Liquidity risk management for credit unions in today’s interest rate environment
Gone are the days of abundant and cheap liquidity for credit unions. Very quickly this period of rising interest rates is now posing significant liquidity risk management challenges.
Between March 14, 2022, and March 14, 2023, the two-year rate on the daily U.S. Treasury yield moved from 1.87% to 4.20% and from 2.14% to 3.64% on 10-year. The higher rates have had various impacts on credit union balance sheets, such as spoiling cheap liquidity.
Because the competition for shares is increasing, some credit unions are experiencing a liquidity squeeze. As yields rose during 2022, credit unions were forced to increase share rates. The average rate that credit unions paid on money market accounts over the past 12 months increased from 0.13% to 0.40%. The rising rates put pressure on the credit union to pay up for shares or see them leave the institution.
National average rate (credit union)
| Date | Q4 2022 | Q3 2022 | Q2 2022 | Q1 2022 | Q4 2021 | Q3 2021 |
| Money Market - 2.5k | 0.40 | 0.24 | 0.15 | 0.13 | 0.13 | 0.13 |
Source: S&P Global Market Intelligence
Another reality credit unions have faced is the impact to liquidity due to tougher economic conditions for members. Credit union members may be dealing with increased loan payments on variable rate loans, decreased savings rates due to inflation and general uncertainty about economic conditions.
The aggregated National Credit Union Association (NCUA) data shows that share growth slowed substantially in 2022, after two years of unprecedented growth. At the same time, credit unions grew their nonmember shares the most since 2014.
Share growth for federally insured credit unions (year-over-year)
| Share draft | Regular shares | Money market | Share certs. | IRA/KEOGH | All other shares | All other shares | Nonmember shares |
| 2014 Q4 |
10.40% | 7.80% | 3.40% | -1.40% | -2.00% | -0.50% |
69.30% |
| 2015 Q4 |
14.50% | 9.70% | 5.60% | 0.60% | -0.40% |
3.60% |
31.90% |
| 2016 Q4 |
2.60% |
11.70% |
7.50% |
4.90% |
2.00% |
14.40% |
31.20% |
| 2017 Q4 |
9.10% |
7.30% |
4.20% |
6.40% |
-0.60% |
0.70% |
17.20% |
| 2018 Q4 |
14.40% |
1.30% |
0.90% |
12.30% |
-0.10% |
8.20% |
15.90% |
| 2019 Q4 |
7.90% |
4.10% |
4.90% |
20.60% |
4.40% |
8.50% |
8.30% |
| 2020 Q4 |
40.20% |
27.80% |
24.40% |
-3.90% |
3.60% |
27.80% |
-9.40% |
| 2021 Q4 |
26.00% |
15.50% |
19.20% |
-10.30% |
-0.80% |
10.60% |
-3.30% |
| 2022 Q4 |
4.10% |
0.20% |
-3.10% |
19.90% |
-1.0% |
-4.1% |
90.1% |
Source: NCUA
Investment growth during 2020 and 2021 was also unprecedented in the credit union industry. Specifically in 2020, investments with maturities from 5 to 10 years and more than 10 years grew by 72.90% and 131.60%, respectively. However, as rates increase, these investments are susceptible to unrealized losses.
Credit unions may collect interest and principal from these investment cash flows, but long-term investments with large unrealized losses are typically not sold. Doing so would mean realizing a loss against net worth. The result is a lot of long-term investments on credit union balance sheets that do not represent true accessible liquidity unless the investments are pledged to a third party at market value.
