The objective of liquidity risk management is to minimise the risk that the group/company will not have sufficient liquidity and/or credit lines to meet its current or future financial obligations regardless of unexpected changes in business and market conditions.
Liquidity can be generated internally or externally as the figure below shows. Each source of liquidity has its own risks, which need to be assessed and managed.
Internal and External Sources of Liquidity and Risks
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Managing Liquidity Risk
The main risks to a company/group's liquidity that need to be assessed and managed are:
- intra-day liquidity exposures
- contingency risks from unexpected changes in cashflow forecasts, and the estimates of how much liquidity will be available from releasing trapped cash and working capital
- structural risk from mismatching of funds flow and positions
- FX rate fluctuations and impact on payment flows and liquidity
- risks inherent in each of the different types of funding
- counter-party risks from the banks and financial institutions providing funding and investments.
The vital first step in managing liquidity risk is to have an accurate, up-to-date and complete assessment of how much liquidity the company/group has and the forecast position in the future. Then and only then, can this be managed. In today's volatile financial and business markets, there is far more intra-day position reporting and use of real-time systems and services.
General strategies as to how to minimise liquidity risk vary. Some companies concentrate all available liquidity centrally, while others use regional concentration. On credit lines, some companies ensure adequate local availability combined with adequate availability of centrally committed credit lines that also include the maintenance of liquidity buffer. While other companies hold and manage all credit arrangements and lines centrally.