Need of Liquid Assets

In a broader sense, liquidity is an universal requirement both people and organizations. Need of liquid assets in day-to-day business operations is not deniable, which is to accommodate expected and unexpected fluctuations in the balance sheet. 

Under the market situation which is less developed and illiquid, firms or corporations are required to keep a relatively high level of liquid assets even yield little or income. At least, 10% - 20% of total asset must be kept in the liquid form.

Example of highly liquid assets is cash balances such as bank notes, gold coin and bullion.

Due to the increasing market orientation, the growth of financial markets and the greater diversity of financial instrument worldwide, the bank or financial institutions no need to hold large amounts of liquid assets, may be about 5%.

However, determination of liquidity sometimes depends on the market and economic performance where certain assets that appear liquid in good times may not be liquid in more difficult periods.

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.

Asset Liquidity Risk

The asset liquidity risk rises if a company is unable to execute disposal transactions at the prevailing market price due lack of market appetite or demand for the asset.

It also caused by the inability to dispose of the asset due to certain Shariah issues or constraints that prohibited the company to do so.