If we’ve learned anything this year, it’s that when it comes to assessing risk, we need to be open to the idea that risk is greater than we think. Contingency funding plans (CFPs) are no exception.
What is a contingency funding plan?
A contingency funding plan (CFP) is a strategic planning document that outlines how a financial institution would address potential shortfalls in liquidity. The purpose of a CFP is to ensure that the FI is prepared for disruptions or changes that could negatively impact its liquidity or financial position. It is a regulatory requirement that helps ensure that FIs can meet their financial obligations in times of stress.
Elements of a contingency funding plan
Elements of a contingency funding plan typically include:
- Identification of potential liquidity stress scenarios: This includes both institution-specific and market-wide stress scenarios, which can be both short-term and protracted.
- Quantification of potential liquidity needs: This involves an estimation of the cash outflows or funding shortfalls that would arise in each scenario.
- Identification of available liquidity sources: This includes regular sources of funding, as well as back-up sources that could be used in stress scenarios.
- Action plan: This details the strategies and procedures for addressing liquidity shortfalls in stress scenarios.
- Monitoring: This outlines the triggers or early warning indicators that will alert the organization to potential liquidity problems.
- Testing: The plan should be tested periodically to ensure it works as intended and to make any necessary adjustments.
- Management oversight: The plan should detail the roles and responsibilities of senior management and other key personnel and should be approved by the board of directors or equivalent governing body.
Related: Lessons Learned from an $8 Million BSA Civil Money Penalty
How to prepare for increased regulatory scrutiny of CFPs
The failure of Silicon Valley Bank (SVB) – and the fact that the bank was falling short of its CFP requirements when leading up to its failure – has elevated regulatory focus on liquidity contingency funding and heightened expectations for monitoring and tracking CFPs. It’s likely that this elevated regulatory focus will actually include asset-liability management (ALM) in general. All financial institutions need to have a more active ALM process. It’s no longer going to be acceptable to just set limits once a year.
What do you need to do to prepare?
Regularly test your plan. You can’t just pull out your CFP in a crisis and hope it works – you should be testing it regularly. Many factors could impact your CFP. For example, if your CRE office portfolio shows signs of credit quality deterioration, such as increased vacancies and/or decreased debt service coverage ratio (DSCR), then those loans may no longer be pledgeable. Ensure your operational readiness by testing the steps needed to obtain funding from contingency funding sources, including being familiar with the pledging process for the discount window and similar sources.
Take your stress tests seriously. Stress testing needs to be done and needs to be taken seriously. A few years ago, everyone thought it was ridiculous to use a 3% stress on interest rates. We all thought there was no way that was going to happen. But it did!
Stress testing needs to be meaningful, and the possibilities need to be considered thoughtfully. Make sure it’s included as part of the ALM as well as strategic planning and budgeting discussions.
Deposits, investments, and concentrations are important for liquidity, too. Often we get caught up with the facets of the lending portfolio and don’t spend a lot of time looking at uninsured deposits or deposit concentrations. Matching assets to liabilities is one of the most important parts of an asset-liability management process.
Model validation is a must. As we talk about ALM, I would be remiss if I didn’t mention the need for a model validation for your ALM monitoring/reporting. An effective model risk management program is critical to ensuring that your data, assumptions and reports are accurate and appropriate.
Keep your ALM risk assessment current. I have to put a plug in for the risk assessment! Make sure that you have a current ALM risk assessment. Review your risks and controls and conduct regular control effectiveness assessments to make sure your processes are in place and working as planned.
Related: Compliance Strategy: Does Your Policy Need a Tune-Up?
Final Takeaways on CFPs
The regulators have made it clear that asset-liability management is going to be a focus during exams, so it is important that you have recently (and regularly) reviewed your policies, procedures, risk assessments, model validations, CFP, reporting and stress testing.
It’s not just about meeting examiner expectations. It’s about ensuring your institution remains strong. Don’t risk it when it comes to contingency funding plans.
Looking for advice for managing emerging risks? Our on-demand webinar The Future of Risk Management: Navigating Uncertainty with Confidence has got you covered.
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