Bank of Montreal 2012 Annual Report Download - page 89

MD&A
MANAGEMENT’S DISCUSSION AND ANALYSIS
profile that considers historical and forecasted trends in changes in the
balances due. These models have been developed using statistical
analysis and are validated through regular model vetting, backtesting
processes and ongoing dialogue with staff in the lines of business.
Models used to predict customer behaviour are also used in support of
product pricing and performance measurement.
Liquidity and Funding Risk
Liquidity and funding risk is the potential for loss if BMO is unable
to meet financial commitments in a timely manner at reasonable
prices as they fall due. Financial commitments include liabilities to
depositors and suppliers, and lending, investment and pledging
commitments.
Management Framework Overview
Managing liquidity and funding risk is essential to maintaining the safety
and soundness of the organization, depositor confidence and stability in
earnings. It is BMO’s policy to ensure that sufficient liquid assets and
funding capacity are available to meet financial commitments, even in
times of stress.
BMO’s Liquidity and Funding Risk Management Framework is
defined and managed under the appropriate corporate policies and
standards. These policies and standards outline key management princi-
ples, liquidity and funding management metrics and related limits and
guidelines, as well as roles and responsibilities for the management of
liquidity and funding risk across the enterprise. BMO has robust limits
and guidelines in place to manage liquidity and funding risk. These
limits and guidelines establish the secured and unsecured funding
appetite for both trading and structural activities, maturity concentration
tolerances, counterparty liability diversification requirements, and
pledging activity. Guidelines are also established for the size and type of
uncommitted and committed credit and liquidity facilities that may be
outstanding to ensure liquidity and funding risk is appropriately man-
aged. An enterprise-wide contingency plan that will facilitate effective
management through a disruption is also in place. Early warning
indicators identified in the contingency plan are regularly monitored to
identify early signs of liquidity risk in the market or specific to BMO.
The RRC oversees liquidity and funding risk and annually approves
applicable policies, limits and the contingency plan and regularly
reviews liquidity and funding positions. The RMC and Balance Sheet and
Capital Management Committee provide senior management oversight
and also review and discuss significant liquidity and funding policies,
issues and action items that arise in the execution of our strategy. The
Corporate Treasury group recommends the framework, risk appetite,
limits and guidelines, monitors compliance with policy requirements and
assesses the impact of market events on liquidity requirements on an
ongoing basis.
BMO subsidiaries include regulated and foreign entities, and therefore
movements of funds between companies in the corporate group are sub-
ject to the liquidity, funding and capital adequacy considerations of the
subsidiaries, as well as tax and regulatory considerations. As such, liquidity
and funding positions are managed on both a consolidated and key legal
entity basis. Liquidity and funding risk management policies and limits are
in place for key legal entities that are informed by legal and regulatory
requirements for each entity, and positions are regularly reviewed at the
legal entity level to ensure compliance with applicable requirements.
BMO employs fund transfer pricing and liquidity transfer pricing
practices to ensure the appropriate economic signals are provided to the
lines of business on the pricing of products for customers and to assess
the performance of each business. These practices capture both the cost
of funding assets and the value of deposits under normal operating
conditions, as well as the cost of supplemental liquid assets held to
support contingent liquidity requirements.
Liquidity and Funding Position Review
Our large and stable base of customer deposits, along with our strong
capital base, is a source of strength. It supports the maintenance of a
sound liquidity position and reduces our reliance on wholesale funding.
The ratio of customer deposits and capital to loans equalled 93.6% at
the end of the fiscal year, modestly lower than 96.5% in the prior
fiscal year due to growth in loans that was higher than growth in
customer deposits.
Customer deposits include core deposits and larger fixed-rate
customer deposits. Customer deposits totalled $203.5 billion at the end
of the year, up from $194.4 billion in 2011. Core deposits are comprised
of customer operating and savings account deposits and smaller fixed-
date deposits (less than or equal to $100,000). Canadian dollar core
deposits totalled $114.3 billion at the end of the year, up from
$103.5 billion in 2011, and U.S. dollar and other currency core deposits
totalled US$76.0 billion at the end of the year, up from US$73.8 billion
in 2011. The increase in our core deposits reflects the current investor
preference for bank deposits. Larger fixed-date customer deposits
totalled $13.3 billion at the end of the year, compared with $17.1 billion
in 2011. Total deposits, which include both customer deposits and
wholesale deposits, increased $21.3 billion during 2012 to $323.7 billion
at the end of the year. The increase in total deposits primarily reflects an
increase in core deposits from organic business growth that was used to
fund loan growth, and an increase in wholesale deposits used to fund
loan and securities growth.
Our funding philosophy requires that secured and unsecured whole-
sale funding used to support loans and less liquid assets is longer term
(typically maturing in two to ten years) to better match the term to
maturity of these assets. Wholesale secured and unsecured funding for
liquid trading assets is generally shorter term (maturing in less than one
year) and is aligned with the liquidity of the assets being funded, sub-
ject to haircuts in order to reflect lower market values during times of
market stress. Supplemental liquidity pools are funded with wholesale
term funding to prudently balance the benefits of holding supplemental
liquid assets against the costs of funding.
Diversification of our wholesale funding sources is an important part
of our overall liquidity management strategy. BMO has the ability to
raise long-term funding through various platforms, including a European
Note Issuance Program, Canadian and U.S. Medium-Term Note Pro-
grams, Canadian and U.S. mortgage securitizations, Canadian credit card
securitizations, covered bonds and Canadian and U.S. senior (unsecured)
deposits. During 2012, BMO issued $15.8 billion of wholesale term
funding in Canada and internationally. Total wholesale term funding
outstanding was $72.1 billion at October 31, 2012. The mix and matur-
ities of BMO’s wholesale term funding are outlined in the tables below.
Additional information on deposit maturities can be found in Table 23 on
page 113.
Material in blue-tinted font above is an integral part of the 2012 annual consolidated financial statements (see page 75).
86 BMO Financial Group 195th Annual Report 2012