Ch 17 Fully revised 2011

Ch 17 Fully revised 2011 - 1 Chapter 17 Liquidity Risk 2...

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Chapter 17 Liquidity Risk 1
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Overview This chapter: Liquidity Risk Causes of liquidity risk. Methods of measuring liquidity risk. Managing liquidity risk. 2
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What Is Liquidity Risk? Liquidity risk is the risk of a sudden surge in demand for liquid funds by customers that may require an FI to liquidate assets in a very short period of time at less than fair market prices (fire sale prices). In an extreme case (e.g., a run on a bank), liquidity risk may lead to insolvency risk. Example—IndyMac Bank (next slide) 3
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IndyMac Bank Failure IndyMac Bank was taken over by the FDIC on July 11, 2008 after a “slow run” or “walk” and was eventually sold to OneWest Bank. One of the largest bank failures in history. The immediate cause of the takeover was a deposit run that began and continued after the public release of a June 26, 2008 letter to the OTS and the FDIC from Senator Charles Schumer of New York. The letter expressed concerns about IndyMac’s viability. In the following 11 business days, depositors withdrew more than $1.3 billion from their accounts. 4
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Liquidity risk arises for two reasons: Liability-side reasons: Arises when a FI’s short-term liability holders (e.g., transaction depositors) seek to cash their claims immediately. Asset-side reasons: Arises from off-balance sheet activities, such as loan commitments. h E.g., When a borrower draws on a loan commitment, the FI must fund the loan on the balance sheet immediately. h Current levels of loan commitments are dangerously high h In 1994, unused commitments to cash ratio equaled 529%. In 2008, 1,015%. Fell back to 609% during the crisis. 5
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This note was uploaded on 07/02/2011 for the course FINA 465 taught by Professor Berger during the Spring '11 term at South Carolina.

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Ch 17 Fully revised 2011 - 1 Chapter 17 Liquidity Risk 2...

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