Liquidity Risk

Paper Summary:

This paper discusses how lately we have witnessed some debacles of the well-known financial institutions caused by liquidity crisis. In particular it looks at Northern Rock and Bear Stearns and how liquidity problems have deeply undermined the profitable trading strategies of the banks.

Outline:
Introduction
Causes of Liquidity Risk
Two Episodes of Liquidity Crisis
Episode 1. Northern Rock (NR)
Episode. 2 Bear Stearns
Liquidity Risk Management
Conclusions

From the Paper:

"NR was a building society mutually owned by its depositors and borrowers in origin, and on 1 October 1997, it converted to a mortgage-trading bank of a moderate size. Since the demutualization, NR changed its strategies dramatically, and adopted an 'originate and distribute' business model. This aggressive business model has helped NR to expand its loan book substantially from L13bn to L87bn, and its share of UK mortgage market from 0.3% (of L 430bn) to 8.35% (of L1046bn) within a short 10-year period, from 1997 to 2006. By the end of 2006, NR has become the eighth largest listed bank by market value in UK. However, over the same period, the ratio of deposits to total assets in the bank fell from 72% to 27%. As viewed from the graph.1 below, at 31 December 2006, 70% (including Wholesale, Securitised bonds and Covered bonds) of NR's liabilities were funded by short-term borrowings, while a mere 22% of the funding is obtained from retail deposits. "

Sample of Sources Used:

• Dr Alistair Milne, Topic Book of Risk Managements, 2007.
• Mr Randall S. Kroszner, Liquidity-Risk Management in the Business of Banking, 2008.
• BBC news, Rescue for troubled Wall Street, 17 March 2008
• Mr Martin Wolf, Big Lessons From Northern Rock, 2007

More papers on Liquidity Risk:

• Analytical Essay # 149895 : "Value at Risk"
• Essay # 9493 : "Risks and Bank Capital Regulation"
• Dissertation or Thesis # 149415 : "UK Risk Management Policies"

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