The risk of liquidity is commonly misunderstood, but plays a vital role in financial stability and market trust. In the collapse of the Silicon Valley Bank (SVB) it was emphasized how the perception of the liquidity risk regularly can escalate to a full-blown crisis with problems with solvency. For financial analysts, the understanding of the bank liquidity of the liquidity risk shouldn’t be only of importance for the assessment of individual banks, but additionally for the evaluation of wider market conditions.
Regardless of whether the evaluation of the evaluation of balance sheet structures, the sources of financing for stress tests or the determination of potential market liquidity disorders must recognize how the liquidity risk influences the pricing of the assets, creditworthiness and systemic risk.
The primary explanation for the SVB error is commonly cited as a failure to treat the danger of liquidity. But what’s liquidity risk? Has SVB failed exclusively since it couldn’t fully meet the redemptions of all insertions? Why wasn’t SVB just selling its loans and financial assets to cover the repayment application of its inserts?
These questions illustrate the everyday confusion between liquidity and solvency. In SVB’s case, it was unclear whether the marketable value of its assets (mainly treasury calculations and bonds) was sufficient to fulfill its liabilities in view of the big losses that they were sitting on. Simply expressed, the worth of his liabilities exceeded the worth of his assets at a certain cut-off date. It was insolvent, not illiquid.
The inserts found that after they were in line for the primary time, they’d get 100% of their deposits back. Waiting for too long and SVB simply expired the funds unless the remaining deposits were insured by the Federal Deposit Insurance Corporation (FDIC). Many of the deposits weren’t insured with FDIC. It could have looked like a pure bank run on the surface. Just it wasn’t.
What is bank liquidity risk?
Structural liquidity risk
The structural liquidity pertains to the risks that a bank has on its balance sheet as a result of the maturity transformation. The bank pools briefly, liquid liabilities and buys in the long run, illiquid debts or loans. The risk of liquidity results from the balance sheet structure as a result of the due abnormality.
Term liquidity risk
The term liquidity refers to a non -agreement between the time of the money inflows of a bank from their assets and the flows of cash to finance its liabilities. Structural and runtime liquidity depend, because the money inflows of the asset sports folio are generally contractual and don’t all the time match liabilities from the drainage of cash. This deposit and short -term credit of money flows are largely behavior -related in nature, not contractually.
Contingent liquidity risk
The contingent liquidity risk refers back to the risk of inadequate means to fulfill short -term obligations. The contingent liquidity is expounded to the sense with structural and term liquidity that there’s all the time the potential for mismatch. Banks all the time need a solution to close the gap briefly -term money.
On a certain day there might be an unusually large withdrawal of the deposit, or many borrower can resolve to cut back their credit line. The discount window of the Federal Reserve, the Repo Market or the Credit Line of the Federal Home Loan Bank (FHLB) are some contingent credit facilities that banks can fall back on. Banks should be certain that you usually have access to those secured lines. Banks also should be certain that they’ve high -quality, unpainted assets as collateral to secure credit.
Market liquidity risk
The risk of market liquidity is the danger of selling assets onto the market as a result of temporary market disorders. This disorder often manifests itself in very large BID-as-spreads.
What is bank liquidity risk management?
Banks depend on various types of liquidity risk management.
There are two basic options for assessing the tactical liquidity risk: net money item and mature misalignment.
Netto bar money position measures the bank’s ability to finance its assets on a completely secured basis. It deals with the ratio or difference between high-fluid securities (not loaded, repo-to-be) and unsecured, short-term rating rating financing agents. Basel LCR, NSFR is an example of such an assessment. This approach is easy and intuitive, but says nothing about timing. In other words, it tells them that the banks can survive, but not for the way long.
Mature pairing approach Corresponds to the tributaries and drains of money which are on the remaining maturity (e.g. NMDS and advance payments). These assembly -based approaches are the Fed method for evaluating and reporting about liquidity risks.
Strategic liquidity risk management
The strategic liquidity risk management refers back to the prediction and administration, similar to news and data in regards to the net assets of a bank, creditworthiness or general credit or market risk position, the power to loan and bond or maintenance of its inserts and investors will influence. There are three questions that the banks should answer with regard to strategic liquidity risk management:
- Funding sources: Are the CD/CPS, Repo, securitation and dependence on backup lines and feeding all supported and reliable? Does the bank have an emergency plan?
- Scenario evaluation: How stable are the behavior models and assumptions under different scenarios and the way are the rankings of the online money or the non -agreement of gaps affected? Has the bank tested the model assumptions under stress scenarios?
- Internal funds transmitted pricing: How quickly will those that award to banks to drag out at certain events? What does it cost to extend additional liquidity or attract recent insoles or investors? And are these costs assigned to the proper business boundaries?
Key Takeaways
The risk of liquidity is greater than just the power to access money – it’s about managing uncertainty by way of timing, availability and money costs. The distinction between liquidity and solvency is crucial, as might be seen in top -class bank errors similar to SVB, by which the assets couldn’t cover liabilities.
Effective liquidity risk management obliges banks to address structural false adjustments, to anticipate liquidity must the contingent and maintain reliable sources of financing. Without a strong strategy, even well -capitalized banks might be exposed to destabilizing crises. Understanding this dynamic is of essential importance for evaluating financial stability and the guarantee of resistance in an unpredictable bank environment.
