Small Credit Unions under $250 million in Assets

NCUA LETTER TO CREDIT UNIONS
NATIONAL CREDIT UNION ADMINISTRATION
1775 Duke Street, Alexandria, VA 22314
DATE:

October 2013

LETTER NO.: 13-CU-10

TO:

Federally Insured Credit Unions

SUBJ:

Guidance on How to Comply with NCUA Regulation
§741.12 Liquidity and Contingency Funding Plans

ENCL:

(1)

Appendix: How to Establish Access to the Federal
Reserve Discount Window and Central Liquidity
Facility

(2)

§741.12 Liquidity and Contingency Funding Plans

(3)

Interagency Policy Statement on Funding and
Liquidity Risk Management

Dear Board of Directors and Chief Executive Officer:
The NCUA Board adopted a final rule on liquidity and contingency funding plans on
October 24, 2013. NCUA adopted this rule to ensure all credit unions conduct sound
liquidity planning, and large credit unions establish access to at least one federal source
of contingent liquidity: the Federal Reserve Discount Window (Discount Window) and/or
Central Liquidity Facility (CLF). As we learned during the financial crisis, sound
liquidity planning and access to federal liquidity sources are vital to the safety and
soundness of the credit union system.
The effective date of the rule is March 31, 2014. The purpose of this letter is to advise
you of your responsibilities under the liquidity rule, explain the impetus for the rule, and
provide guidance on certain liquidity planning expectations and provisions of the rule.
Which credit unions are subject to the rule?
Section 741.12, Liquidity and Contingency Funding Plans (the “liquidity rule”), is
applicable to all federally insured credit unions (FICUs), but does not apply to
corporate credit unions.
The rule establishes a three-tiered framework for credit unions as follows:
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Credit Union
Asset Size1
Under $50 million

Requirement

$50 million or more

In addition to a written liquidity policy, FICUs with
assets of $50 million or more must have a contingency
funding plan (CFP) that clearly sets out strategies for
addressing liquidity shortfalls in emergencies.

$250 million or more

In addition to a written liquidity policy and
contingency funding plan, FICUs with assets of $250
million or more must establish access to at least one
contingent federal liquidity source: the Discount
Window and/or CLF.

FICUs with less than $50 million in assets must
maintain a basic written liquidity policy. The policy
must provide a credit union board-approved
framework for managing liquidity and a list of
contingent liquidity sources that can be employed
under adverse circumstances.

What does my credit union need to do and when?
Table 1 summarizes the rule’s key action steps and compliance dates.

FICUs with
Total Assets:
Under $50 million

Table 1: Timeframes for Compliance
Actions Required by
Actions Required by
March 31, 2014
December 31, 2014
Have a basic written liquidity policy for
managing liquidity in accordance with
§741.12(a).

$50 million or more

Establish and document a contingency
funding plan in accordance with
§741.12(b) and (d).

$250 million or
more

Apply for access to at least one
contingent federal liquidity source in
accordance with §741.12(c).

Conduct advance planning and a test
of contingent funding sources in
accordance with §741.12(c).

What steps are necessary for my credit union to take prior to and after the
effective date of the rule?
Table 2 provides suggested timing for necessary action steps.

1

For the second and third tier requirements, certain credit unions are subject to the higher requirements
when total assets exceed the applicable threshold for two consecutive Call Reports.

2

Table 2: Recommended Timetable for Compliance Action Steps
Regulatory
Recommended Timetable for Monthly Action Steps
Requirement
Nov 2013
Dec 2013
Jan 2014
February-March 2014
Have a basic written
liquidity policy for
managing liquidity in
accordance with
§741.12(a).

Review
NCUA
guidance and
conduct due
diligence.

Complete due
diligence.
Assess current
policy
revisions, if
any.

Finalize draft
changes to
policy, and
present to
credit union
board.

Take credit union board action to
affirm/adopt written liquidity
policy.

Establish and
document a
contingency funding
plan in accordance
with §741.12(b) and
(d).
Apply for access to at
least one contingent
federal liquidity
source in accordance
with §741.12(c).

Review
NCUA
guidance and
conduct due
diligence.

Complete due
diligence.
Assess current
plan revisions,
if any.

Take credit union board action to
affirm/adopt contingency
funding plan.

Contact CLF
and/or Federal
Reserve Bank
to coordinate
process for
establishing
relations and
receive
instructions.

Complete
review of
necessary CLF
membership
and/or Fed
agreements
and
resolutions.

Finalize draft
changes to
plan, and
present to
credit union
board.
Work with
CLF and
Reserve
Banks to
resolve any
issues, and
present to
credit union
board.

