The Federal Home Loan Bank System: Lender of Next-to-Last Resort

"The FDIC recently has observed instances of liquidity stress at a small number of insured banks." So opened the Summer 2017 FDIC Supervisory Insights issue. And so went your exams.

At a recent banking conference an industry consultant said, matter of factly, that in times of stress your Federal Home Loan Bank (FHLB) borrowing capacity would dry up. Nobody challenged him, including me, by the way. But when I mentioned the comment to the attending FHLB rep, she was not particularly happy.

This has happened before. Regulators and consultants promulgate this untruth. And having heard it so much, bankers are beginning to believe it. 

This week I sat in a bank CEO's office where he complained, ranted really, about his latest exam and the regulators' perception of liquidity risk, driven by the aforementioned Supervisory Insights. He was confident in his bank's liquidity position, but felt regulators could artificially create a liquidity problem.

Their conversation goes something like this: pretend that your non-core and wholesale funding dries up, and you are unable to attract local funds via rate promotion because of our restrictions on rates paid above the national rate cap. What would you do? Prepare for that.

I recently wrote that I thought bankers would have to prepare to offer rates more in line with the market. I noted that there was a greater than 100 basis points difference between what a customer could earn on an FDIC-insured Goldman Sachs Marcus account than what they could earn in your bank's money market account. And that bankers are going to have to build the infrastructure that allows them to be closer to market.

The national average rate for a money market account at the end of last year was 0.09%. The Fed Funds Rate was 1.25%-1.50%. So, according to the FDIC rate cap "guidance", you could not exceed 84 basis points on your money market accounts at December 31, 2017 if you were under regulatory scrutiny. Sixty six basis points less than the Fed Funds rate at that time.

I monitor trends. I know loan/deposit ratios are going up, and liquidity ratios are going down (see charts). But what are the chances that your liquidity position plummets, you lose access to your

correspondent line(s), you can't attract local deposits, your municipalities withdraw, and your FHLB line "dries up", all at once? As the FHLB rep mused to me, it could happen if say, an extreme black swan event much worse than the 2007-08 financial crisis happened.

More to the point, she directed me to her FHLB's president's message on their website where he wrote: "As long as markets remain open, and a member has pledged sufficient qualifying collateral and is willing to purchase the requisite amount of capital stock, the Home Loan Bank will always continue to lend to our members to help you meet your community's needs." 

We need a smarter discussion on liquidity. Before we create an artificial liquidity crunch.

The consultant at the above mentioned conference did have some solid recommendations that I would like to share, even though he is a competitor. Pretty magnanimous of me, right?

1. Create detailed funding concentration risk analytics, that includes:

     -  Stratify funding using a liquidity matrix

     -  A deposit loyalty study (to classify what regulators consider non-core as core)

     -  Determine a local rate cap (to use vs. the federal rate cap)

2. Conduct forward looking stress tests that include realistic contingency funding strategies

3. Train board members

4. Update liquidity policy and contingency funding plan to be consistent with the above process

Are you feeling pressure internally or from regulators on liquidity?

~ Jeff

Bankers: Five Ideas to Create a Learning Organization

To get into the holiday spirit, I recently read a short story by William John Locke titled The Story of Three Wise Men. A story of three academics drawn to a country cabin where they delivered a baby to a dying woman. In the book, the author wrote the wise men "had grown old in unhappy and profitless wisdom". In other words, their experiments and theories benefited nobody, as they were all recluses.

I witness lots of wisdom when I interact with bankers. And I wonder, how do we avoid it being "profitless wisdom"?

My answer: create a learning organization. Here are 5 ideas on how to do so.

1. Hire for attitude, reward for effort and results.

So often we look for those with experience. Be careful what we ask for. Because with experience comes entrenched ideas, old habits, and know-it-all ism. There are benefits to experience, as the new employee will be productive quicker. But they are bringing their past culture with them. Instead, consider hiring someone eager and hungry to learn. Someone that is positive and others like to work next to. Someone that will be a builder of your learning culture, not a breaker. 

2. Have a baseline training curriculum.

Do you have a training curriculum by functional position that gives employees the tools to succeed? Based on my experience, I doubt it. You probably have compliance and operations training, because it's required by regulators and needed for employees to function. But do you match the rest of your training, if there is a rest, to your strategy and the job description? Training should start with an orientation program that shows employees the culture you are creating, how to function within it and nurture it, and what your bank's "way" is... i.e. how to answer phones, interact with employees, solve problems, etc. Beyond orientation, do you enroll budding credit analysts in Credit Admin school? Do you use a "test bank" to build a disciplined OJT program so your employees can be proficient at getting things done? 

3. Teach supervisors to supervise.

Banking is a hot-bed for the Peter Principle, advancing good performing employees into positions where they are not equipped to succeed. Does a great wire clerk make for a top notch Deposit Operations supervisor? Supervision and leadership skills to maximize employee performance and job satisfaction are learned skills. So teach them how to coach, reward, discipline, evaluate, and teach. Poor management and supervision is the greatest hurdle to building a learning organization.

4. Allow mistakes.

The amount of effort I have witnessed to avoid audit findings, regulator scrutiny, or supervisor retribution is monumental. Not that I mind this because bankers hire my firm to look at the resulting onerous processes to ask "why are you doing that?".  This no mistakes culture kills experimentation that can lead to significant improvements in how we get things done. An organization that treats mistakes as a lesson learned rather than an opportunity to write someone up is well on its way to becoming a learning organization.

5. Pass on the knowledge.

What good is the wisdom garnered from years of experience if it remains trapped within the mind of the experienced? Create a process to pass on knowledge. For example, perhaps the wire transfer clerk questions a cumbersome process to identity check a customer. The learning organization supervisor encourages employees to identify and solve for cumbersome processes, so the clerk interfaces with the wire transfer software firm to discuss alternatives. She makes a recommendation that looks favorable to the supervisor and compliance. Boom! The bank implements it, and the clerk drafts a "Knowledge Bomb" memo to her co-workers that changed the process for the better. The supervisor publicly acknowledges the accomplishment, and notifies the bank CEO about the clerk's initiative. The CEO publicly acknowledges the clerk in the company newsletter. Per the "allow mistakes" above, if regulators review the process next exam cycle and don't like it, make a modification that works for them and is efficient. But don't use the criticism as an opportunity to embarrass the clerk that designed the process. It would be a lesson learned.

What other ideas do you have for creating a learning organization?

~ Jeff

Further reading:

Harvard Business Review: Building a Learning Organization (1993)

https://hbr.org/1993/07/building-a-learning-organization

Lynda.com: Create a Culture of Learning in 6 Steps
http://pages.lynda.com/rs/063-DFS-642/images/Guide_6Steps.pdf