On November 28, the Fed announced the termination of enforcement action against Hazard Bancorp and Peoples Bank and Trust Company of Hazard, Kentucky requiring them to strengthen board oversight of the banks’ management and operations.

On December 1, The Fed released the text of a speech that Vice Chair for Supervision Michael Barr delivered to the European Central Bank Forum on the importance of effective liquidity risk management. Barr cited weak liquidity risk management as a primary factor in the recent failures of Silicon Valley Bank and Signature Bank and the problems at Credit Suisse that led to its acquisition by UBS. Barr stated that the Fed, “saw during this period that firms were not as well positioned to monetize (that is, to borrow against or be ready to sell) their assets as they should have been. Many underestimated the size and speed with which liquidity needs could appear.”

Barr emphasized one of the more common liquidity risk management failures is one that our experience indicates many banks struggle with, and that is a lack of a bank’s preparedness to borrow from the Fed discount window to create liquidity. The Vice Chair pointed out that, “The discount window provides ready access to funding that can help banks manage their liquidity risks. The ability to access funding at a predictable rate through the discount window should figure importantly into banks’ liquidity risk management plans under a range of scenarios.”

There are a number of steps that banks need to take to prepare to borrow from the discount window. They must first execute legal agreements with the Fed. They must also pre-pledge sufficient collateral to support the funds that they borrow.  Many banks fail to pledge enough collateral and do not recognize that certain types of collateral take more time to pledge.  Less liquid collateral takes longer to assess and value, and these are usually the assets that are best pledged during stress events. Finally, banks should be testing their operational preparedness for discount window borrowing by executing actual transactions at regular intervals.

For more information on the liquidity risk management, please see our article on the Six Pillars of Safety and Soundness- Liquidity. We will also be taking a deeper dive into liquidity risk in a series of upcoming articles on regulatory expectations for liquidity risk management.

Contact us to learn how a strategic partnership with Doran Jones can provide you with cost-effective solutions by leveraging our expertise with these and other critical risk and compliance functions.