How Community Lenders Can Handle Liquidity Challenges in 2024

Over the last couple years, interest rates have shot up from multi-decade lows to multi-decade highs. Now, managing liquidity is among the most pressing responsibilities for any community lender. 

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Liquidity challenges have put regulators on high alert, and community lenders must be prepared to demonstrate that they’re well-capitalized and capable of withstanding a crisis. Although lenders have to be especially mindful of their balance sheets when they face heightened regulatory scrutiny, lower balances, and higher costs, they shouldn’t allow these pressures to make them fearful and reactive. 

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By expanding their product offerings, reengaging with customers, and exploring new markets, community lenders can generate more revenue, improve margins, and effectively manage their liquidity. Although the development of contingency plans is a pillar of responsible liquidity management, it must complement a renewed focus on innovation and business growth. Liquidity management must be a core strategic focus, which will position them for sustainable growth in the years to come. 

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A Difficult Economic Environment

While inflation is coming down and there are signs that the real estate market is recovering, community lenders are still confronting a long list of economic obstacles. The EFFR was just above zero in early 2022, and it surged to over 5.3 percent by August 2023. Despite improved inflation numbers, a cooling labor market, and other encouraging economic indicators, the Fed still hasn’t committed to reducing interest rates. 

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Community lenders also have to remember that the threat of recession remains very real. GDP growth is expected to fall to 1.5 percent in the U.S. next year while the unemployment rate is creeping up. Meanwhile, banks are contending with lower margins, shrinking deposits, and a range of other issues. The 2023 AFP Liquidity Survey found that short-term bank deposit allocations recently hit their lowest level in four years, and regulators are paying close attention to how all these developments are affecting institutions’ liquidity. Lenders also have to brace themselves for maturing CDs over the next few months. 

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The economic situation will remain difficult in 2024, and liquidity will continue to be top of mind for community lenders. However, this doesn’t mean growth has to slow. Liquidity management will be vital, and the most successful lenders will focus on how they can leverage their available liquidity for long-term growth.

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How to Strategically Manage Liquidity

Community lenders need to have a plan for how they will maintain liquidity as interest rates remain high and deposits decline. This plan needs to incorporate updated forecasts that account for interest rates, deposit outflows, and potential economic contractions. One of the most urgent priorities for lenders should be the establishment of contingency funding plans (CFPs) and early warning systems to ensure that they’re prepared for liquidity issues.

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Beyond the fact that regulators are increasingly demanding more comprehensive and data-driven risk management, lenders also need to be taking a closer look at their balance sheets for strategic purposes. When lenders have a more accurate idea of their actual liquidity, they will be able to invest in strategic initiatives with greater conviction and adapt to new circumstances more readily. This means closely monitoring possible credit quality issues, funding concentrations, decreasing account balances, and other risks that could jeopardize liquidity. Lenders should stay away from specific triggers that automatically activate certain internal responses. Instead, they should address problems as they arise and prepare for multiple scenarios. 

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There’s a reason community lenders should expect more stringent assessments of their approach to risk mitigation at their next examination. Liquidity is a core focus for a reason, and lenders should be capable of demonstrating that they take the health of their balance sheet seriously. This isn’t just necessary for compliance—it’s necessary for growth. 

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Effective Liquidity Management Facilitates Growth

When community lenders are worried about liquidity, it can affect their strategic thinking. It’s no surprise that 63 percent of institutions say safety is their “most valued short-term investment objective.” The banking crisis in early 2023 spooked regulators and industry leaders, and the specter of a liquidity crisis casts a long shadow. 

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Community lenders need to have a thorough understanding of their liquidity status, which includes money they can borrow at a reasonable cost while maintaining their principal. Banks can continue to lend and use their assets as collateral instead of selling prematurely. Even in a high-interest rate and low-liquidity environment, lending opportunities abound. Homeowners have over $20 trillion in tappable home equity, and they want to use it, which is why HELOC and HELOAN originations shot up as refi originations collapsed. Community lenders have been particularly active suppliers of home equity lending, accounting for 56 percent of HELOC and 69 percent of HELOAN originations at the end of 2022. 

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While CFPs and early warning systems are key elements of liquidity management, community lenders should also be working to attract and retain customers with new products and services like home equity lending. This will enable lenders to diversify their revenue, grow their business, and improve their liquidity positions all at the same time.