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Friday, May 6, 2011

Deposit Liquidity Risk

The deposit liquidity risk is much related to the banking and financial institutions, both conventional and Islamic. 

This usually happens when banks or financial institutions hardly dependence on the corporate deposits, which providing at a higher rate compared to retail depositors. Corporate depositors normally place their deposits in a huge amount. The 'one-shock' withdrawal from the corporate depositors will cause liquidity issue to the banks and financial institutions to fulfill their obligations.
The liquidity issue occurs when there is a mismatch between asset and liability. Cost will overrun, if the banks or financial institutions acquire funds from more costly market sources such as Negotiable Islamic Instruments (NII).

Long term financing asset normally will have a maturity up to 20 years. While,short term funds liability will be due within 12 months.

In Islamic banking and financial institutions, there are two types of deposits which are:
  • Short-term deposits - usually attributed from current and saving accounts, which is also called low cost deposit.
  • Long-term deposits - usually attributed from profit sharing investment account (GIA), which is also called high cost deposit.
In term of risk concentration, it is much more on high cost deposit. To overcome this situation, the banks and financial institutions will rely on money market to replace withdrawal.

In general, liquidity risk will increase the cost of funding and lower the earning to the banks and financial institutions.

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