The Importance Of Liquidity Risks In Banking

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The banking sector plays a main role in the financial process in every economy, making its efficiency and effectiveness an essential requirement in order to ensure stability and growth (Halling, M. and Hayden, E, 2006). (Diamond, D.W. and Rajan, R.G, 2001), states that banks are involved in valuable economic activities and their major concerns remain their survival and profitability. On the asset side of the balance sheet, banks guarantee the smooth flow of funds by lending to deficit spending units while providing liquidity to savers on the liability side.
In addition, banks provide payment and settlement systems which facilitate trade. However, by ensuring the productive investment of capital and the profitability of other varied functions
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It is a risk arising from a bank’s inability to meet its obligations when they come due without incurring unacceptable losses. This risk can adversely affect both bank’s earnings and the capital. Therefore, a bank’s management priority is to make sure that sufficient fund is available in order to meet future demands of providers and borrowers, at reasonable costs. The vulnerability of banks to liquidity risk is determined by the funding risk and the market risk. Liquidity risk needs to be monitored as part of the enterprise-wide risk management process, taking into account market risk and credit risk to ensure stability in the balance sheet and dynamic management of liquidity risk. A bank should only attempt this if it makes good business sense, not use it as a means to keep afloat. Liquidity risk not only affects the performance of a bank but also its reputation (Jenkinson, 2008). Depositors may lose confidence in a bank if funds are not provided to them on time. The bank’s reputation may become at …show more content…
During this period banks funding sources dried up quickly and they found themselves short on cash to cover their obligations (Olagunju, Adeyanju, and Olabode, 2011). There is a general sense that banks had not fully appreciated the importance of liquidity risk management and the implications of such risk. As result, policymakers have suggested that banks should hold more liquid assets than in the past, to help self‐insure against potential liquidity or funding difficulties (BCBS 2010). Holding of liquid assets such as cash and government securities generally have a relatively low return which imposes an opportunity cost on a bank. In the absence of regulation, it is reasonable to expect that banks will hold liquid assets to the extent they help to maximize the firm’s profitability. Henceforth, policymakers have the opted to require larger holdings of liquid assets. This study seems to establish whether banks’ holdings of liquid assets have a significant impact on their

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