Liquidity Risk in Commercial Banks in India

Liquidity risk is a crucial factor in the business of commercial banking. At the ischolar_main of the 1997 Asian crisis was the failure of banks to meet liquidity risk arising from differences in currency composition of their assets and liabilities. Diamond and Dybvig (1983), Diamond (1997), Diamond and Rajan (1999) have considered liquidity issues centrally important in theory and functioning of commercial banks.

Looked from this perspective, maturity transformation is an important aspect of financial intermediation. Providing deposit insurance is a well accepted measure that enables banks to provide liquidity by maintaining public confidence in the banking system. Similar would be the effect on public confidence where banks are owned by government. With moves towards competition and deregulation, operating in market-oriented business environment becomes crucial which make risk management an important task. The process of financial deregulation leads to increased incidence of market risks such as currency risk and interest rate risk.. Moreover, as clients of commercial banks face competitive business environment, their exposure to credit risk too will increase. In such a situation, maintaining liquidity risk within manageable limits becomes extremely important. Liquidity risk would in fact represent aggregate incidence of market and non-market risks.