Measuring and Managing Liquidity Risk

Preface

The outbreak of the financial crisis in 2007/2008 brought liquidity risk measurement and management to the attention of practitioners, regulators and, to some degree, academicians.

Up until then, liquidity risk was not considered a serious problem and was almost disregarded by risk control systems within banks and by international and national regulations. Liquidity management and fundraising was seen as routine activity, simply a part of more complex banking activity, deserving little attention or effort.

Although the savvy approach would always be to forecast and devise scenarios under which extreme conditions occur, it was barely conceivable that such a difficult economic environment like the financial crisis of 2007 could ever occur. In the economic and financial environment in which banks used to run their business before 2007, liquidity risk simply did not exist. Moreover, it was never considered a problem that couold possibly extend beyond the limits of organizational issues and the development of basic monitoring tools. The design of procedures and systems were believed to cope with the small effects that banks suffered from liquidity risks.

As a consequence of these general considerations, the theory of liquidity risk was vague and restricted typically to market liquidity risk, which is the risk that assets cannot be sold swiftly in the market at a price close to the theoretical value. Although this is an important aspect of the broader liquidity risk notion, ...