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Liquidity risk

Category: Corporate Governance

Liquidity risk. The risk arising from a bank’s inability to meet its obligations when they come due, without incurring unacceptable losses. Liquidity risk includes the inability to manage unplanned decreases or changes in funding sources. Liquidity risk also arises from the failure to recognize or address changes in market conditions that affect the ability to liquidate assets quickly and with minimal loss in value.

Banks can fail either because they are insolvent or because an aggregate shortage of liquidity can render them insolvent. At the same time, bank failures can themselves cause liquidity shortages. The failure of some banks can then lead to a cascade of failures and a possible total meltdown of the system. Contagion here is not caused by contractual or informational links between banks but because bank failure could lead to a contraction in the common pool of liquidity.

As required by the current Instruction No. 386 from 28 August 2001 «On regulation of activity of commercial banks in Ukraine», banks should follow certain liquidity normatives: immediate liquidity (minimum limit — 20%); current liquidity (minimum limit — 40%) and short-term liquidity (minimum limit — 20%).

In addition, NBU will be assessing the following components of liquidity risk: degree of asset liquidity, diversification and concentration of liabilities, cost of funding, maturity mismatch, controls, policies and procedures.

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