Regulatory
Requirement
Conduct advance
planning and a test of
contingent funding
sources in accordance
with §741.12(c).

Take credit union board action to
complete and file necessary CLF
membership requirements and
documents and/or file necessary
lending agreements and
corporate resolutions to obtain
credit from a Federal Reserve
Bank.

Between March 31, 2014 and December 31, 2014
For CLF:
Conduct a test of funds-delivery process in accordance with CLF instructions.
For Discount Window:
Identify unencumbered assets to pledge, pre-position collateral, resolve potential
subordination agreements, and conduct a test transaction.

Why did NCUA issue the liquidity rule?
A major impetus for the liquidity rule is the failure of U.S. Central Federal Credit Union and
the associated wind-down of its temporary successor, U.S. Central Bridge Federal Credit
Union (U.S. Central). U.S. Central played a pivotal role as an agent of CLF by purchasing
CLF stock and thereby extending contingent liquidity protection to consumer credit union
members of U.S. Central’s member corporate credit unions. This provided federal liquidity
coverage to almost the entire credit union system.
U.S. Central Bridge was liquidated in October 2012 as part of its planned resolution. With
this closure, CLF redeemed U.S. Central’s CLF stock and paid out the cash proceeds to U.S.
Central Bridge. When this redemption took place, the agent group arrangement was
terminated. As a result, the roughly 6,000 consumer credit unions that had CLF access
through their corporate credit unions lost that coverage. Since that time, most of the affected
consumer credit unions have not taken action to restore this loss of contingent liquidity.
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The recent financial crisis demonstrated the importance of good liquidity risk
management to the safety and soundness of financial institutions. Many institutions
experienced significant financial stress because they did not manage their liquidity in a
prudent manner. In some cases, these institutions had difficulty meeting their
obligations as they became due because sources of funding were severely restricted.
In the financial crisis, even institutions that were healthy used emergency federal
liquidity facilities when funding costs became prohibitively high.
The rapid reversal in market conditions and limited availability of liquidity during the
crisis illustrated how quickly illiquidity can become a problem. This illiquidity can
last for an extended period, leading to an institution’s inability to meet its financial
obligations and possibly its insolvency. Many of the liquidity-related difficulties
experienced by financial institutions were due to lapses in basic principles of liquidity
risk management.
NCUA remains concerned about the largely diminished liquidity protection for the
credit union system. Thus, this rule builds on lessons learned and is designed to
strengthen credit union liquidity risk management. The liquidity rule is designed to
restore liquidity access, individually and system-wide, to a more prudential level. This
is vital to maintain a strong and resilient credit union system going forward.
What are the key sources of liquidity NCUA looks for in credit union plans?
There are three categories of liquidity sources that apply to liquidity planning. Each of
these sources is relevant to the underlying safety and soundness of a credit union’s
liquidity management program. Essentially, these sources act as layers of liquidity
protection and function similar to a series of financial firewalls. The three categories are:
1. On-balance-sheet liquidity. Maintaining a balance-sheet cushion of highly liquid
assets is your first line of protection. It is essential for credit unions of all sizes to
hold an adequate safeguard of cash and cash equivalents (such as short-term deposits
and short-maturity Treasuries). A simple rule of thumb is to identify the largest
liquidity outflow your credit union has ever experienced and how long it persisted.
Then set your on-balance-sheet liquidity target based on that experience. This
liquidity cushion will buy you some time to avoid service disruptions and enter
external funding arrangements if they become necessary.
2. Access to market sources of funds. Your second line of protection is to be in a
position to borrow from market counterparties. You can build borrowing
relationships with a corporate credit union, a correspondent bank, a Federal Home
Loan Bank, or with repurchase agreement counterparties (or all of these), to name a
few. You need to keep in mind your credit union’s ability to borrow from market
funding sources will require unencumbered assets acceptable to lenders, which can be
readily pledged against your loan. Larger credit unions with greater potential funding
needs should have multiple stable borrowing sources and a clear understanding of
which assets can be pledged.
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3. Contingent federal liquidity providers. The third line of protection is access to a
contingent federal liquidity provider such as the Discount Window or CLF. The
Discount Window and CLF exist to provide backup liquidity in circumstances
where on-balance-sheet liquidity and market funding sources prove inadequate.
While sparingly used, the Discount Window and CLF have proven to be dependable
sources of liquidity in times of crisis or unexpected events. Like the funding sources,
the Discount Window and CLF are both collateral-based lending facilities. All loans
must be fully secured with a first priority security interest.
Generally, a credit union responding to liquidity demands will work through these
sources in the above order. Your credit union needs to specify in its plan which sources it
can access and the priority of steps to follow. NCUA recognizes liquidity resources may
have changed for many credit unions because of the recent financial crisis. This means
you may need to establish new relationships with market counterparties and contingent
federal liquidity facilities.
For most credit unions, the first two sources of liquidity are already integrated into their
day-to-day operations. However, because emergency liquidity is not an everyday need,
most credit unions have not yet chosen to establish relations with a contingent federal
liquidity source. Of the credit unions that are now required to access a contingent federal
liquidity source, slightly more than half have already established relations with the
Discount Window and/or CLF.
What should a written liquidity policy address?
All credit unions need to have a written liquidity policy. The liquidity policy can be part
of an existing policy such as an Asset-Liability Management (ALM) or funds
management policy. Typically it is coordinated with a credit union’s strategic planning
efforts.
Your liquidity policy will govern how your credit union manages its daily operating cash
needs, how it meets forecasted liquidity shortfalls, and how it responds to unforeseen
contingencies. At a minimum, NCUA requires the liquidity policy to include a boardapproved framework for managing liquidity on an ongoing basis as well as a list of
identified liquidity sources that can be tapped during contingency circumstances.
Your liquidity policy should be tailored to the size and complexity of your credit union.
If your credit union has a high reliance on market-sensitive funds (e.g., money market
shares) and assets with more dynamic cash flows (e.g., mortgage loans), you would need
to analyze prepayments and conduct a comprehensive forecast for your sources and uses
of funds. Conversely, if you hold a large percentage of liquid assets, have strong core
deposits, and do not make mortgage loans, your liquidity risk is likely to be less dynamic
and your plan may be more basic. As your size increases, liquidity risk typically
increases in amount and complexity.

