Finance Report
Liquidity risks: its impact on the financial crisis

Summary

Table des matières Summary 2 Definition and causes 3
Definition of liquidity 3 For a financial market 3 For a company 3
Causes 3 Subprime crisis 3 Securitisation 4 Asymmetric information 4 Impact of the liquidity risks 5
For banks 5 Interbank market 5 Case of Northern rock 5
For individuals 6 Investors 6 Borrowers 6 Consumers 6
For companies 6
For economy 7 Decrease of the dollar value 7 Consequence for carry trade 7 Solutions taken by governments 7
The United States: the FED 7
Europe : the ECB 8
Asia 8

Since 2007, the subprime crisis crash has entered the US economy into recession. This crisis is not limited at the American territory but has damaged the entire world. Let’s come back to the propagation of the subprime crisis that induces a liquidity crisis. So the question is how the liquidity crisis happened and what are the different consequences it provoked?

Definition and causes

To understand how it happened we should firstly introduce the subject by a definition.
For a financial market

Liquidity of a financial market represents the capacity to buy and sell a listed asset without any impact on prices. A liquid market is faster and cheaper for transactions. We distinguish:
-Funding liquidity: availability of credit or ease for institutions to borrow or take on leverage.
- Market liquidity: ease for market participants to transact or ability of markets to absorb large purchases.

The link between those two notions is that when funding liquidity is abundant traders have the resources with which to finance trading positions that smooth price shocks and make markets liquid.

For a company

Liquidity risk is the danger that it will be difficult or impossible for an organization to sell an asset in order to provide capital to meet short-term financial demands.
A company needs to remain solvent; the liquidity risk is in