Question

explain why liquidity risk and credit in the financial crisis

Answer 1

The financial crisis in 2007-2008 has been the biggest shock in the banking system since the 1930s and raises key liquidity risks questions. A number of sources, including counterpart parties, short-term creditors, and especially existing borrowers, have been urgently needed for the global financing system. Credit decreased and banks were severely affected by a reduction of liquidity pressures. The decline was probably mitigated by central bank emergency lending programs. Ongoing efforts to control bank liquidity can reinforce the financial system and reduce the risk of liquidity shocks in credit. Financial institutions are able to provide cash on call to depositors and borrowers. The liquidity risk was traditionally the result of banks running. These are episodes in which depositors lose confidence in their bank and withdraw money either because of concerns about the financial situation of the bank or because of concerns about the possibility of other depositors taking action. This could insolve banks by triggering a chain reaction that obligated them to offer illiquid credits. In the past, this instability had been partly controlled by lending, deposit and funding conditions from central banks, the last recourse borrowers. In recent times, funding threats have been minimized by outflows of deposits and more by the access to a variety of financial arrangements and interbanks. This includes untapped loan commitments, repurchase obligations for securitised assets, derivatives market margin calls and the withdrawal of money from wholesale short-term financing arrangements. It highlights the importance, as a stabilizing source of funding, of conventional deposits and of undrawn investments as a possible destabilizing source of liquidity risk on the properties. By comparison with other indicators of liquidity risk, such as securitized equity portfolios, these two results are prominent. This analysis also discusses how credit allocation can be shielded from possible liquidity shocks.