Eldred Buck, Managing Director
Eiger Trading Advisors
May 2011
Liquidity is defined as the ability of a bank to fund increases in its assets and to meet its obligations as they come due, without incurring unacceptable losses.
The raison d’ętre of a bank in an economy is in the role of maturity transformation of its short term deposits; which appear on the right hand side of its balance sheet, into long term loans; which appear on the left hand side of the balance sheet and to make a return for shareholders.
Therefore, any mismatch of this maturity transformation between assets and liabilities makes banks inherently vulnerable to liquidity risk — since banks by the very activity of ‘banking’ are able to leverage their assets in proportion to the liabilities; within regulated ratios of their capital, which completes the liability side of the balance sheet.
Furthermore, liquidity risk is driven from both an institution-specific or non systemic perspective, as well as from the market as a whole, that is, from systemic factors.