5

For credit unions under $50 million in total assets, the policy does not need to be
elaborate, but it must cover certain basic elements that are fundamental to all depository
institutions. Core elements of a basic liquidity policy include the following:
1. Purpose and goals of liquidity management – The policy should establish the
purpose, objectives, and goals of liquidity management. You can begin with a
definition of liquidity risk and why it is important to manage. Liquidity risk is the
risk that a credit union:


Does not have sufficient access to funds to maintain a “business as usual” posture
at all times; or



Does not have the ability to raise or borrow funds at a reasonable cost at all times.

The policy should acknowledge that a failure to manage liquidity can result in an
inability to meet operating cash needs and commitments such as member
withdrawals. This understanding is highly important because an inability to meet
operating cash needs and/or fund member withdrawals could be extremely damaging
to a credit union. Consumer confidence erodes rapidly when a financial institution is
unable to process drafts, dispense currency, or meet loan commitments. Thus,
managing liquidity risk is critically important to the wellbeing of the credit union.
2. Thresholds or limits for liquidity measures and reporting requirements – The policy
should convey the credit union board’s tolerance for liquidity risk. The evaluation
process should include identification of the appropriate ratios that can signal changing
liquidity conditions,2 preparation of periodic cash flow projections, and establishment
of a minimum cash-on-hand target to which you manage. You should set forth
required minimum balances for short-term and overnight funds that are sufficient to
maintain a business-as-usual posture and allowing for unexpected stresses in normal
funding needs that may arise.
Your liquidity plan should require procedures for when and how the credit union will
evaluate and report its liquidity levels relative to the board-approved limits. The
policy should specify the reporting requirements, including the nature and frequency
of management reporting. This includes clearly defining roles and responsibilities for
all aspects of the liquidity management function so the credit union’s board can
ensure accountability. Also, the policy should address under what conditions
designated staff should begin implementing contingency plans.
3. Primary and secondary sources of liquidity – It is important for the policy to specify
what sources you can tap and the priority of steps to follow. Primary sources of
liquidity may include share deposit growth and income from loans and investments.
Secondary sources may include securities available for sale and lines of credit.

2

Ratios that can signal changing liquidity conditions may include the loan-to-share ratio, cash and cashequivalents to total assets ratio, funding coverage ratio, and liquid and unencumbered securities to deposits.

