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Getting a Grip on Liquidity

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Getting a Grip on Liquidity

Notes from the Vault

Federal Reserve Bank of Atlanta,

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Liquidity is a concept financial market participants regularly refer to but don’t often agree on.

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7

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Recommendation

In attempting to define pornography, Supreme Court Justice Potter Stewart quipped, “I know it when I see it.” In the case of liquidity, the quote would most likely be “I know it when I don’t see it.” Liquidity can mean many things to many people, but all agree that its absence is bad. Economist Paula Tkac thinks it’s time to get a grip on this slippery idea. getAbstract recommends Tkac’s thoughtful introduction and outline of liquidity to financial professionals.

Summary

Bankers, traders and regulators each have their own definition of “liquidity”:

  • “Institutional liquidity” – This is the capacity of a financial institution to handle short-term mismatches between its assets and liabilities. Banks typically raise short-term funds to make long-term loans. If a temporary shortage of funds develops due to, for example, a mass withdrawal of deposits, a bank may be unable to meet its obligations. Regulators require that banks maintain sufficient reserves to sustain their institutional liquidity.
  • “Market liquidity” – The ability of markets to quickly and cheaply process ...

About the Author

Paula Tkac is a senior economist and vice president of the Federal Reserve Bank of Atlanta.

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