Beyond Valuation: Basel III and Its Impact on Managing Illiquid Assets

Michael Schouten, Garry Smith and Vijay Krishnaswamy

This article was first published as a chapter in Managing Illiquid Assets: Perspectives and Challenges, by Risk Books.

The fundamental nature of maturity transformation (ie, borrowing short-term money and investing in long-term projects) and its core relevance to a bank’s basic business model means that banks are inherently vulnerable to liquidity risk. By the end of the 20th century, increased sophistication of financial markets had added to the complexity and significance of liquidity risk management. The altered funding profile of bank balance sheets in recent times, where more stable retail funding was supplemented by wholesale funding from capital markets and securitisation alongside generally more complex financial instruments, was generally not matched by increased sophistication of liquidity risk management practices. At some banks, the treasury function was unaware of the true nature of contingent liquidity risks embedded in new products, or that evolving business practices would alter the contingent liquidity risk of existing products.

The global financial crisis that began in 2007 exposed weaknesses in liquidity risk management of many firms right across the

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