Investment growth for federally insured credit unions (year-over-year)
| < 1 year | 1-3 years | 3-5 years | 5-10 years | > 10 years | |
| 2012 Q4 | 9.10% | 0.90% | 18.60% | 27.60% | 8.10% |
| 2013 Q4 |
-10.40% | -16.60% | 22.90% |
60.20% |
11.40% |
| 2014 Q4 |
-3.90% | 11.60% | -4.70% | -30.10% | -21.50% |
| 2015 Q4 |
1.40% | 2.20% |
-5.80% | 0.30% | -20.70% |
| 2016 Q4 |
10.10% | -6.70% |
-9.90% | 10.50% | -12.30% |
| 2017 Q4 |
-3.70% | -8.90% |
4.90% | 3.50% | 3.40% |
| 2018 Q4 |
-1.00% | -0.20% |
-11.90% | 0.10% | -3.50% |
| 2019 Q4 |
11.60% | 6.60% |
-7.60% | -1.90% | 43.90% |
| 2020 Q4 |
24.70% | 23.60% |
35.60% | 72.90% | 131.60% |
| 2021 Q4 |
-8.10% | 1.90% |
71.50% | 81.70% | 40.80% |
| 2022 Q4 |
-9.00% | -0.40% |
-26.40% | 18.70% | 15.40% |
Source: NCUA
Things changed quickly. And if you aren’t staying up on your liquidity monitoring, it can put your credit union in a tough spot. So how can your credit union manage these elevated risks?
1. Ramp up liquidity monitoring
Be sure your liquidity policy indicates the frequency of liquidity reporting. The board may receive quarterly liquidity risk reports, but management reporting should generally be more frequent. Particularly if you are dealing with decreasing liquidity, consider moving to weekly or monthly management reporting.
Monitor the liquidity triggers from your contingency funding plan. In the event of a crisis, you don’t want to be caught off-guard — that’s why frequently monitor liquidity triggers is critical. Shifting conditions could signal growing liquidity risks.
If a 2% outflow of nonmaturity shares is normal or “green,” then 5% might be outside normal business fluctuations or “yellow” and 10% might indicate a major crisis or “red.” With a 5% outflow of nonmaturity shares, you don’t want to wait until month-end or quarter-end to uncover the issue.
2. Examine pro-forma cash flow analysis, and subject your cash flows to stress tests
Credit unions should have robust methods for projecting cash flows from their balance sheet to meet regulatory guidance. Especially in uncertain times, consider pro-forma cash flow models as a critical liquidity tool. Reviewing your current balance sheet is not sufficient; it’s imperative to have realistic expectations of future liquidity.
Regulatory guidance says that regular stress tests are necessary for a variety of institution-specific and market-wide events across multiple time horizons. Stress testing should be layered on top of the pro-forma cash flow model, which helps management to develop plans to address any cash flow shortfalls. If you are contending with decreasing liquidity, liquidity stress testing may inform management’s decisions on next steps.
3. Analyze your funding risks
Managing liquidity risk involves understanding how the credit union is funding its balance sheet. Typically, credit unions a rely on a mix of core shares, noncore shares and other wholesale funding. Management should look at concentration risks, including large depositors, concentrations to certain industries or concentrations of noninsured shares. The CFP should include potential responses to concentration and funding risks you have.
Conducting a study of share behaviors can help your credit union understand the expected maturities on share or whether the credit union has a surge in shares that it should expect to runoff quicker than the rest of its share base. Understanding these risks is a vital to managing your liquidity position.
4. Assess your contingency funding plan (CFP)
Consider your CFP a crisis management tool. It should describe your strategies for addressing liquidity shortfalls. CFP requirements are discussed in the Interagency Policy Statement on Funding and Liquidity Risk Management. Credit unions facing mounting liquidity pressure should take time to review their CFP at their asset liability committee meeting and board meeting. This is also a good time to test the operational components of the plan.
5. Seek an independent review of your liquidity risk management
Management should look to an independent party to evaluate your credit union’s liquidity risk management processes. The reviews should cover the credit union’s liquidity risk management process and determine whether it complies with supervisory guidance and industry sound practices.
How Wipfli can help
Managing liquidity during volatility brings extra challenges. Wipfli professionals are prepared to step up with a range of services to assist your credit union. Our complimentary strategic risk management consultation can pinpoint areas of risk in your institution and discuss recommendations for how to mitigate that risk and strengthen your institution’s overall stability.
Wipfli also performs full liquidity risk management validations to meet regulatory guidelines. Learn more about our ALM consulting services and our enterprise risk management services.
If you find yourself with temporary staffing gaps in your risk team, we can also help.
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