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Community banks face rise of liquidity risk, FDIC warns

In 2017, the FDIC released a paper, Community Bank Liquidity Risk: Trends and Observations from Recent Examinations, which outlines key challenges facing community banks and attempts to raise awareness on liquidity issues facing banks. Now, in 2018, a growing number of banks face funding gaps, creating a renewed interest in the FDIC’s paper.

For institutions with assets of less than $10 billion, the paper suggests that liquidity risk is on the rise and that funding issues are contributing to risk. A historical representation of liquid holdings and wholesale sources shows that liquid asset holdings at community/small banks have begun to decrease. While these holdings are not at pre-recession levels, they present a potential concern about whether adequate cushions are in place.

The paper further discusses the health and stability of a bank’s core deposit base, which ultimately serves as a primary source of funding at smaller institutions. When an institution faces challenges with funding from core deposits, it may turn to wholesales sources, which are typically more costly and less stable. The FDIC paper notes that in recent years many institutions have diversified their funding sources to include wholesale as part of their liquidity risk management strategy. However, the FDIC warns that overreliance on these sources poses a risk, especially if an institution faces financial stress. Since these funding sources must adhere to legal, regulatory and counterparty requirements, they are considered to be less stable if capital holdings deteriorate.

For community banks and institutions with less than $10 billion in assets, the FDIC paper provides useful data, graphs, charts and details that outline overall trends for declining liquid asset levels. It additionally outlines specific funding considerations and reminds institutions of restrictions under the FDI Act to ensure banks are confronting potential liquidity triggers head on. To get a detailed view of liquidity risk trends outlined by the FDIC, we encourage leaders of community banks to read the paper. In the meantime, the FDIC recently announced that it finally revamp deposit rules, a change that banks have been anticipating for quite some time. You can read more about the change on American Banker found here.

Are you looking for more information on liquidity risk management? In the coming weeks, MountainView Financial Solutions, a Situs company, will release several practical e-books designed to help smaller institutions understand, measure and manage liquidity risk. To request a copy, email inquiries@mviewfs.com