In banking,
liquidity is the ability
to meet
obligations when they
come
due
without
incurring
unacceptable losses. Managing liquidity is a
daily process requiring bankers to monitor and project cash flows to ensure adequate liquidity is maintained. Maintaining a balance between short-term assets and short-term liabilities is critical. For an individual bank, clients' deposits are its primaryliabilities (in the sense that the bank is meant to give back all client deposits on demand), whereas reserves and loans are its primary assets (in the sense that these loans are owed to the bank,
not
by the bank). The investment
portfolio represents
a smaller
portion
of assets,
and serves
as the primary
source
of liquidity. Investment
securities can be liquidated
to satisfy deposit withdrawals and increased
loan demand. Banks have several additional options for generating liquidity, such as selling loans, borrowing from other banks, borrowing from a
central bank, such as the US Federal Reserve bank, and raising additional capital. In a worst case scenario, depositors may demand their funds when the bank is unable
Banks can
generally maintain as much liquidity as desired because bank deposits are insured by governments in most developed countries. A lack of liquidity can be remedied by raising deposit rates and effectively marketing deposit products.
However,
an important measure of a bank's value and success is the cost of liquidity. A bank can attract significant liquid funds. Lower costs generate stronger profits, more stability, and more confidence among depositors, investors, and regulators.