Liquidity risk is the risk faced by banks when they cannot meet their obligations in due time and with excessive cost to the company.
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Banks need to be liquid for them to be able to pay for expenses related to daily operations like payments of interest and overhead. Banks sometimes experience sudden liquidity problems like heavy withdrawals of deposits or heavy demands on loan (Insight for Bank Directors 2004). Risks in a traditional banking such as liquidity, credit, interest rate and market risk can also occur from e-banking. Their effects, however, can be different for banks and bank managers compared to operational risk, reputational and legal risk. This holds true particularly for banks which offer different banking activities, in comparison with banks or their subsidiaries which offer electronic banking. Moreover, banks’ inability to meet customers’ demands on time can be enough ground for customers to file suit against the company and eventually damage its reputation (Insight for Bank Directors 2004). If a low level of confidence exists, a bank run can occur and a liquidity problem can turn into crisis which eventually can lead to solvency crisis (Francis 2000).
Credit risk, in most cases, contributes largely to the liquidity problem of an institution. It exist when a debtor do not have the prospect of settling an obligation in full in due time. Although it also happens in traditional banking, there is a bigger chance for this thing to happen in electronic banking. Banks which engage in e-banking may grant credit through non-traditional channels. They also go beyond the traditional boundaries which companies may not be very familiar. The lack of policy to verify the capacity to pay of borrowers applying through e-banking can increase banks’ credit risk (Insight for Bank Directors 2004). In e-banking, assessment of credit quality of a client who is far proved to be less efficient than when he is right in the bank’s premises as in the case of traditional banking. Assessing the nature and quality of collateral is also difficult when it is located in an unfamiliar place (Davies 2000).
These collaterals, particularly real estate properties, if not subjected to proper credit verification oftentimes result into the release of a loan which is greater than the true value of the property made as collateral. Unscrupulous persons can opt to default in payment and willingly allow the bank to foreclose his property. If foreclosure happens, the overvalued property becomes an asset of the institution. In the absence of any positive development within the area of the foreclosed property, no appreciation in the value of the property will take place and the bank will have a hard time selling it. From the Basle Committee on Banking Supervision (1998), below is an example of possible risk and risk management measure in retail electronic banking: Examples of possible risks – Liquidity Problem, Illiquidity of electronic money issuer Possible manifestation – There is an increase of customers who want to redeem Electronic money which could pose problem for banks that offer electronic money schemes Consequence – Bank may suffer losses as it strive to gather more expensive source of funds. If people see a problem in liquidity there may be possibility to have a widespread withdrawal of deposits or redemption of electronic money. Inability of the bank to meet redemption demands on time can damage banks’ reputation.
How to manage risk Funds may be invested in more liquid assets. Usage should be monitored and regular audits should be conducted. Rural commercial banks are up to many challenges as they position themselves for the next century. Commercial banks’ still has to look for long-term access to cost-effective sources. The uncertainties in the sources and costs of loanable funds as well as with the changes in sources and levels of demand will expose banks to increased interest rate and liquidity risks. How the banks manage these risks and uncertainties will play a pivotal role in telling if the company can survive and compete in agricultural financial markets. These risks have prompted the American Bankers Association and the Independent Bankers Association to seek new ways to access alternative sources of loanable funds (Jeon 1999).
Reference: Asset ; Liability Committee. 2004). Insight for Bank Directors. Basle Committee on Banking Supervision, (1998) “ Risk Management for Electronic Banking and Electronic Money Activities.
Howard D. (2000). Chairman Financial Service Authority, BBA Banking Supervision conference, “ The Year Ahead”, London. Jeffrey F. (2000 ). “ The Higher the Risk, the Greater the Fall, The Sunday Star. Jeon, D.
-S. and University of Illinois at Urbana-Champaign. (1999). “ A firm-level model for commercial banks servicing agriculture a multi-stage stochastic programming approach. “