The Liquidity Risk Management in response to the crisis: the case of Banca Popolare di Vicenza

  7     Chapter  1   Introduction  to  Liquidity  Risk   1. Liquidity risk: origin and characteristics The function of transformation of assets’ maturities (mainly oriented to the long-term) in liabilities’ (more related to the short-term), that allows to satisfy the financing necessities of units in deficit fueled by investment opportunities and, at the same time, the investment necessities resulting from units in surplus, represents the intrinsic activity of all banks and determines risk profiles that need to be constantly measured and managed. In fact, that specific function creates a temporal mismatch between assets and liabilities, a mismatch that causes the rise of both an interest rate risk and a liquidity risk. Interest rate risk may be defined as the current and prospective risk of volatility affecting profits or equity due to adverse changes in interest rates. It is associated with asset and liability positions within the banking portfolio and mainly derives from the transformation of maturities. It particularly arises from the mismatch of interest-bearing assets and liabilities in terms of amount, due date and interest rates. With the locution “liquidity risk”, we aim to cover either the possibility that a bank could not cope expected and unexpected cash outflows without prejudice of its ordinary business and its own financial equilibrium (determining the so-called funding risk), and the linked eventuality that it would be forced to monetize a significant position in financial assets that, when encountering inadequate market depth or his temporary malfunction, could take place in conditions of unfavorable price (thus constituting the market liquidity risk). The liquidity risk stands by other risks for many reasons: first, it is a "secondary" risk, alias a risk that is triggered by adverse situations in turn triggered by other financial risks; this is the reason why is defined "consequential" 1 . Furthermore, it’s a risk that requires a different coverage from all others risks: in fact, the ultimate goal is to satisfy the net outflow in a certain period of time, ranging from days, to months, to longer horizons. The capital does not fit well this type of coverage, that needs instead the generation of cash inflows and would be therefore realized through the sale of high-quality liquid assets or the use of the same assets in collateral transactions such as repurchase agreements; so, instead of the capital, to deal with this type of risk we would need a properly risk management (which aims to reduce the cash outflows) and the presence of unencumbered eligible assets to compensate for any additional cash outflows.                                                                                                                           1   See Matz & Neu (2007).