Liquidity Risk

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Within the financial industry, financial institutions face various forms of risk. Financial institutions must effectively handle and manage these various risks to maintain stability and remain competitive. For example, financial institutions can face the risk of insolvency to the risk associated with foreign exchange rates. Nevertheless, not all financial institutions face all types of risk. Additionally, when financial institutions share the same risks, they may not do so at the same level. Some financial institutions may face higher interest rate risk while others face higher insolvency risk. This paper will focus on liquidity risk. Through an analysis of three different types of financial institutions and their level of liquidity risk, one will be able to better understand liquidity risk, its impact on financial institutions, and how it can be mitigated.

When studying liquidity risk, the most important task is to understand what it involves. Saunders and Cornett (2011) and LeJeune (2010) noted liquidity risk to be the risk of an unexpected swell in withdrawals of liabilities which would require a financial institution to liquidate their assets quickly and at a lower rate than expected, also known as a liability-side risk. Furthermore, liquidity risk can be an asset-side risk which involves off-balance sheet activities, such as lines of credit, being exercised precipitously forcing the financial institution to liquidate (LeJeune, 2010; Saunders & Cornett, 2011). Additionally, liquidity risk can arise from a financial institution’s real or perceived failure to satisfy its contractual commitments (Board of Governors, n.d.).
Managing liquidity risk is not an abnormal occurrence for financial institutions as they handle...

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... Principles for sound liquidity risk management and supervision, 1-38. Retrieved from http://www.bis.org/publ /bcbs144.htm
Board of Governors of the Federal Reserve System (Board of Governors). (n.d.). Supervisory policy and guidance topics: Liquidity risk management. Retrieved December 22, 2013, from http://www.federalreserve.gov/bankinforeg/topics/liquidity_risk.htm
LeJeune, A. T. (2010). Risks facing financial institutions: Liquidity, foreign exchange and sovereign risks. International Journal of the Academic Business World, 4(2), 31-37. Retrieved from http://jwpress.com/
Saunders, A., & Cornett, M. M. (2011). Financial institutions management: A risk management approach (7th ed.). New York, NY: McGraw-Hill/Irwin.
Turner, S. H. (2011). What we learned about controlling risk (cover story). Bank Director, 21(4), 40-45. Retrieved from http://www.bankdirector.com/

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