08 Nov 2021  /  by:

By Michael Kerdachi, VP Treasury and Operations

3 Tips on budget planning in an uncertain inflationary environment

How much liquidity is enough for a rainy day?

It’s a question on credit union leaders’ minds right now amid the backdrop of rising interest rates and pent-up consumer savings, but there are steps you can take to ensure a successful business strategy for 2022.

Credit union excess liquidity remains near an all-time high compared to pre-pandemic levels due to strong deposit growth over the past 18 months. Net income for members of Central 1, the primary liquidity provider to the Canadian credit union system, is at a five year high as customers have been keeping their money in easily accessible demand deposit accounts and are taking the hit on paying high mortgage pre-payment penalties as they shop around for lower rates.

However, the tide is turning as consumers prepare to ramp up spending.

The Bank of Canada’s latest Monetary Policy Report predicts that Canadian households will spend 20 percent of the extra savings they have accumulated during the pandemic on consumption in the next two years.

Credit unions could experience a swift drop in deposit driven profits when consumer spending increases. When interest rates rise, consumers are likely to move their money into term deposits, or may choose spend the savings. With this potential shift on the horizon, it’s time for you to consider how to risk-proof your business strategy.

Here are three budgeting tips that will build contingency planning into the 2022 budget:

Budgeting tips:

1. Examine your deposit retention strategy:

As you operate within the current heated real estate market, you must retain and grow sufficient deposits to fund your lending activities. The recent widening of the 5-year Government of Canada bond yield will lead to further opportunities to grow lending in the mortgage space.

As mortgage shoppers examine the potential for new deals, you should examine local residential mortgage demand and whether there is potential for new lending. Securitization is a useful tool for boosting liquidity because it enables you to diversify your risk, gain access to funding, lower the cost of funds and increase margins.

2. Determine your risk appetite:

Given the current uncertainty regarding the timing of Canada’s next interest rate hike, consider using hedging techniques to reduce your exposure to various risks. Our team of capital markets professionals are well versed in the creation of hedging strategies if that’s an area of interest.

Interest rate risk must be managed effectively to ensure rate increases do not erode profitability. The impact of rate changes is not uniform across a credit unions’ balance sheet; generally deposits reprice faster. Central 1’s interest rate derivatives is a helpful resource to restructure balance sheets and optimize value by managing risks.

3. Incorporate digital payments trends into budget planning:

The COVID-19 pandemic further accelerated the migration to digital and contactless payments and growth in online transfers, with an equal decline in cash and cheques. It’s important that you include analysis of both digital and in-branch activity into your budget planning.

Payments Modernization, the largest-ever payments initiative led by Payments Canada, is progressing and you should also factor this major project into your budget planning. A modernized payment system means your financial institution will be able to provide faster, data-rich payments solutions to your customers. Get in touch with our Payments team to discuss the key deliverables for consideration in your 2022 plans and budgeting process. Remember, Payments Modernization is a multi-year initiative and should be part of your planning and budgeting for the next few years.

The Bank of Canada is predicting that inflation will stay above target through much of next year, due to higher energy prices and supply bottlenecks. Continue to assess alternative scenarios amid this backdrop.

Central 1’s Treasury team is here to advise and we’re committed to providing our members with expertise, products and services to ensure their success.