Effective March 31, 2014, all federally insured credit unions (FICUs) will be subject to NCUA’s new liquidity regulation. What exactly the regulation requires depends on a credit union’s asset size.
Why NCUA adopted the reg
NCUA adopted new Section 741.12, “Liquidity and Contingency Funding Plans,” to make sure credit unions prepare for future liquidity pressures by strengthening risk management requirements. The agency states that the recent financial crisis highlighted how vital sound planning and access to liquidity sources are to the safety and soundness of the credit union system. And NCUA believes it’s critical to expand the credit union industry’s borrowing capacity after the liquidation of U.S. Central Credit Union, which had, until 2012, funded most credit unions’ access to NCUA’s Central Liquidity Facility (CLF).
NCUA has adopted a regulation that applies different requirements to different size credit unions. All credit unions will need basic liquidity policies. Credit unions with at least $50 million in assets will have to establish a written “contingency funding plan” (CFP). And credit unions with $250 million or more in assets also will have to have access to the Federal Reserve’s discount window or the CLF. NCUA feels this tiered-regulatory approach is appropriate because if larger credit unions “experience unexpected or severe liquidity circumstances, they’re more likely to adversely affect the credit union system, public perception, and the National Credit Union Share Insurance Fund.”
Letter to CUs No. 13-CU-10
Immediately after adopting this new regulation in October 2013, NCUA issued Letter to Credit Unions No. 13-CU-10, which includes a recommended timetable for compliance and discusses the key sources of liquidity NCUA will look for in a credit union’s plan. It also addresses examiner expectations of a credit union’s liquidity policy, which will be commensurate to a credit union’s size and complexity.
The Letter includes the new regulation, an appendix on how to access the Fed’s discount window and the CLF, and a copy of the 2010 “Interagency Policy Statement on Funding and Liquidity Risk Management” (sent to credit unions in Letter to Credit Unions No. 10-CU- 14). Information in the 2010 Policy Statement remains very relevant, and NCUA incorporated its key provisions on having formal contingency plans into the new regulatory requirements.
Credit unions with less than $50 million in assets
NCUA recognizes that these credit unions present relatively limited liquidity concerns to the agency, as they tend to have lower loan-to-share ratios, shorter duration assets, and higher amounts of balance sheet liquidity than larger credit unions.
That’s why the approximately 4,400 FICUs having less than $50 million in assets must have a basic written, board-approved policy. NCUA’s October Letter discusses five core elements of a liquidity policy:
1. Purpose and goals of liquidity management;
2. Thresholds or limits for liquidity measures, management reporting requirements, and conditions under which designated staff should begin to implement contingency plans;
3. Primary and secondary sources of liquidity;
4. Tools for liquidity risk management; and
5. Periodic review (no less than annually) of policies and plans with revisions as needed.
Credit unions with $50 million or more in assets
There are more than 2,200 FICUs with at least $50 million in assets, and the new regulation will require each of them to have a formal CFP “commensurate with its complexity, risk profile, and scope of operations that sets out strategies for addressing liquidity shortfalls in emergency situations.” The CFP includes policies, procedures, projection reports, and action plans to ensure that “the credit union’s sources of liquidity are sufficient to fund operating requirements under contingent liquidity events.”
NCUA estimates less than 450 of this group already have policies and programs that would comply with the regulatory requirements.
The regulation states that the CFP can be a separate policy or incorporated into the credit union’s asset-liability policy, a funds management policy, or a business continuity policy. In addition to the five basic policy items stated above, Section 741.12(d) lists six provisions that the written CFP must, at a minimum, address:
1. A process to assess the sufficiency of the credit union’s liquidity sources to meet normal and contingent needs;
2. Specific contingency liquidity sources;
3. How the credit union will manage a range of liquidity-stress events;
4. Lines of responsibility within the credit union to address liquidity events;
5. Management processes to be followed when responding to liquidity events; and
6. Frequency of testing and any necessary updating of the contingency funding plan.
Credit unions with $250 million or more in assets
The approximately 770 FICUs with $250 million or more in assets (which hold about 80% of the industry’s assets)—in addition to complying with the requirements above—must have access “to a backup federal liquidity source for emergency situations.” The regulation specifies either the CLF or the discount window. NCUA estimates about half of these large credit unions already have established access.
CUNA and others had urged NCUA to include Federal Home Loan Bank (FHLB) membership as a way to comply with this requirement. NCUA declined to do so, stating that while “FHLBs can be valuable contingency funding sources…[they] are not federal facilities and are not obligated to meet emergency liquidity demands the same way that the CLF and Discount Window are designed to do.” NCUA also was asked to allow large FICUs to meet the requirements of the rule by holding a portfolio of marketable securities, but NCUA says that “these assets have proven to be insufficient in a crisis.”
A large credit union will be in compliance with the emergency liquidity access requirement if it has submitted either a completed application for membership in the CLF (which requires a stock purchase) or the necessary lending agreements and corporate resolutions to obtain credit from the discount window by March 31, 2014.
The regulation specifies that these credit unions must conduct advance planning and periodic testing to ensure that contingent funding sources are readily available when needed. The October Letter specifies credit unions must complete the first annual testing by Dec. 31, 2014, and it addresses how to conduct this testing.
NCUA indicates that it doesn’t have a preference which route a credit union chooses, and notes that an FICU might find it advantageous both to become a CLF member and establish a borrowing relationship with the Fed. Both have collateral requirements. The discount window is designed to handle sudden emergencies, and the Fed can provide same-day access with renewable overnight loans. CLF funding might require one to 10 business days depending on the requested amount (the CLF borrows the funds from the Federal Financing Bank), but the CLF makes loans up to 90 days, which might be renewable under certain conditions.
NCUA emphasizes that all credit unions, regardless of size, should maintain a balance sheet cushion of highly liquid assets (cash and cash equivalents such as short-term deposits and Treasury securities) as a basic element of liquidity risk management.
And all credit unions should have the ability to borrow from market sources—such as corporate credit unions, correspondent banks, FHLBs, and repurchase agreement counterparties— which require having unencumbered assets that they can readily pledge against a loan. And certainly a credit union doesn’t have to have $250 million in assets to consider the merits of joining the CLF or establishing access to the discount window.