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Liquid Nation


Go Big or Go Home Under DICO’s Proposed Liquidity Guidelines

The pace of change in Canada’s credit union system is accelerating. Credit unions are moving away from old school business models and continue to look at new-age means to deliver products and services profitably without putting pressure on capital and liquidity. Problem is, pressure is inevitable and DICO and other provincial regulators are making sure credit unions manage this pressure by binding them to tight capital and liquidity thresholds in-keeping with strict international capital management frameworks like Basel.

DICO draft liquidity and stress testing guidance

Back in July 2016 DICO released its Liquidity and Stress testing Guidance Notes for stakeholder consultation and comment. The comment period is now over and the results are beginning to surface.
In summary DICO has introduced three new metrics for credit unions exceeding $500 million in assets as follows:

  • Liquidity Coverage Ratio (LCR)
  • Net Stable Funding Ratio (NSFR)
  • Net Cumulative Cash Flow (NCCF)

In addition, liquidity stress testing guidance has been issued.

However, we start with DICO’s guidance note on liquidity. Although for the most part the guidance provided on liquidity is nothing new and would already be applied in DICO’s ideal world, a few items should be pointed out:

  • DICO can order a credit union to amend its liquidity policies if they are considered inadequate or imprudent
  • DICO expects the use of data analytics and the quality of information systems to reflect the size and risk profile of the credit union
  • Minimum and target liquidity levels should be established which reflect expected operating needs based on analysis of at least two previous years’ fluctuations, demand changes, income requirements and any other known factors affecting liquidity, and should reflect on and off balance sheet securitizations in any form. For the purposes of calculating DICOs standard liquidity ratio, borrowings should only include securitizations that become due within the next 12 months
  • Securitizations, both on and off balance sheet, should not exceed more than 40% of total regulatory capital and deposits. Of this no more than 5% of securitizations should be anything other than NHA MBS or CMB securitizations unless pre-approved by DICO
  • Contingency funding planning should be formalized and include a range of stress situations

Worried? You probably should be if you are a credit union with dated infrastructure, low resources and a big appetite for securitizations and leverage. It is you that DICO wants to manage and ensure that you are not placing unnecessary and uncontrolled risk into the system.

How does DICO ensure this?

DICO has addressed this through rigourous​​ stress testing requirements to pre-empt liquidity risk. Again stress testing is nothing new and is a staple tool in risk identification and capital management. Some credit unions are better than others in their stress testing quality and use of assumptions. However, most are not good at formulating, monitoring and documenting various stress scenarios. Going forwards DICO expects stress testing for securitization and warehousing risks to include the impact of systemic market factors, contractual arrangements and embedded triggers, and impact of leverage, particularly related to subordination levels in the issue structure. DICO will require tight documentation of all stress assumptions and rationale and will come down hard on anything considered sub-par especially for the larger, more complex credit unions in Ontario. To keep you on your toes, DICO has proposed that stress testing results be submitted to DICO 21 days following each quarter end.

As initially contemplated from January 1, 2017 credit unions with over $500 million in assets have been asked to complete templates for:

Liquidity Coverage Ratio (LCR)
The LCR aims to ensure Ontario’s credit unions have adequate unencumbered high quality liquid assets (HQLA) that consists of cash and cash equivalents. LCR should not be lower than 100% on an on-going basis such that liquidity needs required by day 30 of a stress scenario are met by the HQLA. DICO’s concern has been that liquidity is often tied up in term deposits and investments that will be not easily accessible to the credit union in the immediate short term.

Net Stable Funding Ratio (NSFR)
The NSFR aims to stabilize the funding profile in relation to the composition of a credit union’s assets versus off-balance sheet activities. Again the accepted minimum NSFR is 100% on an on-going basis such that the amount of available stable funding is sufficient to cover required stable funding needs.  Sustainable funding is intended to reduce the likelihood of a credit union dipping into regular sources of funding thereby reducing the risk of eroding liquidity under a stress scenario. The NSFR will limit over-reliance on short term wholesale funding and encourage better assessment of funding risk across on and off-balance sheet items.

Net Cumulative Cash Flow (NCCF)
NCCF looks at cash flows beyond the 30 day horizon by assessing funding mismatches between assets and liabilities. Many credit unions are already doing this and DICO now wants to take this analysis further to include documented thresholds agreed by credit unions for the minimum time frame that the NCCF value remains positive.

Templates with application guidance for each of these metrics are available here and were initially required to be completed and submitted to DICO at the end of each reporting quarter starting with the credit union’s first financial quarter end in 2017.

Liquidity is a clear and present danger and by initiating new metrics, liquidity and stress testing guidance, DICO wants to manage the risk of this danger on the credit union system in Ontario. Considerable work will be required by Ontario’s credit unions to understand these risks more granularly and put in mechanisms to monitor them going forwards.

To learn more about regulatory changes and how these changes may impact your Credit Union, contact Annette Kuckartz, CPA, CA, at 306.664.8327 or [email protected], or your local MNP advisor.