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Liquidity risk management and ALM encompass the processes and strategies a bank uses to: Ensure a balance sheet earns a desired net interest margin, without exposing the institution to undue risks from the interest rate volatility.


Virtually every financial transaction or commitment has implications for a bank’s liquidity. Effective liquidity risk management helps ensure a bank’s ability to meet cash flow obligations, which are uncertain as they are affected by external events and other agents’ behaviour.

Frequently Asked Questions

What is liquidity risk in risk management?

Liquidity risk is the risk to an institution’s financial condition or safety and soundness arising from its inability (whether real or perceived) to meet its contractual obligations.

What is liquidity risk with example?

A liquidity risk example in banks is a decline in deposits or rise in withdrawals (which are liabilities for the bank). As a result, the bank is unable to generate enough cash to meet these obligations. This was dramatically illustrated by the global financial crisis of 2008-2009.

What is meant by liquidity management?

Liquidity Management refers to the services your bank provides to its corporate customers thereby allowing them to optimize interest on their checking/current accounts and pool funds from different accounts. Your corporate customers can, therefore, manage the daily liquidity in their business in a consolidated way.

What is liquidity risk in simple words?

Liquidity risk occurs when an individual investor, business, or financial institution cannot meet its short-term debt obligations. The investor or entity might be unable to convert an asset into cash without giving up capital and income due to a lack of buyers or an inefficient market.

How do banks measure liquidity risk?

To measure the magnitude of liquidity risk the following ratios are used: 1. Ratio of Core Deposit to Total Assets (CD/TA) 2. Ratio of Total Loans to Total Deposits (TL/TD) 3. Ratio of Time Deposit to Total Deposits (TMD/TD) 4.

What is liquidity and why is it important?

Liquidity is the ability to convert an asset into cash easily and without losing money against the market price. The easier it is for an asset to turn into cash, the more liquid it is. Liquidity is important for learning how easily a company can pay off it’s short term liabilities and debts.

What are the types of liquidity management?

The two main types of liquidity include market liquidity and accounting liquidity. Current, quick, and cash ratios are most commonly used to measure liquidity.

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What is the objective of liquidity management?

The primary objective of liquidity management is to maintain a cash position that allows the university to meet daily obligations without incurring the opportunity costs that arise from having excess cash.

How do you calculate liquidity risk?

It’s a measure of a company’s liquidity, efficiency, and financial health, and it’s calculated using a simple formula: “current assets (accounts receivables, cash, inventories of unfinished goods and raw materials) MINUS current liabilities (accounts payable, debt due in one year)”read more.

What causes liquidity problems?

At the root of a liquidity crisis are widespread maturity mismatching among banks and other businesses and a resulting lack of cash and other liquid assets when they are needed. Liquidity crises can be triggered by large, negative economic shocks or by normal cyclical changes in the economy.

How do you hedge liquidity risk?

The first method is to acquire more assets, which can generate future cashflows that can complement the potential net cash outflows. This method can be referred to as hedging with contractual cashflows that naturally complement the term structure of liquidity.

How do you measure liquidity?

The current ratio (also known as working capital ratio) measures the liquidity of a company and is calculated by dividing its current assets by its current liabilities. The term current refers to short-term assets or liabilities that are consumed (assets) and paid off (liabilities) is less than one year.

What is the difference between credit risk and liquidity risk?

Credit risk is when companies give their customers a line of credit; also, a company’s risk of not having enough funds to pay its bills. Liquidity risk refers to how easily a company can convert its assets into cash if it needs funds; it also refers to its daily cash flow.

How does liquidity affect a business?

A company’s liquidity indicates its ability to pay debt obligations, or current liabilities, without having to raise external capital or take out loans. High liquidity means that a company can easily meet its short-term debts while low liquidity implies the opposite and that a company could imminently face bankruptcy.

What are liquidity needs?

Your liquidity needs simply refer to how much readily accessible money you need to cover your regular expenses, upcoming purchases, and/or emergency spending.

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