Capital vs Liquidity

Liquidity, fluidness, liquidity….. In the context of the events of the last few age just how important is liquidity to the survival and well-being of fiscal Institutions? Some believe it has a greater influence on events than Capital! Discuss. (In this assignment you need to outline the role of liquidity, issues arising when liquidity is scarce and comp argon the role of liquidity to that of Capital solely most importantly give your own view on these matters) Role of Liquidity Liquidity can be defined as 1) the ability of a business to meet obligations without disposing of its fixed assets or 2) the degree to which assets of a company can be slow converted into cash. The evolution of asserting has seen their balance sheet composition change. The prototype changed from one of borrowing at low evaluates and impart high rates with little interest rate or liquidity risk to one where borrowing in the in short end and lending in longer maturities. This change created both interest rate risk and liquidity risk. [pic] Figure 1 Liquidity Gap In the early model a 1 month loan at 8% is matched by a 1 month deposit at 5%. The boundary line is locked in at 3%. The only risk to the bank is credit risk, i.e. that the loan gets repaid.

In the modern scenario we have a 150 day loan at 6% funded by a 7 day deposit at 1%. In this example we have credit risk, interest rate risk and liquidity risk. This model facilitates greater margin as it is generally cheaper to borrow in the short term and high rates available if lending in the longer term. The risks are that in 7 days, where will the borrowing rate be (rate risk) and will the bank be able to borrow (liquidity risk)? The hedge of interest rate risk has been made much easier with the outgrowth of interest rate swaps and other derivative items. As these are off balance sheet products, they do not bid liquidity and so the modern model is very vulnerable to any problems with liquidity. The interbank cash market is... If you want to get a full essay, order it on our website: Ordercustompaper.com

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