6

4. Tools for liquidity risk management – The risk management tools should be
consistent with the size and complexity of the credit union. For example, a bucketed
sources and uses of funds template3 or maturity gap template can be utilized where
appropriate. This review should be based on an understanding of how your assets and
liabilities behave in response to changes in market conditions. Generating a forecast
of sources and uses of funds is a fundamental activity for any financial institution.
Tools that are more sophisticated are needed when the credit union’s cash flows are
complex and susceptible to high volatility. Capturing the effects of changing market
rates or varying assumptions about growth of deposits and loans can highlight
potential liquidity shortfalls. Understanding sources of volatility in cash flows will
help you anticipate shortfalls and plan for contingencies.
5. Periodic review and revisions as needed – As with any major policy, your liquidity
policy should set forth a requirement to periodically review and revise, if necessary,
the policies and plans to reflect the credit union’s current tolerance for risk, balance
sheet composition, liquidity strategy, and organizational structure. The frequency of
review can be annually but should be reassessed whenever the credit union
experiences a significant change.
What should a contingency funding plan (CFP) address?
Credit unions with $50 million or more in total assets are required to have a more
comprehensive liquidity policy that incorporates a CFP. A CFP includes policies,
procedures, projection reports, and action plans designed to ensure your credit union’s
sources of liquidity are sufficient to fund operating requirements under contingent
liquidity events. A CFP needs to:


Include a process to forecast and assess whether the credit union’s liquidity
sources are adequate to meet normal and contingent needs. The CFP should
identify plausible stress events and quantitatively evaluate those stress events
under different levels of severity.



Identify specific contingency sources. The CFP should identify any backup
facilities (lines of credit), the conditions related to their use and the circumstances
where the credit union might use them. Management should understand the
various conditions, such as notice periods, that could affect access to backup lines
and test the credit union’s ability to borrow from established backup facilities.



Specify how the credit union will manage a range of liquidity-stress events.
Contingent events arise from both unexpected circumstances and ongoing adverse
business conditions. Credit union specific events are usually the result of the
unique credit, market, operational, or strategic risks that occur because of a credit
union’s business activities. External events may be systematic financial market
occurrences, such as changes in the price volatility of securities, changes in

3

Letter to Credit Unions 00-CU-13, “Liquidity and Balance Sheet Risk Management”, contains a sample
liquidity forecast template as an enclosure.

7

economic conditions, or dislocations in financial markets. The CFP should
include an asset tracking system that monitors which assets are immediately
available for pledging or sale and how much a cash sale of these assets will
generate.


Identify the lines of authority within the credit union responsible for managing
liquidity events. A clear description of roles and responsibilities is a critical
component of the credit union’s CFP. The CFP should provide for a
comprehensive crisis management team with clearly defined roles. Action plans,
and the assignment of responsibility for carrying them out, should be realistic and
formalized in writing. The credit union should integrate the CFP with other
contingent planning activities such as continuity of business planning. It should
provide for frequent communication among the crisis team, the board of directors,
management, and other interested parties.



Outline the management processes the credit union will follow when
responding to liquidity events. To ensure the effective and timely
implementation of the CFP, credit unions should develop a process for identifying
a potential liquidity event before it becomes a crisis. This can be accomplished
through the use of early warning indicators and event triggers that are readily
observable during a credit union’s normal reporting process.



Specify the frequency that the credit union will test its plan and make any
necessary updates. Credit unions should test components of their contingency
funding plan in order to assess their reliability under times of stress. Identified
actions such as loan sales, repurchasing securities, and borrowing arrangements
should be periodically tested to ensure that they function as envisioned. As
conditions and circumstances change, CFP plans should be revised accordingly.

Credit unions under $250 million in total assets are not required to establish access
to a contingent federal liquidity source. However, NCUA encourages all credit
unions to do so if their contingency funding analysis identifies liquidity events pose a
real threat to the credit union. Credit unions can benefit from conducting some level of
liquidity-risk scenario analysis and establishing access to a contingent federal liquidity
source to protect against unforeseen circumstances. A credit union’s actions to enhance
the liquidity strength of the credit union will reflect favorably in the Liquidity (“L”) and
Management (“M”) components in its CAMEL rating.
How do I establish access to a federal contingency liquidity source?
Any federally insured credit union with assets of $250 million or more must
establish access to at least one contingent federal liquidity source for use in times of
financial emergency and distressed economic circumstances. Credit unions subject to
this requirement may demonstrate access to a contingent federal liquidity source by:
1. Maintaining membership in the CLF; and/or
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2. Establishing a relationship at the Discount Window by filing the necessary
lending agreements and corporate resolutions to obtain credit from a Federal
Reserve Bank (pursuant to 12 CFR §201).
Which federal contingency liquidity source is right for my credit union?
The decision about which federal contingent liquidity source to choose – the Discount
Window or CLF – is an individual business decision that certain credit unions must
make. If evaluating the two sources, one dimension you should carefully consider is how
quickly your credit union may need to access emergency liquidity and how long you may
need it.
As shown in Table 3, the Discount Window and CLF lending terms have similarities and
differences; and the differences are important. The key differences are in the timing and
duration of loans. Specifically:


The Discount Window is designed to handle sudden emergencies or operational
issues that require same-day access to contingent federal liquidity.



