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Can I take liquidity risk determinant as a dimension of it in order to examine the impact of liquidity risk on performance of banks? For example in a literature, Tangibility i.e., ratio of fixed assets to total assets was used as a determinant of liquidity risk and results found to have significant relationship of this tangibility ratio with liquidity risk. So based on these findings can i take this tangibility ratio as a measure or dimension of liquidity risk in order to examine the impact of liquidity risk on performance of banks?

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If someone knows answer of this question then please answer it as soon as possible. Thanks – Kamran Dec 24 '12 at 16:37
just rushed back from holidays because the SE emergency pager beeped like nuts. Thanks for ruining my holidays...;-) – Matt Wolf Dec 26 '12 at 7:35

Friend, take a step back and think what you really want to measure. During normal times you should never care about liquidity risk or credit risk of banks, EVER, at least what concerns the text book definitions of liquidity and credit risk. During times of stress you want to throw all accounting gimmicks and monkey numbers aboard and focus on one single number. CASH available to pay off short-term liabilities. NOTHING ELSE. Walk me through one single bank run or bank blowup scenario where any other numbers mattered. So, if accounting numbers during stressed times and accounting numbers during regular market cycles do not matter then why do you want to focus on those? I understand if you want to become an accountant but if you truly show interest in understanding solvency then forget each and every last one concept of what CFA or other accounting related sources teach you regarding liquidity or credit risk of banks.

Believe it or not, but before Lehman went belly up none of the analysts who evaluated the solvency of LEH cared about the inputs to measuring credit or liquidity risk. They all cared about whether LEH can satisfy today's and tomorrow's margin calls and expected redemptions as well as the probabilities of having further credit lines pulled. Those who sat on the other end of the table did not evaluate LEH's credit in any traditional sense. Those decision makers had all ears on T.S. Paulson and also what the FED had up its sleeve, the probability of a bailout, in summary, political decisions where all that mattered. Same with Bear Sterns, same with every other bank prior to having gone belly up.

By the way, even if you looked at liquidity and credit risk way earlier before the last days of LEH' life may I remind you that their liquidity numbers (however faked they were) did not point to a default within days. Lights went out when JPM pulled their lines (for debatable but completely legitimate reasons). Sure, liquidity and credit risk numbers deteriorated over months prior to the crisis but so did everything else. Its like saying that "hey, I told you my 'economic-feel-good-index' went down the river since October 2007, so you have to watch that each time you care about evaluating bank risk". As long as any metric is anchored to a mix of economic, market, sentiment numbers then obviously you observe the higher correlation between such metric and market risk the more overall market stress feeds into the ingredients of such metric.

//beginning of rant(please stop here if not interested)// I recommend you diligently study this "stuff" to get your As in your MBA courses and CFA exams. However, keep in mind that most of the accounting numbers are there for one reason: To feed a whole industry of people who would not exist without this construct and to provide CFOs and CEOs with ever more ways to mask their real numbers. Nobody trading CDSs cares about traditional credit risk evaluations. It is generally those who continuously emphasize the importance WHO DO NOT HAVE A SKIN IN THE GAME, such as accountants, analysts, fund managers, educators, the media. Why I include fund managers? Because I cannot take someone seriously who comes out in 2008 and arrogantly tells the world that his fund performed 5% better than the benchmarks....it is "only" down 37%. //end of rant//

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