Bank’s liquidity: how can they solve the problem of liquidity?
It is widespread that banks always had a principal role in all contemporary financial systems. The basic part of them, commonly, is the change of fluid store liabilities into illiquid resources, for example, advances; this makes banks by and large defenceless against liquidity risk. Due to the potential risks in global financial environment, it has to be assured that a financial institution, such as a bank, is able to continue to perform its fundamental role. Liquidity speaks to the limit of a bank to subsidize increments in resources and meet out of this world due, without bringing about unsatisfactory misfortunes (Basel Committee, 2008a). In other words, we could define that liquidity is assuring access to cash when it is needed. Bank’s liquidity is about the confidence of counterparties and depositors in the institution and its perceived solvency or capital adequacy. Since liquidity costs, it should be in balance because banks have to meet all the regulations, therefore it should exist a manager of liquidity risk. This risk tries to secure a bank’s ability to carry out this fundamental role.
After the global financial turmoil (2008) many banks had negative effect because they could not follow the agreement to fund liquidity and their ability to do business in financial markets without causing important price impact (market liquidity) led to the condition that weakens liquidity and put in danger the global financial stability. There were two important trends that supported the easily broken funding framework at some banks, before the financial crisis. Firstly, instead of stable retail deposits or longer-term debt, there was a rising dependence on short-term wholesale funding. Secondly, banks collected large amounts of assets that turned out to be less liquid than anticipated especially the securitized debt instruments, such as collateralized debt obligations and residentials mortgage-backed securities. In demanded market conditions, banks could not convert into collateral these assets in nonpublic markets. After the above-mentioned problems, the Basel Committee developed the liquidity coverage ratio (LCR), which is to encourage the endurance of bank liquidity and restrict the need for public aid, and the net stable funding ratio (NSFR), which is created to advertise a more stable funding profile regarding to the maturity profile of assets, decreasing the prior of banks to funding-liquidity risk. The whole this situation central banks are the most reliable provider of liquidity; thus, they are playing a major role in the solvency of banks liquidity.
Impact of financial crisis to liquidity risk
Before the credit crisis, it was, for the most part of the world, that liquidity risk was comprehended. In any case, it was maybe not completely valued that financial advancement and global market evolutions had changed certain aspects of liquidity risk in essential ways lately. The effects of these improvements turned out to be strikingly obvious during the recent turmoil.
3.1 Dependence on capital markets
In the first place, the subsidising of major banks has moved towards a more prominent dependence on wholesale subsidising (wholesale deposits, repurchase obligations and other currency market instruments) from institutional and corporate speculators (both financial and non-financial)-a commonly more unstable resousrce of subsidizing than conventional retail deposits. At time of serious market stress, modern wholesale financial specialists tend to display intense hazard avoidance. This was made obvious by the extreme funding issues experienced in 2008 by major U.S. investment banks that had an unstable retail deposit base. At such circumstances, speculators can request higher pay for risk and better rebates to collateral assets with doubtful cash flows, demand banks to approve liabilities at greatly shorter developments, or reject to enlarge financing. In these cases, refinancing sources have to be encountered rapidly to supplant the loss of financing.