What is liquidityrisk?

Liquidity Risk can mean very different things. A bank is illiquid if it cannot meet its payment obligations as they fall due. A financial instrument is liquid if it can be sold timely in volume and at market price. A financial market is liquid if its instruments are liquid or if there is simply enough central bank money available.

As liquidity in its general meaning comprises ‘all’ possible detrimental effects stemming from a bank’s liquidity situation, it might be necessary to differentiate. Primary liquidity risk (illiquidity risk) is the bank’s inability to fulfil all contractual obligations as they fall due; whereas liquidity induced P&L risk describes the bank’s disability to compensate a potential cash shortage or surplus at (normal) market prices.

Liquidity Risk Corporation focuses on primary liquidity risks.

What do you need for managing Liquidity Risk?

Firstly, a bank needs to be able to capture ‘all’ of its active transactions and predict their scheduled cashflows. The bank should be in a position to simulate these cashflows as well as its potential balance sheet under external and internal scenarios, and create consistent stress tests for the regulators.

The bank needs to know and understand its ability to execute strategies against potential cash shortages.

Liquidity Risk Corporation provides a bank with all necessary liquidity risk measurement and management tools.