Join Mailing List

For latest news and information about Treasury and Financial Markets, enter your details below:

Market Guides > Liquidity risk explained

Print Preview Send to a Friend Share

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.

Buy the full article now for just £4.95

If you have already purchased this article, login to view it.

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.

Related Documents

Payment Requiredelearning > Options explained 100% relevant

Learn about the following: Why options are often considered risky. The four basic option positions. In, at and out of the money. Intrinsic and time value. Simple uses for options.

Free to ViewLiquidity Risk Course 97% relevant

Free to ViewRegulation > Does liquidity risk overshadow market risk? 96% relevant

23rd January 2010

In a world where regulators are focusing on liquidity and capital it's easy to overlook market risk. In many firms this means interest rate exposure. In the UK with Bank Rate at an all time low it's tempting to think that hedging fixed rate assets is just a waste of money. After all why pay 3.25% on a 5 year swap when 3 month Libor is only 51 basis points? Surely matching the interest basis on assets and liabilities ends up costing you 274 bps doesn't it?

Registration RequiredBonds Explained 85% relevant

Free to ViewLiquidity risk in a nutshell 82% relevant

10th June 2010

Depositor confidence in the banking system is crucial. It's why banks borrow short term and lend long. Damage this sentiment and the size of cash withdrawals will threaten individual banks and the system as a whole. Hence the new regulatory measures being taken to ensure banks hold sufficient liquid resources to meet just about all eventualities. This is a very brief explanation of the new liquidity regime.

Payment RequiredLiquidity risk measures 80% relevant

25th March 2017

Banks are required to measure the inflows and outflows of cash over a designated period (30 days). This is undertaken for business as usual and stressed conditions. To make stress testing relevant the scenarios are designed by the individual bank. This analysis leads to banks holding High Quality Liquid Assets (HQLA). These are used to cover liquidity shortfalls in times of stress. The Liquidity Coverage Ratio (LCR) is the key measure. It compares the HQLA held with the net cash outflows under stressed condition and thereby indicates whether the bank is sufficiently liquid. By calculating the LCR banks undertake a detailed examination of their balance sheets. This involves evaluating all the factors that affect cash inflows and outflows. The process needs regular (at least annual) updating. Regulators review and evaluate how a bank has undertaken the assessment. Should the assessment be insufficiently detailed a regulatory “add-on” may result. The following explanation is high level and the rules and methods vary between different banks and different jurisdictions.