What is Liquidity Risk? How to Take Precautions for Liquidity Risk? An asset can be bought or sold quickly. This market feature is called liquidity.
Liquid products or liquidity concepts are terms that are frequently heard in daily life. For example, when liquid product is mentioned, a house belonging to a person, real estate or a household product is entered. As we can understand from here, we can say that liquidity is a commercial term. The concept of liquidity is a commercial term used in direct proportion to the meanings such as money, trade, easy money conversion.
What is Liquidity?
The concept of liquidity appears as market liquidity. An asset can be bought or sold quickly. This market feature is called liquidity. The tangible asset purchased or to be sold in the liquidity market does not change in terms of price while being traded. As we can understand from here, liquidity is related to the size of the change between the sales speed and the price to be sold.
The short term term used in money and trading transactions comfortably describes liquidity. Assets with tangible value include assets that can be easily converted into cash. Therefore, assets that can be easily converted into cash can be a security, a financial product or real estate. Examples of liquid products that enter the liquidity market are houses, cars and bonds.
What is Liquidity Risk?
The concept of risk is a term that always preserves its existence in the commercial sector. Since liquidity also refers to a commercial transaction, that is, a commercial term, there is risk here as well. Therefore, first of all, it is necessary to know the concept of risk well.
Another name for the term risk is risk. The probability of an event occurring or the possibility of being affected by the event is called risk. Risks that exist in all areas of life are also present in commercial transactions. Therefore, any phenomenon that threatens the financial assets of any company towards achieving its purpose is defined as commercial risk.
Commercial risks arise from various sources. Therefore, the company president, company owner or company director is not always to blame for commercial risks. It is lost or gained when taking risks in business and other areas of life.
The term liquidity risk is generally encountered in the banking sector. If the bank does not have liquidity products that can fulfill its responsibilities, liquidity risk is mentioned. Banks give importance to their balance sheets against liquidity risk. In order to prevent the liquidity risk in these balance sheets, the asset maturity structure is kept longer than the passive maturity structure.
How to Take Precautions for Liquidity Risk?
Liquidity risk management principles should be established in response to liquidity risk. These principles must be strictly followed. These measures, including liquidity risk management, are taken by the banking sector. First, risks are defined, and then liquidity risk measures are created according to these definitions. These measures are carried out by experts. Taking precautions and defining risks also bring financially specific trainings.
Information on Liquidity Risk Management
A bank or financial institution that has a liquidity problem increases its responsibilities in a short time and may not even be able to provide the money form it needs by converting its assets into cash at reasonable prices. Therefore, it is essential to establish liquidity risk management.
In liquidity risk management, financial institutions try to balance the situation of insufficient liquidity and insufficient liquidity, that is, the cost of these two opposite concepts. All of these efforts are included in liquidity risk management.
The main responsibility in the liquidity risk management process is management. The board of directors of institutions has different responsibilities and duties in this area. Appropriate organizational structure is established in order to manage the liquidity risk. Strategies, policies, procedures are prepared and finally put into writing. It is signed by the relevant board of directors. In this case, liquid products, liquidity transfer pricing, liquidity cost, risk and benefits are taken into consideration.
Why Does Liquidity Risk Occur?
As the financial deficit grows, the liquidity risk also increases. Therefore, the increase in financial deficit and liquidity risk is directly proportional. The financial deficit should not be enlarged. Necessary measures should be taken before this deficit gets too big.
Various phenomena also affect liquidity risk management. For example, the size of the bank, risky liquid assets, external financing, low risk liquid assets, profitability of assets and return on equity are the factors affecting liquidity risk management.
What Does Liquidity Management Purpose?
What is important in liquidity management is the assets that are expected to turn into cash within one year. Debts due within one year also become important in liquidity management. Short-term debt payment management is liquidity management. Therefore, the sole purpose of liquidity management is to pay off short-term debts. In this way, the assets that are expected to turn into cash within one year will have already turned into cash.
Liquidity Risk Management Principles
Considering, discussing and translating a variety of topics such as central bank loans, liquid assets, asset reduction, financial strategy, contingency planning, stress testing, measuring liquidity risk, measuring asset liquidity, liquidity demand sources, triggering factors, liquidity positions by maturities. liquidity risk management principles.
These principles also refer to the measurement of the relevant risk in order to manage the risk. Monitoring and controlling liquidity risk is about measuring liquidity risk within a commercial framework. Funds are the first issue here. Funds are measured and various monitoring tools are used in this measurement process. Therefore, companies should develop robust methods for this work.
Liquidity Risk from Market News
When we look at the market news, we encounter many institutions that have liquidity problems and succumb to liquidity risk. It is exposed to liquidity risk due to poorly regulated assets and the inability of these assets to have sufficient resources to meet the increase.
In response to the liquidity shortage, liabilities are increased in a short time and assets are converted into cash at reasonable prices. After this liquidation event, the liquidity problem is eliminated thanks to the provision of the necessary funds.
In the management of liquidity risk, active and passive management has focused on traditional facts. In rough definitions, liquidity risk is made as the cost of obtaining funds in a short time in order to meet deposit withdrawals or loan demands. Liquidity risk actually arises when customers want to liquidate their investments or positions.