| Categories of |
| Financial risk |
|---|
 |
| Credit risk |
| Market risk |
| Liquidity risk |
| Investment risk |
| Business risk |
| Profit risk |
| Non-financial risk |
Deposit risk is a type of liquidity risk [1] of a financial institution that is generated by deposits either with defined maturity dates (then such deposits are called 'time' or 'term' deposits) [2] or without defined maturity dates (then such deposits are called 'demand' or 'non-maturity' deposits).
Deposit risk is a risk of probable cash outflows from a financial institution that is caused by changes in depositors' behavior. In its turn, it consists of early withdrawal or redemption risk, rollover risk and run risk.
As a result, these risks might lead to dropping or even losing a liquidity of a financial institution if it cannot to attract new deposits instead of withdrawn ones. Wherein, the impossibility of the financial institution to refinance by borrowing in order to repay existing deposits is called a refinancing risk. [8]
An early withdrawal risk affects a rollover risk through decrease of cash flows that will be repaid in the future. The early withdrawal and rollover risks depend on a term to maturity of deposits. The more maturity, the more early withdrawal risk, and the lower rollover risk, and vice versa. The main financial determinants of the early withdrawal and rollover risks are interest rates of the financial institution and its competitors, term to maturity and age of deposit, credit rating of the financial institution, and amount of deposit insurance.
The considered types of deposit risk are usually evaluated by 'Cash Flow at Risk' (also CFaR) approach. Thus, 'Cash Flow at Deposit Risk' is possible cash outflows from a financial institution over a fixed period of time that are predicted with chosen confidence level. [9] [10]
In business, economics or investment, market liquidity is a market's feature whereby an individual or firm can quickly purchase or sell an asset without causing a drastic change in the asset's price. Liquidity involves the trade-off between the price at which an asset can be sold, and how quickly it can be sold. In a liquid market, the trade-off is mild: one can sell quickly without having to accept a significantly lower price. In a relatively illiquid market, an asset must be discounted in order to sell quickly. Money, or cash, is the most liquid asset because it can be exchanged for goods and services instantly at face value.
The money market is a component of the economy that provides short-term funds. The money market deals in short-term loans, generally for a period of a year or less.
Fractional-reserve banking is the system of banking operating in almost all countries worldwide, under which banks that take deposits from the public are required to hold a proportion of their deposit liabilities in liquid assets as a reserve, and are at liberty to lend the remainder to borrowers. Bank reserves are held as cash in the bank or as balances in the bank's account at the central bank. The country's central bank determines the minimum amount that banks must hold in liquid assets, called the "reserve requirement" or "reserve ratio". Most commercial banks hold more than this minimum amount as excess reserves.
Full-reserve banking is a system of banking where banks do not lend demand deposits and instead, only lend from time deposits. It differs from fractional-reserve banking, in which banks may lend funds on deposit, while fully reserved banks would be required to keep the full amount of each customer's demand deposits in cash, available for immediate withdrawal.
A certificate of deposit (CD) is a time deposit sold by banks, thrift institutions, and credit unions in the United States. CDs typically differ from savings accounts in that the CD has a specific, fixed term before money can be withdrawn without penalty and generally higher interest rates. The bank expects the CD to be held until maturity, at which time they can be withdrawn and interest paid.
A bank run or run on the bank occurs when many clients withdraw their money from a bank, because they believe the bank may fail in the near future. In other words, it is when, in a fractional-reserve banking system, numerous customers withdraw cash from deposit accounts with a financial institution at the same time because they believe that the financial institution is, or might become, insolvent. When they transfer funds to another institution, it may be characterized as a capital flight. As a bank run progresses, it may become a self-fulfilling prophecy: as more people withdraw cash, the likelihood of default increases, triggering further withdrawals. This can destabilize the bank to the point where it runs out of cash and thus faces sudden bankruptcy. To combat a bank run, a bank may acquire more cash from other banks or from the central bank, or limit the amount of cash customers may withdraw, either by an imposing a hard limit or by scheduling quick deliveries of cash, encouraging high-return term deposits to reduce on-demand withdrawals or suspending withdrawals altogether.
