Warning – Dangerous Intersection: IRR and Liquidity

Published May 16, 2023

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We get frequent alerts related to traffic and accidents—sometimes from text alerts and other times from our chosen GPS app. The Financial institutions (FI) industry was recently served an alert in the form of bank closures. One of the major closures was Silicon Valley Bank who was alerted at the intersection of Interest Rate Risk (IRR) and Liquidity.  Someone may think they are not like Silicon Valley Bank. They don’t have 200 billion in assets, don’t have 93 percent of their deposits uninsured, or are not likely to have 25 percent of their deposits leave in one day. They are right, not everyone is the same. However, you likely have liquidity concerns that need to be understood and addressed.

At MCM, we have been in discussions with clients about IRR and Liquidity nearly every day since early March.  Recently, these discussions have centered around what examiners will say or ask about next and how should Management respond.  For this article, we also want to discuss what your FI should be doing today.  To quote Simon Sinek, “Genius is in the idea.  Impact, however, comes from action.”  Let’s start a to-do list and take some action.  Consider the action items below to start your list.

  1. Analyze your institution’s behavior since 2021

Before you say again “That’s not me!,” consider following along as we share some interesting observations from an example community bank that mirror trends that we are seeing across the industry.  (Note: If you received this article from MCM, this is NOT your bank.  It is however, a random bank that we identified in the Midwest for the purpose of illustrating the trends we are seeing.)  Each of the points below measure changes from December 31, 2021 to December 31, 2022, based on publicly available information in the bank’s Call Reports (source:  www.ffiec.gov).

  • Total assets grew 15%. By comparison, SVB only grew 0.2%.
  • Total cash, due from banks, and federal funds sold declined 74%. By comparison, SVB only declined 4.7%.
  • Unrealized losses in the investment portfolio were of the total book value. By comparison, SVB’s unrealized losses were only (2.11%) of the total book value.
  • Total deposits grew 11.9%. This is better than SVB, who declined 7.9% in total deposits.  For the example bank, the deposit growth was in time deposits, which grew 28.1%.  While we can’t be sure, this is likely the result of a certificate of deposit special.
  • Federal funds purchased increased from $0 to $18 million.
  • Other borrowed money – Federal Home Loan Bank (“FHLB”) advances grew 158%.
  • Leverage ratio increased from 10.47% to 10.88%.
  • Tangible Common Equity (“TCE”) ratio dropped from 10.45% to 10.14%.   The TCE ratio measures a company’s tangible common equity (“TCE”) as a percentage of the company’s tangible assets. It can be is used to estimate a bank’s sustainable losses before shareholder equity is completely wiped out.

Most of the bullet points above result in less liquidity.  The bank likely has less borrowing capacity and fewer liquid assets than it did a year earlier.  We can’t tell how much capacity the bank has to borrow from FHLB.  We recommend you compare that amount for your institution too.

Recommendation: Analyze your institution similarly.  Look for positions where the institution is taking more risk than previously.


  1. Analyze your deposit base

It’s not likely that your deposit base is as concentrated in large depositors as SVB.  But that doesn’t mean your base is risk-free.  Can you identify:

  • How many of your deposits are uninsured? If you are larger than $1 Billion in total assets, you are required to report this on the Call Report.  For the rest of the FIs out there, it is important to know.  In good times, uninsured deposits are typically stable and often behave like insured deposits.  However, in tough times, they can leave an institution in a hurry and in large quantities.
  • Who are your largest depositors? If you ran a report of the top 20 or top 50 depositors in the institution, what percentage of the total deposits do they make up?  Could you withstand the effect if they all left together in a short period of time?

Recommendation:  Research and know the amounts of uninsured depositors and top depositors for your institution.  Run a stressed cash flow scenario that incorporates the risk of cash outflow of the top 50 depositors.   Also, run a stressed cash flow scenario that assumes that all uninsured deposits leave in a short period of time.


