Pub. 8 2019 Issue 6

November/December 2019 25 l e a d i n g a d v o c a t e f o r t h e b a n k i n g i n d u s t r y i n k a n s a s liquidity developments. The ultimate effect of any single event should be taken into consideration, and the bank should game- plan alternative strategies in response. Investments and Liquidity: Banks traditionally used the investment portfolio as a store of liquidity. This original purpose seemed to have faded somewhat as alternative sources of funding became available and widely used. Today, it may make sense for banks to revisit the role of the investment portfolio as a vehicle for managing liquidity. Proper identification of bonds and bond-types that provide reasonably consistent and predictable cash flow, as well as securities that are readily sold in the secondary market, is critical. The risk/reward relationship for securities should be viewed with an eye toward liquidity risk. When purchasing a bond or considering alternatives, portfolio managers should take a hard look at the cash flow uncertainty or optionality as well as the underlying price sensitivity. Scenario Cash Flow Analysis: From a liquidity management standpoint, the ability to monitor the scenario dynamics of investment cash flows is extremely important. Projected cash flows under the existing rate environment are a necessary starting point, but must be supplemented by additional projections for different rate scenarios. We know portfolios that contain callable bonds and/or MBS will experience faster cash flows when rates fall, and slower cash flows when rates rise. This asymmetry of cash flows and the degree to which those cash flows are uncertain needs to be calculated and reflected in an analytic reporting model. Liquidity risk management is obviously important in today’s environment from both a regulatory standpoint and from the perspective of prudent bank management. Having the right processes, tools, and management practices in place will help the bank maintain healthy performance and an optimal risk/reward profile. Jeffrey F. Caughron is a Managing Director with The Baker Group, where he serves as President and Chief Executive Officer. Caughron has worked in financial markets and the securities industry since 1985, always with an emphasis on banking, investments, and interest rate risk management. Contact: 800-937-2257, jcaughron@GoBaker.com .