Liquidity – Positioning Your Credit Union for Long-term Solutions
With the recent focus on contingency liquidity planning, many credit union management teams are evaluating how to meet the potential demand that a rapid-onset, high-impact liquidity event may have on their balance sheet. In order to meet a hypothesized short-term contingent event, management teams are turning to the Central Liquidity Facility (CLF) or Federal Reserve Discount Window (Discount Window) as a short-term lender of last resort.
The focus of this blog is on collateral choices eligible to pledge for Discount Window borrowings. Many credit union management teams are concerned with the total borrowing capacity when evaluating loans and investments to pledge through the Discount Window, which is a valid concern. However, this should not be the only consideration – and, in fact, using this as the sole decision driver may hinder the ability of the credit union to secure a long-term solution for a short-term liquidity event. The collateral that tends to yield the highest borrowing capacity also tends to have the least amount of market value risk due to credit concerns (i.e., Treasurys, Agencies, etc.) which also tends to be the most liquid. Management teams must ask the question:
Would we want to pledge our most liquid assets to secure the highest possible borrowing capacity, or should we instead pledge our less liquid assets that will yield a borrowing capacity sufficient to help meet a short-term emergency liquidity event?
Discount Window extensions of credit are very short-term, and are not designed to be a long-term solution to a liquidity event. Management teams should remember the purpose of this lender
of last resort, and be sure to leave enough liquid assets unencumbered by this credit facility to help ensure there is a certain amount of on-balance sheet liquidity to be used as part
of a long-term solution to a contingent liquidity event.