Imagine a company as a camel in a desert. It doesn’t matter how much gold $($assets$)$ it’s carrying — if it can’t find water $($cash$)$, it won’t survive the journey. This is the essence of funding liquidity risk: the risk that a firm can’t meet its cash obligations as they come due.

$\textbf{What is Funding Liquidity Risk?}$

$\textbf{Funding liquidity risk}$ is the risk that a firm won’t have enough cash or funding sources to meet its immediate obligations. These obligations may include bond coupon payments, margin calls, withdrawals, or debt repayments.

Some cash needs are predictable $($like rent and birthdays$)$, and some are not $($like sudden hospital bills or angry regulators$)$. The ability to forecast these needs is part of sound liquidity risk management.

$\textbf{Key Sources of Funding Liquidity}$

Financial institutions rely on multiple sources to “quench their thirst” in dry times:

Cash and Treasuries – The coconut water of the balance sheet: safe, liquid, and a bit boring.
Retail and Wholesale Deposits – Like fair-weather friends, they’ll stay until the going gets tough.
Trading Book Liquidation – Sell what you can, but hope your assets don’t behave like used gym equipment on Craigslist.
Securitization – Turn loans into tradeable securities. Great until 2008. Risky if investors ghost you.
Borrowing – Sometimes expensive. Lenders may only offer you “umbrella insurance” when it’s already raining.
Central Bank Borrowings – Lender of last resort. But like asking your parents for money as an adult — comes with awkward questions and conditions.

$\textbf{Case Studies: When Things Went Dry}$

🌧️ Northern Rock $($UK, 2007$)$

Funded long-term mortgages using short-term debt.
When markets panicked post-2007, it needed £3B from the Bank of England.
BBC leaked the story ➜ mass withdrawal ➜ bank run ➜ nationalized.
Lesson: Don’t mismatch your funding. It’s like buying a house on a credit card.

🌕 Ashanti Goldfields $($Ghana, 1999$)$

Hedged gold price by shorting forwards.
EU central banks limited gold sales ➜ gold price soared ➜ margin calls triggered.
Couldn’t post cash fast enough ➜ losses, mine sold, equity diluted.
Lesson: Just because your asset value rises doesn’t mean you’re safe. Margin calls want cash, not gold bars.

🛢️ Metallgesellschaft $($Germany, 1993$)$

Sold long-term oil contracts; hedged using short-term futures.
Oil prices dropped ➜ margin calls ➜ cash drain ➜ positions closed ➜ $1.3B loss.
Lesson: If you’re hedging a marathon with sprints, be ready to pay every lap.

$\textbf{Reserve Requirements}$

Think of this as a rainy-day fund — a slice of deposits held with the central bank:

U.S. reserve ratio: $10%$
UK: No mandatory requirement
Higher reserve ratios reduce money supply and can create liquidity strain.

🚰 Basel III to the Rescue: LCR and NSFR

$\textbf{Liquidity Coverage Ratio (LCR)}$

This ratio answers: “Can you survive a $30$-day storm?”

$\frac{\text{High-quality liquid assets}}{\text{Net cash outflows over 30 days}} \geq 100%$

Breakdown:

Numerator: Cash, top-rated government securities — basically, stuff that can be sold quickly without a yard sale.
Denominator: Predicted outflows under stress — like a horror movie where everything goes wrong.

$\textbf{Net Stable Funding Ratio (NSFR)}$

This asks: “Do you have stable funding for the long haul?”

$\frac{\text{Available stable funding}}{\text{Required stable funding}} \geq 100%$

ASF includes capital, long-term debt, and reliable deposits.
RSF is the amount of funding your assets and commitments require.

💡 Why LCR and NSFR?

Because:

LCR ensures you don’t run out of cash during short-term stress.
NSFR ensures you’re not partying on short-term credit when your bills last 10 years.

Together, they act like a cash diet and a long-term exercise plan for banks.

$\textbf{The BIS Principles}$

Developed after the 2007–09 mess, the Bank for International Settlements $($BIS$)$ laid down 17 commandments of liquidity discipline. Highlights:

🧭 1. Fundamental Principle for Liquidity Risk Management and Supervision

“Dig the well before you are thirsty.”

Lesson: Plan your liquidity before the crisis hits.

Banks must maintain a comprehensive liquidity risk management framework.
This framework should ensure sufficient high-quality, unencumbered liquid assets are available even during severe stress events.
Supervisors must ensure the framework is functioning and the bank is genuinely liquid, not just on paper.

👉 Key idea: Have a reservoir of safe, sellable assets ready at all times.

🏛️ 2. Liquidity Risk Management Governance

“A fish rots from the head down.”

Lesson: If top management ignores liquidity risk, disaster starts at the top.

The board of directors must define and approve the bank’s risk tolerance.
Senior management must actively manage liquidity and report to the board.
Liquidity risk should be embedded into product design, pricing, and performance metrics.
Approvals must include the cost and availability of liquidity in business planning.

👉 Key idea: Leadership must take ownership of liquidity risk, not delegate it to chance.

📊 3. Liquidity Risk Measurement and Management

“What gets measured, gets managed.”

Lesson: You can’t manage what you don’t monitor.

Establish a sound cash flow forecasting process across business lines, legal entities, and currencies.
Diversify funding sources — don’t rely on one lender or instrument.
Manage intraday liquidity — ensure payment obligations can be met in real time.
Monitor collateral positions, differentiating encumbered vs. unencumbered assets.
Conduct regular stress testing to simulate adverse scenarios.
Prepare a Contingency Funding Plan (CFP) that outlines backup liquidity sources and crisis roles.

👉 Key idea: Track everything — cash in, cash out, timing, stress scenarios, and backup plans.

🔍 4. Disclosure

“Sunlight is the best disinfectant.”

Lesson: Transparency prevents hidden dangers.

Banks should regularly disclose their liquidity positions and risk management framework.
Disclosures should allow market participants to assess the bank’s resilience in stressed conditions.

👉 Key idea: Be open about your liquidity — it builds market confidence and prevents surprise shocks.

🛡️ 5. Supervisory Responsibilities

“Trust, but verify.”

Lesson: Regulators must check, not just hope.

Supervisors should assess both the bank’s liquidity position and its risk management framework.
They must intervene if there are gaps or weaknesses.
Rely on internal reports, public data, and prudential reports.
Collaborate with other authorities, especially in times of market stress.

👉 Key idea: Supervisors are the guardians of systemic stability. They must act early and decisively.

🧠 Memory Anchor Summary Table:

Category	Proverb	Keyword
Fundamental Principle	“Dig the well before you are thirsty.”	Preparation
Governance	“A fish rots from the head down.”	Accountability
Measurement & Management	“What gets measured, gets managed.”	Monitoring
Disclosure	“Sunlight is the best disinfectant.”	Transparency
Supervision	“Trust, but verify.”	Oversight

🕵️‍♂️ Transparency and Supervision

Banks must:

Disclose enough so investors aren’t flying blind.
Let supervisors check their water tanks — err, balance sheets — regularly.
Accept intervention if their cash planning turns into wishful thinking.

💬 Final Word: Cash ≠ Comfort, but No Cash = Crisis

Liquidity funding risk isn’t just about having money — it’s about having the right amount, at the right time, from the right places. Just like comedy — timing is everything.

🏦 FUNDING LIQUIDITY RISK: WHY “CASH IS KING” IN A CRISIS