Risk Measurement

How to Quantify and Manage

Liability Stickiness
By Leonard Matz

A practical guide for evaluating deposits

and nondeposit liabilities.

L
iquidity risk management is not just about liq- For the most part, stickiness is the result of the
uid asset reserves. It isnt even mainly about funds providers confidence in the bank. The Bank
liquid asset reserves. Face it: Most banks for International Settlements (BIS) defines stickiness
hold relatively small amounts of unencumbered, as the tendency of funding not to run off quickly
marketable assets compared to potential liquidity under stress.2
needs under stress conditions. It is not unusual to Lets first identify eight characteristics that
see banks with marketable securities equivalent individuallybut especially in combination
to less than 20 percent of total assetswith half determine stickiness.
of that only marketable in normal capital market 1. Is the liability an insured deposit? Once upon
conditionsand half of that 10 percent already a time, all government-insured deposits were
encumbered for one purpose or another. Unencum- confidently assumed to be sticky. Despite the
bered,
red,, marketable
maarke securities equivalent to just five occasional panic, government insurance is
percent
peercen nt off total
totaal assets isnt a whole lot of protection
p undoubtedly a major factor that increases sticki-
in a stressed
stresssed funding
ffun g environment.
environment. ness. But, as the following anecdote makes clear,
Did
D som someone
meon ne ssay core
co deposit?
os Okay,
kay, but wwhat is government insurance is no longer sacrosanct.
a ccore dep
deposit?
posit?? A deposit obtained through
osit obtained th ough b a branch
offi
fice?? An insu
ffi
fice? insured
u edd deposit? deposit obtaine
osit? A deposi obtained from The rush to withdraw money ... came a day after
a consumer or small business? Notice that all of these fears arose that Countrywide Financial [the big-
questions attempt to defi ne a stable
fine stable deposit
depos
d t by
y virtue gest
e thhome-loan
om
me loan cocompany thee Uni
pany in th United States]
ed States
of a single characteristicc of stability.
ability could
cou file for bankruptcy protection
uld ile for ban uptcy protect on becabecause
ause oof
The problem for liquidity risk managers is actu- a worsening credit crunch stemming from the
ally bigger than how or how accurately we define sub-prime mortgage meltdown.
core deposits. The truth is that some nondeposit
liabilities are more stable than some deposits. The The parent firm borrowed $11.5 billion Thursday
question is not: Which deposits are least likely to be by using up an existing line of credit from 40
withdrawn during a liquidity event? The question banks, saying the money would help the lender
is: Which liabilities are least likely to be withdrawn meet its funding needs and continue to grow.
during a liquidity event?
Its because of the fear of the bankruptcy, said
What Is Stickiness? [Bill] Ashmore, President of Irvines Impac Mort-
gage Holdings . Its got my wife totally freaked
Liquidity risk managers need to forecast future out, he said. I just dont want to deal with it. I
cash flows. Part of that exercise requires forecasting
potential liability losses in different scenarios and at
Leonard Matz is Director, Liquidity and Interest-Rate Risk Consulting, at
different stress levels. We need a method to estimate
SunGardBancWare, Boston, Massachusetts. Contact him at
liability stabilitywhat we now call stickiness.1 lmm50@comcast.net.

