Liquidity – Background and Key Concepts

In this chapter, the concepts of liquidity and liquidity risk are brought into the picture and an overview given of the various liquidity concepts. It establishes that liquidity risk is the risk of being unable to meet obligations as they become due and payable or only being able to do so at an unsustainable cost. Liquidity gap is the maturity mismatch between assets and liabilities in each maturity segment. The chapter introduces the time element further into the risk definitions and the management of liquidity. The three time dimensions of liquidity risk are: tactical, structural and contingency depending on the timeframe they appear in. The chapter also introduces the overall liquidity management framework, the ‘6 Step Framework’. It ends with the conclusion that the optimal liquidity level set at individual bank levels is lower than the macroeconomic risk would require.