Understanding Basel III, What Is Different After January 2015

Understanding Basel III, What Is Different After January 2015

According to Claudio Borio, (Monetary and Economic Department, BIS), a liquidity crisis is defined as a sudden and prolonged evaporation of both market and funding liquidity, with potentially serious consequences for the stability of the financial system and the real economy.

Market liquidity is defined as the ability to trade an asset or financial instrument at short notice with little impact on its price.

Funding liquidity is defined more loosely, as the ability to raise cash (or cash equivalents) either via the sale of an asset or by borrowing.

I like the way Claudio describes it: Liquidity crises are not like meteorite strikes; rather, they are the endogenous result of the build-up in risk-taking and associated overextension in balance-sheets over a prolonged period â€“ what might be termed the build-up of financial imbalances.

Unmistakable signs of such imbalances are the growth of (overt and hidden) leverage; unusually low risk premia and volatilities, and buoyant asset prices.

A corollary is that the build-up to the crisis is characterised by â€œartificial liquidityâ€. There is a self-reinforcing process between liquidity and risk-taking.

The easing of funding liquidity constraints during the expansion phase supports greater risk-taking, by facilitating position taking and an increase in exposures.

This improves market liquidity and boosts asset prices.

As a result, volatility and risk premia fall, in turn inducing a further relaxation of funding liquidity constraints.

When this mutually reinforcing process goes too far, it results in overextensions in balance sheets and it sows the seeds of its own destruction.

Today we will start with liquidity.
Country USA
Author George Lekatis
Binding Kindle Edition
Format Kindle eBook
IsAdultProduct
NumberOfPages 246
PublicationDate 2015-01-29
ReleaseDate 2015-01-29

Country	USA
Author	George Lekatis
Binding	Kindle Edition
Format	Kindle eBook
IsAdultProduct
NumberOfPages	246
PublicationDate	2015-01-29
ReleaseDate	2015-01-29