Liquidity means a bank has the ability to meet payment obligations primarily from its depositors and has enough money to give loans. So, liquidity risk is the risk of a bank not being able to have enough cash to carry out its day-to-day operations.
Provision for adequate liquidity in a bank is crucial because a liquidity shortfall in meeting commitments to other banks and financial institutions can have serious repercussions on the bank’s reputation and the bank’s bond prices in the money market.
Liquidity risk can sometimes lead to a bank run, where depositors rush to pull out their money from a bank, which further aggravates a situation. So, banks like JPMorgan Chase (JPM) and Wells Fargo (WFC), investment banks like Goldman Sachs (GS) and Morgan Stanley (MS), as well as other banks included in the Financial Select Sector SPDR Fund (XLF) must proactively manage their liquidity risk to stay healthy. These four major banks together form approximately 22% of XLF.
Overall, banks form roughly 43% of the ETF, with capital markets, insurance, and diversified financial companies forming the rest. In conditions of tight liquidity, these banks generally turn to the Fed.
View more information: https://marketrealist.com/2019/10/must-know-credit-and-liquidity-risks-in-banking/