Question

Liquidity risk and asset transformation risk.

When bank received, they buy more risky assets but received deficit that less risky or issue less risky assets.

When bank give out loan on that they take more risk but when the received deficit issue certificate those they make less risk.

What do they do and how do they do?

Answer 1

Liquidity Risk: Liquidity risk is a risk that is incurred when investments like securities and commodities are not traded quickly. It is a financial risk which reduce the market value of investments. Securities cannot be easily converted into assets; chances of capital loss will arise during this conversion. Liquidity risk arises when someone wants to sell his assets, but there is lack of buyers to purchase these. So, the seller cannot sell his assets at the market value because it is hard to bring sellers and buyer together. An other reason of liquidity risk is, slow trading in securities or commodities markets.

Transformation Risk: Risk transformation is a way that is used to manage risks to desired results. Risk can be identified and transformed from one form to another by risk transformation alignment. Transformation of risk can be done with awareness and involvement of individuals. Everyone should have a responsibility to report risks when they identify the presence of risk. Risks cannot be more harmful when these are managed properly before arising critical conditions.

When the risks are arisen, banks starts dealing to utilize the risks for maintain its positive position in wealth. Suppose a bank has assets that are risky, bank always prefer to sell these assets at certain extent of loss. To overcome financial losses bank can receive loans from central bank of India or by issuing securities. So, deficit financing and capital marketing both are helpful to overcome the period of recession in banks. Banks gives loans to priority sectors. But, there are chances of losing money in case of long term debt. So, issue the deficit certificates to their debtors to make loans secure.