  1. Engage your Asset Liability Committee (“ALCO”) in frank candid discussion about the Bank’s IRR and liquidity positions

If you analyze your institution similar to the above, don’t hide the results.  Talk about them in ALCO and document the conversation.  Don’t buy into the idea that you are fueling the examiners next report.  The examiners are already looking at all of the above before they come to your FI.  You will be giving them fuel if you do not identify the risk before they do.

Recommendation:  For your next ALCO meeting, consider ditching the canned, repeated ALCO minutes.  Invite someone to the meeting for the express purpose of taking meeting minutes.  Review the minutes and ensure they capture all the discussion points, including action steps.


  1. Review your Contingency Funding Plan (“CFP”)

Liquidity strains are often linked to financial weaknesses on multiple fronts (credit quality, capital, funding), and a comprehensive and up-to-date CFP helps management navigate funding and liquidity stress at a time when their resources and attention are dedicated to addressing a number of issues.  If you haven’t updated your CFP in a while, now is a good time to dust it off.

Recommendation:  Be sure to incorporate the loss of uninsured deposits and deposits of your largest customers into at least one of the scenarios in the CFP.


  1. Review all of your borrowing lines

Yes, all of them.  Make sure you know whether they are committed or uncommitted.  Most federal funds purchased lines are uncommitted, or will require collateral if they are committed.  Be sure you have all paperwork up to date, and you have tested the mechanics for all lines.  If your institution is in a liquidity crunch and needs to access funds today, it will be a tough afternoon if you have forgotten wire instructions, passwords, or have the wrong people authorized.

Recommendation:  Schedule time this quarter, and no less often than annually, to mechanically test every borrowing line.


  1. Stress test your liquidity projections.

Every FI, including yours, should have a forecast of cash flow for liquidity.  This forecast should include a 30-day cash flow forecast, and include a pro forma out to 12 months, with interim time periods of 90 and 180 days.  The forecast should include surplus or deficit funding for each time period measured.  Once the base case is established, you should run the forecast under a variety of stressed situations.

Recommendation:  Review the assumptions surrounding the base and the stressed scenarios.  Ensure the assumptions are well-grounded, documented, and reviewed by ALCO.  Results of the scenario should be documented in ALCO meetings.

The FDIC Supervisory Insights from Summer 2017 provided a meaningful article on liquidity risk and reflects possible examiner approaches.  We recommend reading the full ALCO article on this topic.


  1. Analyze your on-balance sheet liquidity.

Most FIs calculate a liquidity ratio in the same manner.  The standard formula for the liquidity ratio is (Net Cash, Short-term, and Marketable Assets) / (Net Core Funding and Volatile Liabilities).

Included under Marketable Assets are the FI’s unencumbered securities. Most FIs should have a minimum liquidity ratio in the Asset/Liability or Liquidity Policy.

We recently discussed liquidity with an examiner, and they suggested that banks should analyze the on-balance sheet liquidity further by subtracting any unencumbered security that has a fair value more than 5% below its book value.  The rationale is that the FI is less likely to take the loss from selling the security.  (If the FI were to borrow against the value, it is considered off-balance sheet liquidity.)  The examiner called this “adjusted on-hand liquidity”.  They did not suggest a policy minimum; instead, they said that the FI should understand what they have and be prepared to discuss it.  Some FIs may be surprised how low this adjusted on-hand liquidity ratio is; for some FIs, it may even be negative in the current environment.

Recommendation:  Review your institution’s liquidity ratio and analyze further with an adjusted on-hand liquidity calculation, as noted above.  Discuss it with the ALCO and determine if any steps should be taken to shore up liquidity.

Final thoughts

A wise man once said, “Financial Institutions can run out of a lot of things, but they must keep cash and capital above water.”  He was right.  By working through the considerations above, your institution can ensure that (1) it has a plan to make sure they don’t run out of capital or cash, and (2) it will be able to tell their story in greater detail.

If you would like to discuss any of the above items, or if you would like assistance on any of them, please reach out to the authors of this article.