Liquidity transformation
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Liquidity transformation is the creation of relatively more liquid assets from relatively less liquid assets.
One of the roles undertaken by banks is to provide investors with highly liquid deposits - including ones that can be withdrawn on demand - while using the deposited funds to finance illiquid longer-term loans.
- Does traditional asset management lead to fire sales and financial instability?
- "Through allowing investors to withdraw capital at short notice, traditional asset managers provide liquidity services that are similar to banks.
- For example, though they may invest in illiquid assets such as corporate bonds, bank loans, and emerging market stocks, open-end mutual funds have liquid liabilities.
- Specifically, mutual funds allow investors to redeem any number of shares at the fund’s end-of-day net asset value (NAV), effectively pooling liquidation costs across investors.
- In contrast, investors who directly hold the underlying investments bear their own liquidation costs when selling those assets.
- Can liquidity transformation by asset managers cause financial stability problems?
- ... A key concern on one side of the debate is that liquidity transformation increases the scope for fire sales.
- Redemptions from an open-end fund can force sales of illiquid assets, depressing asset prices and thereby stimulating further redemptions and fire sales."
- Liquidity transformation in asset management: Evidence from the cash holdings of mutual funds - European Systemic Risk Board (ESRB) - 2016.
See also
- Asset backed securities (ABS)
- Asset management
- Corporate bond
- Collateral swap
- European Systemic Risk Board (ESRB)
- Financial stability
- Fire sale
- Liquidity
- Liquidity insurance
- Liquidity swap
- Mutual fund
- Net asset value
- Redemption
- Repo
- Securities Financing Transactions Regulation
- Spillover risk
- Sterling Monetary Framework
- Stress
