Question

Write a memo outlining the impact that COVID-19 has had on liquidity risk for the financial institution.

Answer 1

Liquidity risk refers to the risk that a security or Asset will not be converted to cash without a loss of capital or income.Due to this banks will be unable to meet its demand for short term loans.

Credit quality has deteriorated in some areas as per the reports of rating agencies like Moody, especially in sectors or geographies that are most affected by the outbreak of corona virus. This could have an effect on stress-testing in general.

Markets have been highly volatile in past few months, and that has made price discovery more challenging. Rapid liquidity shifts and unexpected demand drops are already causing some challenges for market participants that need to “see” pricing. Similarly, volatility and associated dislocations has limited the effectiveness of hedging relationships.

Recent interest rate cuts have affected bank's profitability. This, along with a shutting down of business activity, has depressed banking profits for some time, and concerns about this have already been reflected in the sharp drops across many firms’ stock prices. This introduced a secondary challenge, because certain deferred tax assets, like net operating losses (NOLs), don’t count fully toward a bank’s regulatory capital requirements.

Covid-19 has caused companies and factories to shut down, employees losing their jobs, share prices going down. Due to this the securities available with bank will be traded at a lower rates than before, thus causing liquidity risk to banks.

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