FEBRUARYMARCH 2009 BANK ACCOUNTING & FINANCE 39

Risk Measurement

dont care about losing 90 days interest, I dont Two related concerns apply to brokered depos-
care if its FDIC-insuredI just want it out.3 its. First, it is plausible to assume that access to
funds from this source will be constrainedif
2. Is the liability secured? Whether it is a deposit not cut offin bank-specific stress scenarios
or a capital markets borrowing such as a repo, likely to involve a loss of confidence in the
backing by quality collateral is another strong bank. Second, severe stress scenario forecasts
contributor to stickiness. must reflect that fact that deposits obtained by
3. Are the funds controlled by the owner? When U.S. banks from brokers are legally restricted
the funds placed in your bank are controlled by to well-capitalized banks. (Exceptions can be
an agent or manager of the money, that agent made.) Accordingly, forecasts for bank-specific
may have a legal or quasi-legal responsibility to scenarios that might lead to a reduction in the
preserve the principal. For example, pension fund banks capital should treat all deposits obtained
managers. On the other hand, if the controller of from brokers as volatilenot sticky.
the money is the consumer or small business that
owns the funds, the bank is less likely to lose this
money at the first sign of trouble.
Putting It All Together
4. Does the depositor or liability counterparty have
other relationships with the bank, such as loans?
A funds provider that has a relationship with the
Step 1
bank may be reluctant to incur the costs, time and Using the eight characteristics defined above, we
effort needed to transfer all of his or her accounts. can begin to identify the sticky and volatile liabili-
More typically, the stickiness of the funds from ties. The obvious problem is that the information
counterparties who have relationships with the we need comes from different sources in the banks
bank stems simply from familiarity. records. For example, two types of liabilities, Internet
5. Is the depdepositor or liability counterparty a net deposits and brokered deposits, are identified by the
wer?? Funds
borrower?
b
boorrow F providers who owe the bank marketing channel.
sums
sum llarger
ms large er than the am
amount funds that
ount of the fund Exhibit 1 shows a work sheet that can be used to
they
theey provide
y provi
p ide mayy simplyy take comfort
omfort iin their identify the sources for the information we need.
right
rig
ght oof off
offset.
fse
6. Do
Does
oes the
t fu ffunds
d provider
nds ovider lack Internet
ack In access to
ernet ac
h ffunds? Typically, few, if any, administrative
the
Step 2
hurdles restrain transfers
fer from
om e-banking
e-baank ng accounts.
accounts. We wwill
il always
alw
ways lack
lack a clear,
cle , bright
bright line
ine separating
se
separating
g sticky
st cky
Customers with only y an online relationship, who
nline relationsh p, w
wh o from volatile liabilities.
rom volat le liabbilit e nstead, w must recognize a
Instead, we must recognize
can more easily move funds electronically, may continuum. Once we know the information sources
be significantly more prone to changing firms to we need to quantify sticky and volatile liabilities, with
obtain better rates or to react to negative news as much granularity as possible, we can combine all of
about their current firm.4 For purposes of liquidity our information and create such a continuum.
stress testing, ATM withdrawals can be considered We can use the work sheet in Exhibit 2 to reflect a
separately from evaluations of deposit stickiness. stickiness continuum.6 (Replace the list of counter-
7. Is the depositor or liability counterparty finan- party and product types shown in the exhibit with
cially unsophisticated? For example, not likely your own categories.)
to follow financial news closely. Even outside of
the e-banking sphere, well-informed consumers
may prefer not to deal with a bank whose reputa-
Step 3
tion is questioned, simply to avoid the frictions of Stickiness is scenario dependent. Most of the eight
recovering funds if a failure occurs, even if their characteristics discussed above are descriptors for
funds are fully covered by deposit insurance.5 counterparty confidence. This is vital information for
8. Did the bank obtain the deposits directly rather bank-specific scenarios involving a loss of confidence
than through a third-party deposit broker? in the bankespecially moderate and high-level

40 BANK ACCOUNTING & FINANCE FEBRUARYMARCH 2009

 Risk Measurement

Exhibit 1. Stickiness Worksheet

Stickiness Characteristic Identification Sources*
Are the funds insured? Deposit size.
Are the funds secured? Liability type (for example, repo) or counterparty type
(for example, municipal).
Funds controlled by the owner rather than a manager, Customer information records.
agent or fiduciary?
Does the funds provider have other relationships with Customer information records.
the bank?
Is the funds provider a net borrower? Customer information records.
Does the funds provider lack Internet access to the funds? Channel. All deposits not obtained through the Internet.
Is the depositor or liability counterparty likely to be Combination of account size and customer demograph-
relatively insensitive to financial information? ics (for example, age, income).
Did the bank obtain the deposits directly rather than Channel.
through a third-party deposit broker?
* Avoid double-counting. For example, many customers with small accounts are also relatively insensitive to financial information.
* The more granularity the better. For example, for secured counterparties, list repo borrowings and municipal deposits separately. For
funds providers who are managers, agents or fiduciaries, list pension funds, mutual funds and other counterparty types separately.

