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Definition: liquidity and liquidity risk

For the purpose of prudential supervision, liquidity is defined as: “The ability of a market participant to finance its assets, to satisfy the demands of its counterparties and to fulfil any arising obligations without incurring undue losses.”

Liquidity risk is further subdivided into funding liquidity risk and market liquidity risk:

  • funding liquidity risk is specified as: “The risk that a market participant cannot efficiently meet its cash flow and guarantee needs for its present and future commitments without unduly affecting its daily management and financial condition”, whereas
  • market liquidity risk is defined as: “The inability of a market participant to counterbalance or eliminate a position at a fair market price because of issues of market depth or insufficient market liquidity or a market disturbance.”