ABSTRACT
INTRODUCTION e last chapter considered the interest rate and FX risks an institution might take as part of its funding strategy. One of the central questions was how much the bank’s cost of funds might change if interest rates moved given how it plans to borrow. Here we look at another aspect of funding: the risk that the rm might not be able to borrow at all, or only at prohibitive cost, perhaps due to a fall in con dence or to a market-wide crisis. is is liquidity risk.*
Liquidity risk in a rm occurs due to the mix of assets and liabilities, so we look at both sides. Asset liquidity concerns the ability to turn an asset into an amount of cash close to where it is marked; liability liquidity concerns the behaviour of a rm’s liability base in various conditions. Once we have seen how some of the di erent parts of the balance sheet behave, liquidity risk management is introduced; this process is designed to keep liquidity risk within bounds without subjecting the rm to too high a cost of funds.
