Liquidity Risk
Presented by Manel Fendri
Definition of Liquidity Risk
What is it? Why does it exist? How to measure it?
The risk that a firm won't be able to Because the timing of cash inflows and By looking at the availability of cash and assets
meet its short-term obligations. outflows is uncertain. that can be quickly converted into cash.
Asset Maturity Mismatch
01 When short-term liabilities exceed short-term
Causes of
assets, liquidity risk arises.
Liquidity Risk Insufficient Market Depth
02 If a market has limited participants or trading
volume, it can lead to liquidity problems.
Funding Dependency
03 Heavy reliance on short-term funding
increases vulnerability to liquidity shocks.
sources
Effects and Consequences of Liquidity Risk
Bankruptcy Reputation risk Opportunity cost
When liquidity risk is not managed properly, a Customers and investors will avoid a company When short-term funds need to be used, long-
company may become insolvent. that cannot fulfill its promises. term growth opportunities may be missed.
Liquidity Risk Indicators
Market Depth
Assess the number of buyers and sellers in a market to
gauge liquidity.
Bid-Ask Spread
A large spread indicates illiquid markets, posing
liquidity risk.
Funding Costs
Higher funding costs may signal worsening liquidity
conditions.
Measuring and Assessing Liquidity
Risk
Current ratio
A measure of a firm's ability to pay its short-term liabilities with its
current assets.
Cash flow adequacy
A measure of a firm's capacity to generate cash inflows over time.
Stress testing
A simulation of financial risks under hypothetical adverse scenarios.
Managing and Mitigating Liquidity Risk
1
Risk Identification
Identify risks that can affect the
company's liquidity position.
Contingency Planning 2
Establish measures to deal with potential
liquidity problems.
3 Contingency Planning
Establish measures to deal with potential
liquidity problems.
Communication
4
Communicate the company's liquidity
profile to internal and external
stakeholders.
Federal Reserve Basel Committee
Requires institutions to Sets global standards for
maintain a minimum level of banking regulation and
liquidity.
Regulatory supervisory practices.
Framework for
Liquidity Risk SEC
Dodd-Frank Act Management
Requires stress testing and Requires disclosure of
contingency planning. liquidity risk.
Effects and Consequences of Liquidity Risk
Global Financial Crisis Bank Runs Bond Market Volatility
The 2008 crisis exposed the dangers of Instances of multiple depositors withdrawing Sharp price swings in the bond market can
insufficient liquidity in the financial system. funds simultaneously due to fear of a bank's create liquidity crunches for investors.
solvency.
8
Effects and Consequences of Liquidity Risk
Thank you very much!
Global Financial Crisis Bank Runs Bond Market Volatility
The 2008 crisis exposed the dangers of Instances of multiple depositors withdrawing Sharp price swings in the bond market can
insufficient liquidity in the financial system. funds simultaneously due to fear of a bank's create liquidity crunches for investors.
solvency.
8
Conclusion
Liquidity risk is a critical consideration for
businesses and financial institutions.
Understanding its causes, consequences, and
management techniques is crucial for
maintaining stability and resilience in the face
of uncertain financial conditions.
Thank you very
much!
Thank you