Learning Objectives:

  • Define liquidity risk and its two dimensions.

  • Understand funding risk and its management.

  • Apply liquidity risk measurement and management techniques.

4.1 Defining Liquidity Risk

Liquidity risk is the risk that a bank will not be able to meet its financial obligations as they fall due . The BTRM programme covers “liquidity risk management” as a core topic . It has two dimensions:

  • Funding Liquidity Risk: The risk that the bank cannot obtain sufficient funding to meet its obligations.

  • Market Liquidity Risk: The risk that the bank cannot sell assets quickly without a significant price discount.

4.2 Measurement and Management

Banks use various tools to manage liquidity risk:

  • Liquidity Gap Analysis: Measuring the mismatch between expected cash inflows and outflows .

  • Liquidity Coverage Ratio (LCR): Ensuring sufficient high-quality liquid assets to cover net cash outflows over 30 days.

  • Net Stable Funding Ratio (NSFR): Ensuring stable funding for long-term assets.

  • Contingency Funding Plan (CFP): A plan for addressing severe liquidity stress.

4.3 ALCO Governance

The Asset-Liability Committee (ALCO) is the primary governance body for liquidity and interest rate risk . The BTRM programme covers “ALCO governance” and “ALCO MI pack” as key elements of bank risk management . ALCO is responsible for setting liquidity policies, monitoring risk exposures, and approving funding strategies.

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