Measuring and Managing Liquidity and Funding Risk

Lennart Gerlagh, Marc Otto

Credit institutions define liquidity management objectives as part of their strategy execution plans. Liquidity management activities are typically delegated to asset and liability management (ALM) and/or treasury functions that identify, measure and manage the liquidity position of the bank in a robust framework based on a defined risk appetite. This implies that ALM and/or treasury need to have an insight into the current and projected liquidity profile of the balance sheet (for both on- and off-balance-sheet positions) and manage the liquidity mismatch that results from the bank’s maturity transformation role. Credit institutions will also have an independent risk function in place to identify the inherent liquidity risks and provide assurance that these risks are (and will continue to be) effectively managed and mitigated within the risk appetite of the credit institution.

DEFINITION OF LIQUIDITY RISK

Liquidity risk can be divided into two subcategories.

  • 1.

    Funding liquidity risk: this is the risk arising from the potential inability of the bank to meet both expected and unexpected current and future cashflows and collateral needs. Funding liquidity risk can be further

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