The CLF is designed to handle sustained emergencies or operational issues that
require contingent federal liquidity for a few days up to several months.
Table 3: Key Similarities and Differences in Lending Terms
DISCOUNT WINDOW
CLF

Similarities

Both the Discount Window and CLF function as safety valves to relieve liquidity
pressure on individual depository institutions and to stabilize broader liquidity systems.
Both are fully secured collateral-based lenders.
Both met emergency liquidity needs for individual institutions and for entire systems
during the latest financial crisis.

Differences

For more
information

The Discount Window is able to advance
same-day funds to qualifying credit
unions (subject to collateral
requirements).

CLF funding may take 1-10 business days
depending on the requested dollar amount
(also subject to collateral requirements).

The Discount Window’s overnight loans
may be renewable, but any series of
rollovers is expected to be brief in
duration.

The CLF makes loans up to 90 days, and
these 90-day loans may be renewed for an
additional term under certain
circumstances.

www.frbdiscountwindow.org/started.cfm

www.ncua.gov/Resources/CLF

For further details on how to establish access to the Discount Window and/or CLF, see
the Appendix to this letter.
9

Can my credit union access both the Discount Window and CLF?
Yes. The combination of both the Discount Window and CLF would provide the
greatest protection for your credit union in the event of a sudden and sustained
liquidity emergency. For example, in a liquidity crisis where balance sheet and
market sources are not enough, your credit union would have the ability to
immediately tap large amounts of federal backup liquidity through the Discount
Window. In addition, if emergency liquidity needs persist for more than a few days,
you would have the flexibility to maintain federal backup liquidity through CLF for up
to several months at a time. Credit unions with dynamic contingent liquidity demands
would be well served to establish access to both facilities.
How do I conduct advance planning and periodic testing to ensure my contingent
federal liquidity source is readily available when needed?
Initially, all credit unions subject to §741.12(c) will have until December 31, 2014, to
comply with the provision to “conduct advance planning and periodic testing to ensure
that contingent funding sources are readily available when needed.” This period will
allow sufficient time for those credit unions opting to use the Discount Window to assess
and position eligible collateral necessary to enable a test loan transaction; and for those
opting to join CLF to learn and execute the new CLF testing procedure. After 2014,
credit unions subject to the testing requirement will be expected to conduct such advance
planning and periodic tests no less frequently than annually. The testing procedures for
the Discount Window and CLF are different due to differences in their respective
operational structures and funding sources.
Testing at the Discount Window
For the Discount Window, a credit union with eligible collateral in place may contact
their respective Federal Reserve Bank Discount Window personnel by telephone and
conduct an overnight (one business day) test-borrowing transaction. You will need to
take steps ahead of time to identify your credit union’s unencumbered eligible collateral.
You will also need to take steps to pre-pledge all or some portion of your eligible
collateral at the Discount Window before you will be able to conduct either a test or other
borrowing transaction.
Testing at CLF
CLF will be releasing final test procedures by March 31, 2014. For CLF, a credit union
is not permitted to conduct a test loan transaction.4 However, CLF can conduct a test
transfer of funds between itself and members to verify the correctness of the delivery
instructions of record – the same wire instructions used for actual liquidity advance
requests. For credit unions that choose CLF as their contingent federal liquidity source,
such tests will satisfy the regulatory requirement for “periodic testing to ensure
contingent funding sources are readily available as needed” pursuant to §741.12(c).
4

CLF match-funds all of its liquidity advances with loans from Treasury’s Federal Financing Bank (FFB).
Under the terms of this arrangement, CLF is only authorized to seek an advance from FFB when the
underlying CLF advance is for an actual liquidity need as set forth in Title III the Federal Credit Union Act.

10

The NCUA Board believes it is essential for every credit union to have a sound
process for identifying, measuring, monitoring, and controlling liquidity risk that is
commensurate with each credit union’s needs. And for larger credit unions, it is
essential to have established access to a federal liquidity source. When a large credit
union experiences unexpected or severe liquidity pressures, it is more likely to have a
material impact on the credit union system, consumers, and the National Credit Union
Share Insurance Fund.
This new rule will strengthen credit unions’ resilience in liquidity events – both at the
individual credit union level and throughout the entire system. The rule strikes an
appropriate balance between a responsible regulatory framework and liquidity
management expectations that are scaled to the size and complexity of individual
credit unions.
If you have questions related to the liquidity rule or this letter, please contact your NCUA
regional office, district examiner, or state supervisory authority.
Sincerely,
/s/
Debbie Matz
Chairman
Enclosures

11