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Market Guides > Liquidity risk explained

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Published: 1st November 2009 by William Webster

A contractual cash flow report for a bank will show you that liabilities have shorter maturities than assets. That's because running liquidity risk generally makes money. But it has risks. Lack of confidence can lead to a real shortage of cash. That's why banks hold liquidity buffers. But measuring liquidity risk goes beyond what is contracted. It needs to assess the behaviour of markets and individuals. It's why stress testing is in vogue. Stress testing can't predict the future but it can give you an estimate for your liquidity buffer. It's likely to be a lot bigger than previously and it's going to cost your firm more, that's unless you can pass the cost on through transfer pricing.

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Document Summary

Why banks borrow short and lend long. Why liquidity risk was perceived as minimal. Why liquidity lite is not an option. Measuring liquidity risk. Option like properties. Contractual cash flow reporting, strengths and weaknesses. How wholesale and retail behaviour affects the position. Stress testing. FSA CP 08 22. Liquidity risk drivers. What's liquid? The liquidity buffer. Quality of management. Contingency funding plan. Estimated liquidity costs and implications.

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