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Liquidity risk management

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  • Goodhart, C.

Abstract

Liquidity and solvency are the heavenly twins of banking, frequently indistinguishable. An illiquid bank can rapidly become insolvent, and an insolvent bank illiquid. As Tim Congdon noted, (FT, September 2007), in the 1950s liquid assets were typically 30 percent of British clearing banks’ total assets, and these largely consisted of Treasury Bills and short dated government debt. Currently, such cash holdings are about ½ percent and traditional liquid assets about 1 percent of total liabilities. Nor have prior standards relating to maturity transformation been maintained. Increasing proportions of long-dated assets have been financed by relatively short-dated borrowing in wholesale markets. Bank conduits financing tranches of securitised mortgages on the basis of three month asset-backed commercial paper is but an extreme example of this. Northern Rock is another. Such time inconsistency issues are hard to resolve, especially in the middle of a (foreseen) crisis; it is worth noting that many, though not all, of the aspects of this present crisis were foreseen by financial regulators. They just did not have the instruments, or perhaps the will, to do anything about it. If, when trouble strikes, the lifeboats are manned immediately, with extra liquidity being provided on easy terms, then there is encouragement to the banks to build even more densely on the flood plain. Why should the banks bother with liquidity management when the Central Bank will do all that for them? The banks have been taking out a liquidity ‘put’ on the Central Bank; they are in effect putting the downside of liquidity risk to the Central Bank. What is surely needed now is a calm and comprehensive review of what the principles of bank liquidity management should be.

Suggested Citation

  • Goodhart, C., 2008. "Liquidity risk management," Financial Stability Review, Banque de France, issue 11, pages 39-44, February.
  • Handle: RePEc:bfr:fisrev:2008:11:6
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    File URL: https://publications.banque-france.fr/sites/default/files/medias/documents/financial-stability-review-11_2008-02.pdf
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    Cited by:

    1. Jean Tirole, 2011. "Illiquidity and All Its Friends," Journal of Economic Literature, American Economic Association, vol. 49(2), pages 287-325, June.
    2. Ahmed Arif & Ahmed Nauman Anees, 2012. "Liquidity risk and performance of banking system," Journal of Financial Regulation and Compliance, Emerald Group Publishing, vol. 20(2), pages 182-195, May.
    3. Pagès, H., 2009. "Bank incentives and optimal CDOs," Working papers 253, Banque de France.
    4. Pagès, Henri, 2013. "Bank monitoring incentives and optimal ABS," Journal of Financial Intermediation, Elsevier, vol. 22(1), pages 30-54.
    5. Enisse Kharroubi & Edouard Vidon, 2009. "Liquidity, Moral Hazard, and Interbank Market Collapse," International Journal of Central Banking, International Journal of Central Banking, vol. 5(4), pages 51-86, December.
    6. Robin Dottling, 2018. "Bank Capital Regulation in a Zero Interest Environment," Tinbergen Institute Discussion Papers 18-016/IV, Tinbergen Institute, revised 01 May 2018.
    7. repec:sgm:jbfeuw:v:2:y:2015:i:4:p:14 is not listed on IDEAS
    8. Sonia Ondo-Ndong & Laurence Scialom, 2008. "Northern Rock: The anatomy of a crisis – the prudential lessons," EconomiX Working Papers 2008-23, University of Paris Nanterre, EconomiX.
    9. de Haan, Leo & van den End, Jan Willem, 2013. "Bank liquidity, the maturity ladder, and regulation," Journal of Banking & Finance, Elsevier, vol. 37(10), pages 3930-3950.
    10. repec:eee:ecmode:v:67:y:2017:i:c:p:193-202 is not listed on IDEAS
    11. William A. Allen, 2015. "Asset choice in British central banking history, the myth of the safe asset, and bank regulation," Journal of Banking and Financial Economics, University of Warsaw, Faculty of Management, vol. 2(4), pages 18-31, June.
    12. Mark Mink, 2011. "Procyclical Bank Risk-Taking and the Lender of Last Resort," DNB Working Papers 301, Netherlands Central Bank, Research Department.
    13. Rötheli, Tobias F., 2010. "Causes of the financial crisis: Risk misperception, policy mistakes, and banks' bounded rationality," Journal of Behavioral and Experimental Economics (formerly The Journal of Socio-Economics), Elsevier, vol. 39(2), pages 119-126, April.
    14. lim, yu zhi, 2017. "Empirical Evidence of Risk and Performance: Top Glove Corporation Berhad," MPRA Paper 78457, University Library of Munich, Germany.
    15. repec:eee:macchp:v2-2263 is not listed on IDEAS
    16. Nikolaou, Kleopatra, 2009. "Liquidity (risk) concepts: definitions and interactions," Working Paper Series 1008, European Central Bank.

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