Q. In context with the banking business, which among the following is a correct definition of liquidity risk?
Answer: Risk arising from funding of long term assets by short term liabilities or funding of short term assets by long term liabilities
Notes: Liquidity risk refers to the potential difficulty a bank faces in funding long-term assets with short-term liabilities. This mismatch can lead to a situation where a bank cannot meet its short-term obligations, especially during financial stress. According to the Basel III framework, maintaining adequate liquidity is crucial for banks to withstand financial shocks. Historically, liquidity crises, like the 2008 financial crisis, highlighted the importance of effective liquidity management.