Glossary term
Funding Liquidity Risk
Subject: Risk Management, Financial Risk (Credit, Market, Liquidity)
Also known as: Funding risk
Funding liquidity risk is the risk that an institution cannot raise cash or refinance debts when needed, or can only do so at a very high cost, and so cannot meet its payments as they fall due.
Explanation
Funding liquidity is about the liabilities side of the balance sheet. A firm may own good assets but still be unable to pay if depositors withdraw, lenders refuse to roll over short-term loans, or markets close to new issues. It differs from market liquidity risk, which is the difficulty of selling an asset without moving its price. The two can feed each other: when funding is tight, forced sales hit market prices, which in turn damages confidence and funding. Banks watch funding concentration, the share of short-term wholesale funding, the stability of deposits and the spread of maturities. Tools include liquidity ratios, stress tests and a contingency funding plan. The amount and cost of funding often reflect market views of the firm's credit quality. Many bank failures began as funding failures, with the assets still sound on the day lenders left.
Example
A consumer lender finances multi-year loans with 90-day commercial paper, rolled over each quarter. When investors worry about the sector, they decline to buy new paper. The company has 300 million due in a month and no buyers. Even though its loans are performing, it must sell loans at a discount and draw on bank backup lines to pay.
Not to be confused with
- Market Liquidity Risk
- Market liquidity risk is difficulty selling an asset at fair price. Funding liquidity risk is difficulty raising cash to pay obligations.