Reference no: EM133010304

Liquidity risk describes the uncertainty that a financial institution might fail to generate sufficient cash to meet cash outflows. The financial manager of a bank plays an important role in the management of the bank's liquidity by putting adequate liquidity plans in place. Such liquidity management plan can include the following actions or techniques.

Maintaining proper cash flow management practices, to ensure that the bank remains liquid and also profitable. This helps to avoid liquidity issues that often arise due to unhealthy cash flow management practices such as having too much cash on hand at any point in time.

Problem 1: Constantly and actively measuring the liquidity risk of the bank, to help identify warning signs of a pending liquidity crisis. Three common ratios that can be used to measure a bank's liquidity coverage include quick ratio, current ratio and cash ratio.

Problem 2: Monitoring the overall financial affairs of the bank to ensure that the bank maintains a balance of cash and cash equivalents, that is sufficient to mitigate liquidity risk at any given point in time. This would help the financial institution to meet its daily cash needs and to meet most or a major part of its short term financial obligations.