The Liquidity Risk Management Guide: From Policy to Pitfalls

1 Introduction

Much has been written about what went wrong in banking prior to and during the financial crises. These are, however, in many cases two distinct elements, which both contributed to the unprecedented financial crises.

From the start of the new millennium banks and capital markets enjoyed almost extraordinary times of prosperity where almost every factor both external and internal helped to fuel the growth. Macroeconomic conditions were generally good in the Western world and globalization became more than a buzz word with the influx of Asia and the Eastern bloc. Banks and in fact many other industries were reaping the benefits of deregulation, which had taken place simultaneously in various corners of the world. Apart from a short breather around the dotcom bubble the markets were moving forward at a great pace.

Credit spreads dropped, which helped to fuel the real economy and mid-sized corporates were financing themselves at yields only available to quality sovereigns a few years earlier. The other side of the coin was the search for sufficient yields on investments, which became more and more challenging as time passed with the ever increasing inflows of cash. Technological advances both within actual systems and the field of financial engineering meant that banks met investor demand for ‘unchanged’ yields with increasingly complex derivatives products. There is no reward without risk and in spite of the strong ratings that most of these products were granted, ...