Federal Agencies Issue Joint Guidance on Risk Management and Contingency Funding

In response to the events of the first half of 2023, a group of federal agencies, including the Federal Reserve, has issued joint guidance on risk management and contingency funding for depository institutions. The guidance emphasizes the importance of liquidity risk management and preparedness in the face of evolving depositor behavior and market conditions.

The joint guidance stresses the need for depository institutions to maintain actionable contingency funding plans that consider a range of possible stress scenarios. The events witnessed in 2023 highlighted the unprecedented level and speed of deposit outflows in certain institutions, leading to acute liquidity and funding strain. Such occurrences serve as a reminder to depository institutions that they must be vigilant in assessing the stability of their funding and have a diverse array of funding sources to access during adverse circumstances.

To ensure operational readiness, the guidance calls for regular testing of contingency borrowing lines, thereby ensuring that staff are well-versed in accessing these resources. Depository institutions are advised to recognize the operational challenges involved in moving and posting collateral to access critical funding promptly.

Moreover, the agencies emphasize that contingency funding plans should take into account the dynamic nature of financial markets during times of stress. Contingency lines may become unavailable, and therefore, institutions should be prepared to utilize a range of contingency funding sources.

The joint guidance underscores the importance of reviewing and revising contingency funding plans periodically and more frequently as market conditions and strategic initiatives change. Institutions that increase the share of their liabilities comprised of less stable funding should assess their capacity to borrow from contingency funding sources accordingly.

Access to a range of reliable contingency funding sources is deemed a key component of safety and soundness by the agencies, reflecting the need for proactive risk management measures.

Incorporating the Federal Reserve's discount window as part of contingency funding arrangements is highly encouraged. The discount window is a crucial tool for managing liquidity risk, and depository institutions are advised to establish and maintain operational readiness to borrow from it. Familiarity with the pledging process for different collateral types is essential, and pre-pledging collateral can prove useful if liquidity needs arise suddenly.

For credit unions, the Central Liquidity Facility serves as a contingent federal liquidity source. Federal and state-chartered credit unions can access this facility when their liquidity and market funding sources prove inadequate. The guidance outlines specific requirements for credit unions of different sizes, mandating access to at least one contingent federal liquidity source and the inclusion of contingent liquidity sources in their policies.

The issuance of joint guidance by federal agencies reflects the collective effort to bolster risk management and contingency funding planning across depository institutions. As the financial landscape continues to evolve, institutions are urged to proactively assess and address liquidity risks, ensuring stability and resilience in the face of uncertain times.