Question

Why do banks prefer to manage liquidity risk by adjusting liability side instead of assets?​

Answer 1

Answer:

Asset Liability Mismatch arises in the following situation: The Primary source of funds for the banks is deposits, and most deposts have a short- to medium-term maturities, thus need to be paid back to the investor in 3-5 years. In comparison, the banks usually provide loans for a longer period to borrowers.

Answer 2

The banks' main source of funds is loans, and most deposits have short-or medium-term maturities, so in 3-5 years they need to be paid back to the lender. By contrast, banks usually give loans to lenders for a longer period of time.

Explanation:

• Banks face multiple threats such as asset losses, interest rates, currency exchange risks. Control of assets liability (ALM) is the tool for managing interest rate risk and liquidity risk posed by various banks, including financial services companies.
• Banks are vulnerable to liquidity risk when liquid deposits (liabilities) turn into illiquid loans (assets). These are the banks' main activities, and the role of liquidity risk management in maintaining their sustainability. The liquidity status is also linked to the trust of the stakeholders.

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