Liquidity risk refers to the incapacity of any bank or financial institution to pay off its obligations and dues. Liquidity risk is inherent in every nook and corner of business, posing a threat to their structure of finance and existence.
The easiest way to mitigate liquidity risk is to hold adequate funds to meet future demands.
Liquidity risk can be mitigated or managed in the following ways:
Identify the liquidity risk in advance.
Develop liquidity risk indicators as metrics to quantify the risk.
Estimate the cash flows with a gauge of the forecast.
Make a comparison of the assets and liabilities to judge their illiquidity.
Conduct a stress test to analyze the worst-case scenario.
Finally, mitigate the risk using measurable financial performance.
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