What is Contingency Funding Plan?
Contingency Funding Plan(CFP) is a set of policies and procedures that serves as a blue print for a bank to meet its funding needs in a timely manner at a reasonable cost. A CFP is a projection of future cash flows and funding sources of a bank under market scenarios including aggressive asset growth or rapid liability erosion. To be effective it is important that a CFP should represent management's best estimate of balance sheet changes that may result from a liquidity or credit event. A CFP can provide a useful framework for managing liquidity risk both short term and in the long term. Further it helps ensure that a bank can prudently and efficiently manage routine and extraordinary fluctuations in liquidity. The scope of the CFP is discussed in more detail below.
Use of CFP for Routine Liquidity Management :
For day-to-day liquidity risk management integration of liquidity scenario will ensure that the bank is best prepared to respond to an unexpected problem. In this sense, a CFP is an extension of ongoing liquidity management and formalizes the objectives of liquidity management by ensuring:
- A reasonable amount of liquid assets are maintained.
- Measurement and projection of funding requirements during various scenarios.
- Management of access to funding sources.
Use of CFP for Emergency and Distress Environments :
Not necessarily a liquidity crisis shows up gradually. In case of a sudden liquidity stress it is important for a bank to be seen to meet its obligations in an organized, candid, and efficient way. Since such a situation requires a spontaneous action, banks that already have plans to deal with such situation could address the liquidity problem more efficiently and effectively. A CFP can help ensure that bank management and key staffs are ready to respond to such situations. Bank liquidity is very sensitive to negative trends in credit, capital, or reputation. Deterioration in the company's financial condition (reflected in items such as asset quality indicators, earnings, or capital), management composition, or other relevant issues may result in reduced access to funding.
Scope of CFP
The sophistication of a CFP depends upon the size, nature, and complexity of business, risk exposure, and organizational structure. To begin, the CFP should anticipate all of the bank's funding and liquidity needs by:
- Analyzing and making quantitative projections of all significant on- and off balance-sheet funds flows and their related effects.
- Matching potential cash flow sources and uses of funds.
- Establishing indicators that alert management to a predetermined level of potential risks.
The CFP make projection on the bank's funding position during both temporary and long term liquidity changes, including those caused by liability erosion. The CFP should explicitly identify, quantify, and rank all sources of funding by preference, such as:
- Modification or increasing liability structure.
- Using other alternatives for controlling balance sheet changes.
The CFP includes asset side as well as liability side strategies to deal with liquidity crises. The asset side strategy may include; whether to liquidate surplus money market assets, when to sell liquid or longer-term assets etc. While liability side strategies specify policies such as pricing policy for funding, the dealer who could assist at the time of liquidity crisis, policy for early redemption request by retail customers, use of NRB discount window etc. A CFP also chalks out roles and responsibilities of various individuals at the time of liquidity crises and the management information system between management, ALCO, traders, and others.
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