We regard cash inflows (i.e. paid in favour of our central bank account) as being
positive and cash outflows as negative. Deals between the bank’s entities that are
not executed via third parties (internal deals) are treated like regular transactions.
As they match out, it has to be ensured that such deals are completely reported (by
both parties).
Definition:
Cash liquidity risk is the risk of economic losses resulting from the fact the sum of
all inflows and outflows of a day t plus the central bank account’s balance Btñ1 of the
previous day are not equal to a certain anticipated (desired) amount.
This definition aims at manifestations of cash liquidity risk such as:
1 Only being able to
Ω Raise funds at rates higher than or
Ω Place funds at rates lower than (credit ranking adjusted) market rates (opportunity
costs)
2 Illiquidity: not being able to raise enough funds to meet contractual obligations
(as a limit case of the latter, funding rates rise to infinity)
3 Having correctly anticipated a market development but ending up with a ‘wrong’
position.
Regardless if cash liquidity risk is manifested gradually as in 1 or absolute as in 2 –
where 2 can be seen as an ‘infinite limit’ of 1 – the probability of the occurrence of 2
can be developed as a continuously monotonous function out of 1.
In addition to analysing our liquidity position relative to the market, we need to
estimate our projected liquidity position and the degree of its uncertainty for predictable
periods of market fluctuations.
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