ILST Liquidity: What Is It, What Counts, and When
When it comes to internal liquidity stress testing (ILST), financial institutions must carefully assess whether they have enough high-quality, reliable funding sources to meet potential liquidity needs during periods of stress. ILST liquidity frameworks help banks and credit unions pinpoint weaknesses in their funding profile, determine how resilient they are to liquidity shocks, and guide strategic decision-making around balance sheet management.
In this post, we’ll answer the question “What is ILST liquidity?” and dive into the components of an ILST ratio—specifically the numerator. We’ll outline which funding and liquidity sources count toward this numerator, and over which time horizons they’re eligible.
What Is ILST Liquidity?
An Internal Liquidity Stress Test (ILST) is a forward-looking assessment that estimates how much cash or readily convertible assets an institution would need to weather various liquidity stress scenarios. The main objective of ILST is to ensure that a bank maintains adequate liquidity to continue operations without facing a funding shortfall under stress conditions.
The Role of the ILST Ratio
At the heart of ILST is the calculation of a ratio that compares:
Numerator: The sum of available liquidity sources
Denominator: Estimated net cash outflows under the chosen stress scenarios over a set time horizon
A healthy ILST ratio (i.e., a ratio above 1 or the institution’s internal threshold) indicates that the firm has sufficient funding to meet anticipated obligations under stressful conditions.
What Counts As ILST Liquidity?
1. Cash
Cash is the most liquid asset. It can be immediately used to cover outflows without any conversion or collateral requirements.
2. High Liquidity Assets (HLA)
Regulators often define HLA as assets that can be quickly converted to cash with minimal loss in value. Examples include government securities or government-sponsored enterprise (GSE) securities.
3. Wholesale Funding
Some institutions rely on the wholesale market for short-term funding (e.g., federal funds, repos). While wholesale funding can be sensitive to market conditions, it may remain partially accessible if the institution’s credit quality is stable.
4. Federal Home Loan Bank (FHLB) Advances
FHLB advances are secured loans from a regional Federal Home Loan Bank. They are often considered a reliable source of liquidity for eligible member institutions, provided the institution has sufficient collateral to pledge.
5. Discount Window (FRB DW)
The Federal Reserve’s Discount Window (DW) provides secured credit to depository institutions, acting as a backstop during times of stress.
6. Brokered CDs
Brokered deposits can provide additional funding capacity. While potentially more rate-sensitive than core deposits, they can still count toward available liquidity if contractually locked for a certain term.
When Counts As ILST Liquidity?
According to Regulation YY, firms must run ILST at a minimum for the overnight, 30-day, 90-day, and 1 year time horizons. Although, leading practice firms conduct their internal liquidity stress test daily for the first month and monthly through year one. Another leading practice of ILST is to align the funding options above with the operational constraints of the real-world with the timing of your ILST (e.g. days to settle asset sales, ability to raise wholesale funding in stress, etc.) Below is a general guideline of when certain funding sources should be claimed in your ILST.
Overnight: Cash is king for a reason and that reason is it’s as liquid as it gets. Some UST sales can be same day settled, but for arguments sake (and prudent liquidity risk management) it’s best to have enough cash on hand to handle one day’s worth of stressed outflows
30 Days: Cash + HLA, the end goal of the ILST (in eyes of the regulators) is to size your HLA buffer, so for that reason we’ll only include cash and HLA in the first month. If your bank is not subject to Reg YY feel free to consider other safe, reliable sources of wholesale funding to cover outflows, but be realistic about capacity and timing.
90 Days: Cash + HLA + Reliable Short-Term Wholesale Funding, this is where nobody would bat an eye at including some FHLB advances, brokered deposits, etc. Be sure to show that your firm can (and has via BAU or test transactions) operationally use the types of wholesale funding you’re claiming
1 Year: Cash + HLA + Wholesale Funding, this is where you can reasonably claim most types of funding moves (except probably not deposit growth at the same time as deposit attrition).
Conclusion
ILST liquidity is all about ensuring that an institution can cover potential outflows during a liquidity stress event by leveraging the right mix of high-quality assets and reliable funding sources. When calculating the numerator in an ILST ratio, banks and credit unions typically include highly liquid assets, cash, and secured funding sources like FHLB advances or the discount window, while also considering the reliability of wholesale funding and brokered deposits.
The time horizons for these sources vary, as short-term stresses require the most immediate and certain forms of liquidity. In contrast, longer-term stresses allow for more strategic asset disposition and potential reliance on term funding. By accurately categorizing and stress-testing each funding source over appropriate time horizons, institutions can gain a comprehensive view of their ILST liquidity position—and stay prepared for whatever stress scenarios may arise.