Broaden Your Perspective with Liquidity Stress Testing

“Because I said so.” Few phrases convey a universal response of utter dismay like this one. I remember vividly as a child hating this response and, like most children, vowed never to let those words escape my lips. Those same childhood memories influence our responses to this day and leave us searching for the ultimate reason behind decisions.

A good example of this is the examiner request for liquidity stress testing. When I speak to credit unions about liquidity stress testing, there is often a sigh followed by a response questioning its purpose. Thankfully, I can keep my childhood promise and state, “Because the Examiner said so.” But in truth, that is not my reply, because there is value in the liquidity stress testing beyond the seemingly arbitrary request.

Liquidity stress testing is not about what will happen in the future, but rather what our response will be when something happens. Despite our best planning, we will never be able to forecast for unexpected liquidity events. Stress testing gives us the ability to go over the top with unrealistic scenarios to help us prepare for even the unplannable circumstances.

One of the largest rebuttals I hear is, “Do you really believe this is going to happen? It’s so unrealistic!” This is a true statement, it is unrealistic. However, we only need to take account of the last couple of years to understand the meaning of “unrealistic.” Did anyone foresee a global pandemic that led an economic downturn? Or the unprecedented federal stimulus response that led to massive excess liquidity in the system? When thinking about this test, we need to pause and remember that, despite our best efforts, we cannot plan our future - only our reaction.

Think about it like this. Athletes spend countless hours on agility training to prepare their bodies to react to a situation without hesitation. Although less exciting than watching the performance of a sports star make the game winning play, liquidity stress testing is a similar preparation, but for dexterity of the mind. It’s forecasting agility at its best.

Studies have shown that institutions that go through the process of planning are better prepared when the actual extraordinary event occurs because they have trained for it and their reaction time is therefore better.

The other rationale for this kind of testing is that showing the work is important. I have not seen an institution since the pandemic with a liquidity problem. Everyone knows that, so why are we still going through this painful exercise? I like to compare it to math class; you know the answer, but the teacher will not give you credit until you show your work. The examiner knows you have enough liquidity, but showing your work in liquidity stress testing displays your intent to keep it that way and how you plan to get there.

So, the next time liquidity stress testing finds its way to your desk, instead of the emotions that accompany “because I said so,” try shifting your perspective. Proceed with the mindset that it will sharpen your agility and make the most of the process to enhance your future reaction time. Who knows, maybe you’ll even make the game-winning catch!

Melissa Scott serves as Vizo Financial’s vice president of ALM services. In this role, she is responsible for managing and providing ALM reporting, modeling, validation and consulting services to credit unions. She is also responsible for providing ongoing training, support and education for ALM users, management and their board of directors. She also holds the designation of certified public accountant (CPA) and is a member of the North Carolina Association of Certified Public Accountants.