic, and status quo scenarios.
- Assess the potential liquidity risk posed by other activities such as asset sales and securitization programs.
- Analyze and make quantitative projections of all significant on- and off-balance sheet fund flows and their related effects.
- Match potential sources and uses of funds.
- Establish indicators that alert management to a predetermined level of potential risks.
- Identify and assess the adequacy of contingent funding sources. The plan should identify any back-up facilities (lines of credit), the conditions related to their use and the circumstances where the institution might use them. Management should understand the various conditions, such as notice periods, that could affect access to back-up lines and test the institution's ability to borrow from established backup line facilities.
- Identify the sequence in which sources of funds will be used for contingent needs. The uncertainty of the magnitude and timing of available resources may call for different priorities in different situations.
- Assess the potential for triggering legal restrictions on the bank's access to brokered deposits under PCA standards and the effect on the bank's liability structure.
- Accelerate the timeframes for reporting, such as daily cash flow schedules, in a problem liquidity situation.
- Address procedures to ensure funds will meet the overnight cash letter.
Include an asset tracking system that monitors which assets are immediately available for pledging or sale and how much a cash sale of these assets will generate.