Liquidity risk is a risk to an institution's earnings, capital and reputation arising from its inability (real or perceived) to meet its contractual obligations in a timely manner without incurring unacceptable losses when they are due. Liquidity Risk and Liquidity Risk Management The liquidity risk of banks arises from funding of long-term assets by short-term liabilities, thereby making the liabilities subject to rollover or refinancing risk. “One bank told me they are full and they can’t take on more risk.” Analysts say poor liquidity is exacerbated by fully automated, high-speed market-makers.
The course is targeted at an intermediate level and assumes a basic understanding of banking products and services. Regulators, analysts, risk and banking professionals who need to better understand the liquidity risk management challenges and strategy within a bank. Liquidity risk is usually of an individual nature, but in certain situations may compromise the liquidity of the financial system. 2.1 Liquidity 10 2.2 Liquidity risk 15 3 Liquidity linkages 20 3.1 Liquidity linkages in normal times 20 3.2 Liquidity linkages in turbulent times 23 4 A description of the current turmoil 38 5 Policy recommendations and conclusions 42 Appendix 45 References 57 European Central Bank Working Paper Series 68 CONTENTS For banks this would be measured as a spread over libor, for nonfinancials the LRE would be measured as a spread over commercial paper rates. Culp denotes the change of net of assets over funded liabilities that occurs when the liquidity premium on the bank's marginal funding cost rises by a small amount as the liquidity risk elasticity. In banking parlance, liquidity is a financial institution's capacity to meet its obligations as they fall due without incurring losses. There are several ways to express this risk tolerance, such as the percentage of total debt obligations not fully funded at a point in time. Liquidity Risk at Banks: Trends and Lessons Learned from the Recent Turmoil Jim Armstrong (Bank of Canada) and Gregory Caldwell (Offi ce of the Superintendent of Financial Institutions) The market turmoil that began in late 2007 underscored the importance of liquidity to the functioning of financial markets and the banking sector. A key component of this system is a firm’s liquidity risk tolerance, which is the level of liquidity risk that the bank is willing to assume.

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