The Bank Credit Analysis Handbook: A Guide for Analysts, Bankers and Investors, 2nd Edition

Chapter 10

Liquidity

[L]iquidity . . . is at the core of banking. Credit institutions typically transform short-term, liquid liabilities into long-term, illiquid assets. In so doing, banks allow customers to smooth out their consumption and investment patterns. . . . In providing this important economic function, banks protect their customers against liquidity problems, but—at the same time—become exposed to such risks themselves. In an extreme case . . . runs, even on sound banks [may occur] when customers withdraw their deposits on a massive scale.

—European Central Bank1

Lack of access to funding sources and weak liquidity management are typical factors that lead to bank failures.

—Dominion Bond Rating Services2

Banks are machines for taking liquidity risk [borrowing] short-term deposits and [making] long-term loans. . . . [T]he credit squeeze has proved that liquidity has been forgotten in the quest to regulate banks’ capital.

—Financial Times, Editorial3

Liquidity is arguably the most difficult attribute for a bank analyst to explore. Not only are there myriads of possible ratios, each one offering its own reading of a bank’s liquidity profile, often at odds with that provided by the other results, but a bank’s liquidity changes by the minute.

If seasoned analysts and competent regulators can barely agree on near-universal grounds to pass judgment, retail depositors—and even sophisticated investors—often remain in the dark until it is too late. Worse yet, even when it is not ...