Liquidity risk is the potential inability to meet the bank’s liabilities as they become due. It arises when the banks are unable to generate cash to cope with a decline in deposits or increase in assets. It originates from the mismatches in the maturity pattern of assets and liabilities. Measuring and managing liquidity needs are vital for effective operation of commercial banks. By assuring a bank’s ability to meet its liabilities as they become due, liquidity management can reduce the probability of an adverse situation developing.The liquidity risk in banks manifest in different dimensions: a) Funding Risk – need to replace net outflows due to unanticipated withdrawal/non-renewal of deposits (wholesale and retail);
(b) Time Risk – need to compensate for non-receipt of expected inflows of funds, i.e., performing assets turning into non-performing assets; and (c) Call Risk – due to crystallisation of contingent liabilities and unable to undertake profitable business opportunities when desirable.
