There are three categories of liquidity sources that apply to liquidity planning. Each of these sources is relevant to the underlying safety and soundness of a credit union’s liquidity management program. Essentially, these sources act as layers of liquidity protection and function similar to a series of financial firewalls. The three categories are:
- On-balance-sheet liquidity. Maintaining a balance-sheet cushion of highly liquid assets is your first line of protection. It is essential for credit unions of all sizes to hold an adequate safeguard of cash and cash equivalents (such as short-term deposits and short-maturity Treasuries). A simple rule of thumb is to identify the largest liquidity outflow your credit union has ever experienced and how long it persisted. Then set your on-balance-sheet liquidity target based on that experience. This liquidity cushion will buy you some time to avoid service disruptions and enter external funding arrangements if they become necessary.
- Access to market sources of funds. Your second line of protection is to be in a position to borrow from market counterparties. You can build borrowing relationships with a corporate credit union, a correspondent bank, a Federal Home Loan Bank, or with repurchase agreement counterparties (or all of these), to name a few. You need to keep in mind your credit union’s ability to borrow from market funding sources will require unencumbered assets acceptable to lenders, which can be readily pledged against your loan. Larger credit unions with greater potential funding needs should have multiple stable borrowing sources and a clear understanding of which assets can be pledged.
- Contingent federal liquidity providers. The third line of protection is access to a contingent federal liquidity provider such as the Discount Window or CLF. The Discount Window and CLF exist to provide backup liquidity in circumstances where on-balance-sheet liquidity and market funding sources prove inadequate. While sparingly used, the Discount Window and CLF have proven to be dependable sources of liquidity in times of crisis or unexpected events. Like the funding sources, the Discount Window and CLF are both collateral-based lending facilities. All loans must be fully secured with a first priority security interest.