Cash and cash equivalents (CCE) are the most liquid current assets found on a business's balance sheet. Cash equivalents are short-term commitments "with temporarily idle cash and easily convertible into a known cash amount". An investment normally counts as a cash equivalent when it has a short maturity period of 90 days or less, and can be included in the cash and cash equivalents balance from the date of acquisition when it carries an insignificant risk of changes in the asset value. If it has a maturity of more than 90 days, it is not considered a cash equivalent. Equity investments mostly are excluded from cash equivalents, unless they are essentially cash equivalents.
Liquidity risk is a financial risk that for a certain period of time a given financial asset, security or commodity cannot be traded quickly enough in the market without impacting the market price.
A money market fund is an open-ended mutual fund that invests in short-term debt securities such as US Treasury bills and commercial paper. Money market funds are managed with the goal of maintaining a highly stable asset value through liquid investments, while paying income to investors in the form of dividends. Although they are not insured against loss, actual losses have been quite rare in practice.
A time deposit or term deposit is a deposit in a financial institution with a specific maturity date or a period to maturity, commonly referred to as its "term". Time deposits differ from at call deposits, such as savings or checking accounts, which can be withdrawn at any time, without any notice or penalty. Deposits that require notice of withdrawal to be given are effectively time deposits, though they do not have a fixed maturity date.
In accounting, liquidity is a measure of the ability of a debtor to pay their debts as and when they fall due. It is usually expressed as a ratio or a percentage of current liabilities. Liquidity is the ability to pay short-term obligations.
Refinancing risk, in banking and finance, is the possibility that a borrower cannot refinance by borrowing to repay existing debt. Many types of commercial lending incorporate balloon payments at the point of final maturity. The intention or assumption is often that the borrower will take out a new loan to pay the existing lenders.
Asset and liability management is the practice of managing financial risks that arise due to mismatches between the assets and liabilities as part of an investment strategy in financial accounting.
In finance, an asset–liability mismatch occurs when the financial terms of an institution's assets and liabilities do not correspond. Several types of mismatches are possible. An asset-liability mismatch presents a material risk at institutions with significant debt exposure, such as banks or sovereign governments. A significant mismatch may lead to insolvency or illiquidity, which can cause financial failure. Such risks were among the principal causes of economic crises such as the 1980s Latin American Debt Crisis, the 2007 Subprime Mortgage Crisis, the U.S. Savings and Loan Crisis, and the collapse of Silicon Valley Bank in 2023.
In financial economics, a liquidity crisis is an acute shortage of liquidity. Liquidity may refer to market liquidity, funding liquidity, or accounting liquidity. Additionally, some economists define a market to be liquid if it can absorb "liquidity trades" without large changes in price. This shortage of liquidity could reflect a fall in asset prices below their long run fundamental price, deterioration in external financing conditions, reduction in the number of market participants, or simply difficulty in trading assets.
The Diamond–Dybvig model is an influential model of bank runs and related financial crises. The model shows how banks' mix of illiquid assets and liquid liabilities may give rise to self-fulfilling panics among depositors. Diamond and Dybvig, along with Ben Bernanke, were the recipients of the 2022 Nobel Prize in Economics for their work on the Diamond-Dybvig model.
A bank is a financial institution that accepts deposits from the public and creates a demand deposit while simultaneously making loans. Lending activities can be directly performed by the bank or indirectly through capital markets.
An asset swap refers to an exchange of tangible for intangible assets, in accountancy, or, in finance, to the exchange of the flow of payments from a given security for a different set of cash flows.
Reserve Requirements for Depository Institutions is a Federal Reserve regulation governing the reserves that banks and credit unions keep to satisfy depositor withdrawals. Although the regulation still requires banks to report the aggregate balances of their deposit accounts to the Federal Reserve, most of its provisions are inactive as a result of policy changes during the COVID-19 pandemic.
Liquidity regulations are financial regulations designed to ensure that financial institutions have the necessary assets on hand in order to prevent liquidity disruptions due to changing market conditions. This is often related to reserve requirement and capital requirement but focuses on the specific liquidity risk of assets that are held.