Four questions of Banking Essay Example | Topics and Well Written Essays - 2000 words

Four questions of Banking - Essay Example A bank which cannot fulfil the obligations is said to be illiquid. If such a case arises then the bank is said to have defaulted which causes the shareholders and the depositors of the bank to incur heavy losses. Funding liquidity risk on the other hand is defined as the probability that the bank won’t be able to pay its obligation in a certain time period in future. So there exists a major difference between the two concepts of funding liquidity and funding liquidity risk. Funding liquidity has only two possible outcomes, i.e. either the bank would be able to pay its liabilities or the bank won’t be able to pay its liabilities at a particular time in future. Funding liquidity risk on the other hand can have infinite possible outcomes depending on the distribution of future incomes. It is spread over a time period not a particular time. As per the theoretical definition of funding liquidity a bank can be said to be liquid as long as the outflows is less that the inflows and the stock of money held. The market liquidity is a function of three different perspectives. The most popular and crudest measure is the bid-ask spread is called width. A low or narrow bid ask spread is said to be tight and reflects more liquidity in the market. Depth refers to the market’s ability to absorb sale of a position. Another feature of the market liquidity risk is the resilience which refers to the market’s ability to bounce back from temporarily incorrect prices. In period 2 banks can therefore not only trade in interbank market but also obtain liquidity either from depositors depositing money in the banks or by selling assets. Whereas deposits is considered as the natural hedge against liquidity risk which arises out of the giving out loans, but the problem is that it not always possible for the banks to fetch new deposits by attracting new depositors. So inflow and outflow can be considered to be