Setting the Scene: Why Liquidity Is Important in a Bank

Robert Fiedler

Banks play a central role in the management of liquidity and its risk: on the one hand they act as payment agents and providers of funds for individuals, corporates and other banks; on the other, they are subject to liquidity risk themselves. While the granting of a loan reduces the recipient’s liquidity risk, it generates liquidity risk within the bank, for which the bank seeks economic compensation. In this chapter we briefly describe how banks measure and manage their economic success and the associated risks. We progress from an ex post view of income and expenses to a forward-looking perspective that describes the bank’s earnings in the future as well as their aggregation over time to values that can be attributed to arbitrary points in time. Because these values are determined by future events, they are uncertain in nature and thus bear the risk of possible detrimental deviations (value risk). Banks have to accept risks, as they are an integral part of their value creation process, but this raises the necessity of managing them. We discuss how capital is perceived as a buffer for value risks.

Banks, financial transactions and balance sheets

Banks are very specific