Sources of Liquidity Risk: Theory and Empirical Evidence

Jon Pogach

This chapter reviews the literature pertaining to liquidity stresses. We begin by discussing commonly identified sources of liquidity stress from the funding side, including deposits, commitment, secured funding, interbank lending and intraday credit. We then move on to discuss how financial institutions meet their funding needs through use of the asset side of the balance sheet. Given the discussion on asset sales, we subsequently discuss an alternative channel through which financial institutions may meet their liquidity needs, namely, their internal capital markets. We conclude by discussing regulatory developments for the purpose of regulating and monitoring liquidity risk. In the regulatory discussion, we first examine the regulatory measures adopted by Basel III and finish by discussing developments in the incorporation of liquidity stress-testing into supervisory stress tests.

Deposits

Insured deposits

Deposits play a critical role in the literature and the discussion of liquidity in financial institutions. The influential work of Diamond and Dybvig (1983) presents a model in which a bank run on demandable deposits can create inefficient firm liquidation. Throughout