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Liquidity Risk

Liquidity risk is the risk that an individual, company, or financial institution will be unable to meet its short-term financial obligations because it cannot convert assets into cash quickly or without a significant loss in value. This type of risk is especially critical in banking and financial markets, where the inability to access liquid funds can lead to insolvency or financial instability. Managing liquidity risk involves maintaining an adequate level of cash or liquid assets to cover liabilities as they come due.

Example

A bank experiences liquidity risk when it cannot quickly convert its long-term loans into cash to meet sudden customer withdrawal demands.

Key points

• Refers to the risk of not being able to meet short-term financial obligations due to the inability to liquidate assets quickly.

• Critical for financial institutions that rely on converting assets to cash to meet demands.

• Proper liquidity risk management ensures enough liquid assets are available to cover liabilities.

Quick Answers to Curious Questions

It ensures that institutions can meet their short-term obligations, like customer withdrawals, without selling assets at a significant loss.

The company may be forced to sell assets at discounted prices or face insolvency if it cannot meet its obligations.

By maintaining a buffer of liquid assets and diversifying funding sources, businesses can reduce the impact of liquidity shortfalls.

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