Liquidity Risk - the risk of not being able to efficiently meet present and future cash flow needs without adversely affecting daily operations. Liquidity is evaluated on the basis of the credit union's ability to meet its present and anticipated cash flow needs, such as, funding loan demand, share withdrawals, and the payment of liabilities and expenses. Liquidity risk also encompasses poor management of excess funds.
The examiner considers the current level of liquidity and prospective sources of liquidity compared to current and projected funding needs. Funding needs include loan demand, share withdrawals, and the payment of liabilities and expenses. Examiners review reliance on short-term, volatile sources of funds, including any undue reliance on borrowings; availability of assets readily convertible into cash; and technical competence relative to liquidity and cash flow management. Examiners also review the impact of excess liquidity on the credit union's net interest margin, which is an indicator of interest rate risk.
The cornerstone of a strong liquidity management system is the identification of the credit union's key risks and a measurement system to assess those risks.
Key factors to consider in evaluating liquidity management include:
- Balance sheet structure;
- Contingency planning to meet unanticipated events (sources of funds —adequacy of provisions for borrowing, e.g., lines of credit, corporate credit union membership, FHLB agreements);
- Contingency planning to handle periods of excess liquidity;
- Cash flow budgets and projections; and
- Integration of liquidity management with planning and decision-making.
Examiners will consider the overall adequacy of established policies, limits, and the effectiveness of risk optimization strategies when assigning a rating. These policies should outline individual responsibilities, the credit union's risk tolerance, and ensure timely monitoring and reporting to the decision makers.
Examiners determine that the liquidity management system is commensurate with the complexity of the balance sheet and amount of capital. This includes evaluating the mechanisms to monitor and control risk, management's response when risk exposure approaches or exceeds the credit union's risk limits, and corrective action taken, when necessary.
Read more about this topic: CAMEL Rating System
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