Though deposits are up now, banks and financial services companies should make sure their liquidity will be as sound as possible in the months ahead.
When it comes to liquidity, there’s good news and less-good news for banks and financial services companies right now. First, the good news: The current economic downturn has spurred depositors to save up cash and keep their money parked at their current bank, generally speaking. In fact, S&P Global recently reported that the industrywide loan-to-deposit ratio fell to 69.5% in the most recent quarter, its lowest since 1991.
The less-good news is that several critical events – some of them playing out right now – will present a variety of risks for the entire economy and the financial sector specifically in the months ahead. The federal supplement to unemployment benefits just expired and might not come back. Many mortgage deferrals are coming to an end. States are reopening economies in fits and starts. The transition away from the London Interbank Offered Rate standard is coming up next year. The U.S. presidential election is this year.
Many banks are in the early stages of preparing for possible future declines in liquidity. And in some cases, that preparation might not be enough. Their liquidity stress testing might not account for significant developments within the economy or include all key drivers of liquidity. And they might not be considering the possibility that a substantial portion of their deposits could get run off suddenly for unforeseen reasons.
Our team developed a liquidity “health check” for banks. Here are some of the questions we typically ask to test their liquidity “vitals.”
- Have you recently assessed your liquidity ratios and policies for relevancy and completeness?
- Are you monitoring the right key risk indicators for signs of stress that might be coming?
- Is your liquidity stress testing comprehensive, including all key drivers on both sides of the balance sheet?
- Have you tested for severe overall economic conditions?
- Have you developed and tested different stress scenarios? For example, what would the financial impact be if a certain percentage of your depositors were unemployed?
- Is your pricing on money market accounts adding to or taking away from your margins?
- Have you monitored the unused lines of credit in various economic cycles to understand the potential impact?
The process of assessing the financial impact on liquidity is an art. There is an optimal way of managing liquidity in changing environments that can add to the bottom line.