Liquidity buffer and term structure of funding


In this chapter we investigate how the liquidity buffer (LB from now on) comes about in the running of the business of a financial institution. In greater detail, we will study:

  • when the need to set up a LB arises;
  • how the LB is financed;
  • how LB costs are charged to banking products.

Hopefully we will clarify some concepts that eventually will assist in the liquidity management and the assignment of costs and/or benefits to the different departments within a financial institution.


It is worth defining the LB and its relationship with counterbalancing capacity (CBC), which is a concept normally used in liquidity management practice, although we have not yet introduced it in our analysis. We should stress the fact that there is not a single definition for both and banks often adopt different criteria to define them.

In general, it is possible to define CBC such as to embed it in the LB as well, hence making it a part of the LB.

Definition 7.2.1 (counterbalancing capacity). CBC is a set of strategies by which a bank can cope with liquidity needs by assuming the maximum possible liquidity generation capacity (LGC).

CBC identifies all the possible strategies to generate positive cash flows to make cumulated cash flows, up to given future date, always greater than or at least equal to zero. Positive cash flows can be generated by contractual redemptions and/or interest ...

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