Liquidity Risk – New Lessons and Old Lessons
Posted: 11 November 2008 | Source: SunGard
The flight to quality that began in 2007 reminded many banks of the importance of liquidity risk management. While maintaining ample liquidity for significant stresses is a costly proposition, there is a balance to be struck between short-term earnings and long-term survival.
The crisis also reminded us that liquidity risk is a consequential risk. However, this time, none of the usual suspects such as credit and trading losses triggered the liquidity stresses. Instead, liquidity problems resulted from the belated recognition of risk in mortgage backed securities which led to a massive flight to quality and, for some banks, the need to fund off-balance sheet commitments. While the initial cause of both problems was excessive exuberance in US residential mortgage underwriting, problems quickly spread.