Liquidity: As Explained Through Black History
In honor of Black History Month and the newly released NCUA Supervisory Priorities, I thought it’d be perfect timing to tackle a topic that’s on most credit union professionals’ minds: liquidity. Today’s blog will focus on the different types of liquidity concerning a credit union.
While liquidity is normally a primary concern for the Chief Financial Officer or executive level staff, it is a good idea for compliance professionals to be aware of liquidity issues. NCUA examines credit unions based upon their liquidity risk, which affects the overall health of the credit union.
NCUA’s Examiner’s Guide defines liquidity as
“a credit union’s capacity to meet its cash and collateral obligations at a reasonable cost. Maintaining an adequate level of liquidity depends on a credit union’s ability to efficiently meet both expected and unexpected cash flows and collateral needs without adversely affecting the credit union’s daily operations or financial condition.”
A simpler way to frame this definition for beginners like us is: how much cash does a credit union have on hand for spending or paying off imminent debts? How quickly can a credit union convert its assets into cash for spending or paying off debts? Cash flow matters for financial institutions.
There are different levels to liquidity, and to help explain the different types of liquidity, I will use monumental moments from the American cult classic film: Set It Off. For those who aren’t aware, Set It Off helped solidify the careers of some of the most prominent Black actresses we love today, including: Jada Pinkett Smith (Stony), Kimberly Elise (TT), Vivica Fox (Frankie), and Queen Latifah (Cleo). The movie also produced gif-worthy moments, which believe it or not is more relevant to the credit union industry than you probably realized!
Low liquidity occurs when a credit union’s cash is tied up in non-liquid assets or the credit union cannot quickly convert its assets into cash. Non-liquid assets are usually properties which cannot be sold almost immediately and likely have depreciative values which frequently results in a loss to the seller. Examples of non-liquid assets include things like real estate, buildings, or even cars. Theoretically, these properties can take FOREVER to sell.
If you, a compliance professional, don’t understand low liquidity, we will now cut away to TT:
If your CFO has a similar reaction as TT (above) when asked by examiners about the liquidity balance sheet, then your credit union likely has low liquidity.
High liquidity occurs when the credit union can easily convert its assets into cash to pay off short-term debts. These credit union liquid assets can be sold almost immediately and normally indicate the credit union has good financial health. Examples of liquid assets a credit union may own include cash, draft accounts, share accounts, liquid securities such as stocks or government bonds. Theoretically, these items can be sold or exchanged within minutes in a healthy market.
For those compliance professionals who are confused about high liquidity, TT will explain now:
Omg! This woman needs an Oscar!! If you notice your CFO has a similar reaction as TT (above) when asked by NCUA examiners about the balance sheet, then your credit union likely has high liquidity.
Too High Liquidity
Be aware that high liquidity can be tricky. Extremely, high liquidity could mean that your credit union has too much cash on hand. Extremely, high liquidity typically indicates the credit union is not sufficiently investing its resources or failing to diversify its investments (too many of the same assets). This is important to know, because NCUA examines credit unions for concentration risk.
For those compliance professionals who really have no clue why “too much cash” could be a bad thing, keep reading. If a NCUA examiner considers your credit union as one with extremely, high liquidity, your CFO will likely respond with
A credit union looking for investment opportunities to level out its extremely, high liquidity should consult trusted counsel, financial advisors, and accountants to determine the best investment decisions for its size and complexity.
Here are resources on the subject which you may find helpful:
· Liquidity and Balance Sheet Risk Management | NCUA
· Can we help each other with Liquidity? | Lendkey| NSC Blog | NAFCU
· Measure Liquidity Strategically: What’s Your Plan? | Piper Sandler| NSC Webinar Library | NAFCU
· How Credit Unions Can Grow Membership Amidst Liquidity Challenges | Upstart | NSC Blog | NAFCU
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About the Author
JaMonika Williams, Regulatory Compliance Counsel, NAFCU
JaMonika Williams joined NAFCU as regulatory compliance counsel in July 2022. In this role, JaMonika assists credit unions with a variety of compliance issues.