2024 Journal of Community Bank Case Studies

2024 COMMUNITY BANK CASE STUDY COMPETITION

Part I.6: Liquidity Liquidity measures a company’s ability to fulfill short-term financial obligations. The banking industry is unique because a bank’s assets are loans, and its liabilities are deposits. In accounting practices for typical institutions, this is backward. However, a bank makes money by lending customer deposits and earning interest on those loans. From the institution’s perspective, this system converts depositors into creditors (whom the bank must eventually repay) and loans into assets. Relative to every other area of financial services, this arrangement seems unconventional. For this reason, a simple current ratio is of little use in determining a bank’s liquidity; it is necessary to use a ratio that measures the bank’s ability to repay its depositors to evaluate the liquidity of a bank. The net loans and leases to deposits ratio (LDR) is the most common measure of liquidity used for banks. This ratio is calculated by dividing net loans and leases by deposits. The higher the value of this ratio, the lower the bank’s liquidity. For example, shown in Figure 5, FCCB’s LDR was 96.19% in 2023. In other words, for every dollar a consumer deposited, FCCB lent approximately

ninety-six cents. The more deposits a bank lends out, the greater the risk that the bank may be unable to fulfill obligations to depositors in the future. Following the bank closures of 2023 (evaluated in Part II), liquidity management is a heightened concern for regulators. Compared to PG4, FCCB has consistently shown lower liquidity over the last five years. Based solely on this measure, one might conclude that FCCB is riskier than the average bank in this peer group. However, according to Nasdaq, the optimal LDR ratio is 80-90% (Trefis). Therefore, even though FCCB has maintained a ratio consistently higher than that of its peers, the bank is still within optimal ranges in most years. Part II: Responding to the 2023 Bank Closures Part II.1: FCCB vs SVB, Signature, and First Republic As mentioned in the Executive Summary, to evaluate and explain the causes of the 2023 bank closures, we utilize the message from Governor Bowman found in the Federal Reserve System’s first 2023 issue of Community Banking Connections. In the spring of 2023,

SVB, Signature Bank, and First Republic Bank failed, revealing vulnerabilities within the banking industry concerning liquidity. The banks that failed experienced significant customer withdrawals within just

Figure 5: Net Loans & Leases to Deposits FCCB vs PG4

0.00% 20.00% 40.00% 60.00% 80.00% 100.00%

FCCB PG4

2019

2020

2021

2022

2023

Source: FFIEC UBPR Call Reports, FCCB. PGAR, PG4; 2023 SEC 10-K report, CZFS.

12