Exhibit 2. A Stickiness Continuum

Tolerance for credit quality or Entity Amount Percent
liquidity concerns
Money market mutual funds

Rating sensitive providers

Very
ery ssensitive
y sensi itive to perceived
deterioration
deeteri
t iorati i iin credit quality
tiion Pension funds
safety
orr safeety
y
Insurance
rance co
companies

Other
er funds providers with fiduciary responsibility

Broker/dealers

Reg
giona and m
Regional oneey ccenter
money ter banks in your countr
country

Foreign
F i b banks
k

Large corporations

Community banks in your market area

Local, uninsured, unsecured depositors

Customers who are net borrowers (their loan balances

Only sensitive to credit quality exceed their deposit balances)
and liquidity when problems are
very bad and highly publicized
Local, secured funds providers

Insured depositors

stress tests under those scenarios. For most systemic Stress tests involving systemic scenarios should
scenarios, on the other hand, the information devel- consider quite different influences on liability sticki-
oped in steps 1 and 2 is barely relevant. ness. Examples include the following:

FEBRUARYMARCH 2009 BANK ACCOUNTING & FINANCE 41

Risk Measurement

Loss of rate-sensitive deposits in scenarios in the approaches outlined in this article. While the
which market rates are likely to be high remaining life of term liabilities can be clearly and
Early withdrawal of retail time deposits in sce- accurately established, for the most part, sticki-
narios where market rates are likely to be high ness is a messy concept. It is hard to identify, hard
Loss of funds from capital markets counterpar- to quantify and varies based upon scenario and
ties during capital markets flights to quality degree of stress.
Reduced availability of funds from all sources Nevertheless, even subjective quantifi cations
during so-called credit crunches of stickiness can be a huge help to liquidity risk
forecasts and stress tests. All forecasts are by defi-
Maturity of Time or nition subjective because they require estimation
of future conditions or changes that cannot be
Term Liabilities known in advance with total certainty. And, since
useful liquidity stress tests must address very low
Up to this point, we have not considered remain- probability events, little historical data is available
ing life as a characteristic of stickiness. This is not for reference.
because the remaining life of time or term liabilities The goal is not an unachievable level of perfection.
is less important or less influential than any of the Instead, our goal is to use stickiness concepts to
eight stickiness characteristics previously defined. disaggregate liabilities into a stickiness continuum
Quite the contrary, remaining life is, in some sce- and, in combination with remaining life, use that
narios, the single most important determinant of information to make the most accurate assumptions
stickiness. In any bank-specific scenario, the remain- we can make.
ing life for liabilities that cannot be redeemed prior Careful application of the concepts and practi-
to maturity is arguably more important than any cal procedures outlined here should substantially
of the eight characteristics defined here. The same improve all liquidity forecasts based on broad
is truee for systemic
sys scenarios that do not involve a assumptions.
signifi
sig ficantt increase
gnifi
ficant inccre in market rates.
Remaining
R mainiing life
Rem l is addressed
ddress d separately
sepa ately from fro the
Endnotes
other
othher eight
e ght stickiness
eigh stiick s ffactors fo
for two reasons
reasons:
Remaining
Reemainning life is concept
g li conceptually
ually didifferent from the
ferent fro 1
Describing liability stability as stickiness is a coinage from the
other
her eight
oth e t factors.
act
c Remaining
Rema life is not id
ing lif identifi- mid-1980s, probably attributable to Brian Ranson, then at the
able by product type, counterparty type, marketing
bll b Bank of Montreal.
channel or depositor dem demographics.
graphics. In Instead,
s ead, it aaris-
ris 2
Basel
Bas el C
Committee
mm tt e on Ban
Bankingng SSupervision,
upervisi n BISBIS, Prin
Principles
cip es oof
es from the defining ele element of term liabilities.
nt term liabilities. Sou
Soundnd Liqu dity R
Liquidity isk Ma
Risk M men and Sup
Management ervision, Pa
Supervision, ragraph
Paragraph
For liquidity riskmanagement purposes, 30 (Sept. 2008).
best-practice diversification treats maturity 3
E. Scott Reckard and Annette Haddad, A Rush to Pull Out
diversification (also known as rollover risk) sepa- Cash, L.A. TIMES, Aug. 17, 2007, www.latimes.com/business/la-
rately from diversification by type or product. fi-countrywide17aug17,0,1835165.story?coll=la-home-center.
4
International Institute of Finance, Principles of Liquidity Risk

Stickiness: A Messy Concept 5

Management (Mar. 2007), at 17.
Id.
Readers looking for a simple formula or pack- 6
Adapted from a chart developed by the Office of the Comp-
aged solution are undoubtedly dissatisfied with troller of the Currency.

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42 BANK ACCOUNTING & FINANCE FEBRUARYMARCH 2009