Liquidity risk is often misunderstood, but it plays a key role in financial stability and market trust. The collapse of Silicon Valley Bank (SVB) highlights how perceptions of liquidity risks (often mistaken for solving problems) can quickly escalate into a full-scale crisis. For financial analysts, understanding bank liquidity risks is essential not only to assess individual banks, but also to assess broader market conditions.
Analyzing balance sheet structures, stress test funding sources, identifying potential market liquidity disruptions, analysts recognize how liquidity risk affects asset pricing, creditworthiness and systematic risk. It must.
The main cause of SVB disorders is often cited as failing to manage liquidity risk. But what is liquidity risk? Has SVB failed because it was unable to fully meet the redemption of all depositors? Why could SVB simply not be able to sell loans and Treasury assets to cover depositor repayment requests?
These questions show the typical confusion of liquidity and solvency. In the case of SVB, it was unclear whether the asset had marketable value (most of which Very liquid The Treasury bill and bonds) would have been enough to meet its debt given the enormous unrealized losses it had sat in. Simply put, the value of the liability exceeded the value of the asset at a particular moment. It went bankrupt and was not illiquid.
Depositors realized that if they were in line first, they would regain 100% of their deposit. If they waited too long, the SVB would simply have run out of funds unless the remaining deposits were insured by the Federal Deposit Insurance Corporation (FDIC). Much of the deposit was not FDIC insurance. On the surface, it may have looked like pure banking runs. But that wasn't the case.
What is bank liquidity risk??
Structural fluidity risk
Structural liquidity refers to the risks that a bank poses to its balance sheet for maturity conversion. The bank pools short-term liability and purchases or issues long-term illiquid obligations or loans. The liquidity risk here arises from the structure of the balance sheet due to maturity discrepancies.
Terminology Liquidity Risk
Liquidity over a period refers to the discrepancy between the timing of a bank's cash inflow from an asset and the cash outflow to fund its liabilities. Asset portfolio cash inflows are usually contractual in nature and do not always match the cash outflow of liabilities, so structural and terminology liquidity is relevant. These deposits and short-term borrowing cash flows are essentially primarily behavioural and uncontracted.
Contingent liquidity risks
An accidental liquidity risk refers to the risk of insufficient funds to meet Sudden or unexpected Short-term obligation. Contingent liquidity is related to structural and term liquidity in the sense that there is always a possibility of mismatches. Banks always need a way to insert gaps with short-term cash.
On certain days there may be an unusually large withdrawal of deposits, and many borrowers may decide to lower their credit lines. A Federal Reserve Discount Window, Repo Market, or Federal Mortgage Bank (FHLB) credit line is some contingent credit facilities available to banks. Banks should ensure that these secure lines are always accessible. Banks also need to ensure high quality, unhindered assets that they use as collateral to protect their credit.
Market liquidity risk
Market liquidity risk is the risk that arises from the inability to sell assets to the market at “fair value” due to temporary market disruptions. This confusion usually appears in very large bid spreads.
What is Bank Liquidity Risk Management?
Banks rely on several forms of liquidity risk management.
Tactical liquidity risk management
There are two basic methods for assessing tactical liquidity risk: a mismatch approach between net cash position and maturity.
Net cash position It measures the bank's ability to fund fully secured assets. It examines the ratio or difference between highly liquid securities (unobstructed, repo qualifying) and unsecured short-term ratings sensitive funding. Basel LCR, NSFR are examples of such evaluations. This approach is simple and intuitive, but it doesn't say anything about timing. In other words, it tells the banks can survive, but not how long.
Maturity mismatch approach Matches cash inflows and outflows based on residual maturities (e.g., the entire loan), liquidation period (e.g., AFS or investment), short-term accidental outflows (e.g., credit and guarantee lines) and action maturities . For example, NMD and prepayment). These flow-based approaches are the Fed's way of assessing and reporting liquidity risks.
Strategic liquidity risk management
Strategic liquidity risk management is how news and information about a bank's net worth, creditworthiness, or overall credit or market risk location affects the ability to hire or retain or retain depositors and investors. refers to forecasting and managing the There are three questions banks need to address regarding strategic liquidity risk management.
- Funding source: Are all the dependencies on CD/CP, repository, securitization, and backup lines, all the Fed backtesting and reliable? Does the bank have a contingency plan?
- Scenario analysis: How stable are behavioral models and assumptions under various scenarios, and what impact will net cash or discrepancies gap ratings have? Did the bank test the model's assumptions in stress scenarios?
- Internal fund transfer price: How quickly do people lending to the bank withdraw, taking into account a particular set of events? What is the cost to increase additional liquidity and attract new deposits and investors? And are those costs allocated to the right business line?
Key takeout
Liquidity risk is more than just the ability to access cash. It is about managing uncertainty in timing, availability and cost of funds. The distinction between liquidity and solvency is important, as seen in the failure of famous banks like SVB, where asset values were unable to cover liabilities.
Effective liquidity risk management requires banks to address structural inconsistencies, anticipate contingent liquidity needs, and maintain reliable sources of funding. Without a robust strategy, even capitalized banks could face a volatile crisis. Understanding these dynamics is essential to assess financial stability and ensuring resilience in an unpredictable banking environment.
