When a bank’s assets and liabilities are not aligned

Solution

• Liquidity Risk arises when a bank cannot meet its short-term obligations (like depositor withdrawals or loan disbursements) due to mismatch in timing between assets and liabilities. • For example, banks typically accept short-term deposits but lend them out as long-term loans. If depositors suddenly demand funds, the bank may struggle to generate liquidity without incurring losses. • This is why banks implement Asset-Liability Management (ALM) frameworks across different time buckets (daily, monthly, quarterly, etc.). • Other risks: o Credit Risk → borrower default. o Market Risk → adverse changes in interest rates, forex, or prices. o Operational Risk → process or system failures. o Capital Risk → insufficient capital buffer. Thus, the mismatch between assets and liabilities tenure primarily creates Liquidity Risk.