FEDERAL RESERVE BANK OF SAN FRANCISCO
Y2K Liquidity Contingency Planning
Points to consider in a Y2K Liquidity Contingency Plan
Here are some suggestions for shaping your Y2K liquidity contingency plan:
1.When you estimate how much liquidity you may need for a YZK problem, we strongly suggest that you focus on developing a worst-case scenario. Consider two points.
First, there is little need to plan for a minor increase in the demand for cash. Most
banks can easily accommodate minor increases in deposit withdrawals and loan
demand from existing liquidity sources.
Second, the risks and rewards associated with liquidity are asymmetrical. By that we
mean that the risk of having too much liquidity - less robust profits - is almost always
much smaller than the risk of not having enough liquidity - in the extreme, bank failure.
Consequently it makes sense to focus contingency planning on a potentially severe
crisis.
2.Don't look in the rear view mirror to formulate your estimates of liquidity needs. In the last two decades, most bank liquidity crises have been institution specific. Typically a single bank goes through one or more events, such as public announcements of large loan losses that erode the confidence of uninsured depositors who then begin to withdraw their funds. Any Y2K liquidity crisis is likely to significantly different. Consider that:
In a typical institution-specific liquidity crisis, during the 1980s and 1990s, when confidence in a bank became an issue, the funds most often withdrawn were uninsured portions of deposit balances and uninsured loans to the bank such as federal funds sold. However in a Y2K liquidity crisis, it seems reasonable to expect that insured funds might be withdrawn. Indeed it is plausible that more insured than uninsured deposits might be withdrawn. Some consumers and businesses may withdraw cash because they expect that Y2K computer failures will cause a devastating collapse.
Arguably a much larger number are likely to withdraw cash because they are worried about temporary disruptions in the payment system and want to have more cash on hand for transactions. The key here is that neither group is likely to make different decisions for insured deposits than they make for uninsured deposits. Your contingency plan should assume a level of withdrawals from insured deposits thatis no less than the level it assumes for uninsured funds.
In a typical institution-specific liquidity crisis during the 198Os and 1990s, the biggest liquidity headache was deposit withdrawals. However, in a Y2K liquidity crisis, it seems reasonable to suspect that funding loan commitments may be an equal or even larger liquidity headache. Instead of cash reserves, many customers and businesses rely on lines of credit for liquidity. Many consumers and businesses do not keep much extra money in checking, NOW, savings and MMDA accounts. Either they do not have such extra cash or, if they do, they have it invested in CDs, stocks or bonds. Consumers who want to hold cash in January of 2000 are probably going to get that cash from their credit cards, their unsecured personal lines and their home equity lines. Businesses who want to hold cash may likely draw down their existing lines of credit. Your Y2K liquidity contingency plan should assume a high level of new advances for existing credit cards and lines of credit.
If there is a Y2K liquidity problem, it will probably impact financial markets, not just individual financial institutions. In a typical, institution-specific, liquidity crisis, like those we saw in the 1980s and 1990s, a bank could easily sell marketable assets like Treasury securities to raise cash quickly. Often the issue for those banks was simply whether or not they had enough marketable assets. The situation in a systematic crisis is quite a bit different. In a systemic crisis. lots of investors try to sell their marketable securities. As a result, prices for those securities plummet. Your Y2X liquidity plan should not emphasize the sale of marketable securities as a primary source of new funds.
In a typical-institution specific liquidity crisis during the 1980s and 1990s, borrowing from the Federal Reserve discount window was often the funding source of last-resort. Borrowing from the Federal Reserve gave market participants and the public the impression that the bank was in a deep financial hole. Whether or not the bank actually was in serious trouble, the perception created by the Fed borrowing was not helpful.
AY2K liquidity problem, on the other band, does not reflect more badly on your bank than it does on any other financial institution. It is a systemic crisis. As a result, borrowing from the Fed is not likely to generate a perception that fuels any loss of confidence in your bank.. Borrowing from the Fed discount window should be emphasized in your Y2K liquidity contingency plan.
ESTIMATING YOUR WORST-CASE LIQUIDITY NEED OR LIQUIDITY CONTINGENCY
Planning for Deposits
A typical liquidity contingency plan focuses on some percentage of deposit loss. In other words, it might look at the impact of twenty, forty or sixty percent losses in uninsured funds. For your Y2K liquidity contingency plan, it might make more sense to look at fixed dollar losses. If potential deposit losses are driven more by a desire to hold cash for transactions than by a loss of confidence in the system. It might make more sense to base your estimate of deposit losses on the number of customers.
This is, of course, purely speculative and might well be wrong. Nevertheless it seems reasonable that a family or business with cash on deposit in an amount equal to a few days worth of transactions will, if they become concerned about Y2X problems, be far more likely to withdraw most of the their deposits than a family or business with cash on deposit equal to many weeks worth of transactions. Thus for your liquidity contingency plan, you might define one or two dollar amounts and then apply them like this: Worst-case consumer account withdrawals will be projected to be the lessor of the balance in their checking or savings account or X dollars per account. Worst-cast business account withdrawals will be projected to be the lessor of the balance in their checking account or Y dollars per account.
Loan Funding
Here are four suggestions for estimating the amount of worst-case Y2K loan funding demand ...
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