What Is a Liquidity Gap?

Liquidity gap is a term used in several types of financial situations to describe a discrepancy or mismatch in the supply or demand for a security or the maturity dates of securities. Banks deal with liquid💃ity risks and potential liquidity gaps to the extent that they need to make sure they have enough cash on hand at all times to meet re🔯quests for funds.

When the maturity of assets and liabilities differ, or there is a higher than expected demand for funds, the bank might experience a shortage of cash and, thereforeꦜ, a liquidity gap.

Understanding a Liquidity Gap

A firm might also experience a liquidity gap when they don't have enough cash on hand to meet 澳洲幸运5开奖号码历史查询:operational needs and hav⛄e assets and liabilities maturing at different times. Liquidity gaps can also occur in the markets when there is an insufficient number of investors to take the opposite side of a trade, and people who are looking to sell their securities are unable to do so.

For banks, the 澳洲幸运5开奖号码历史查询:liquidity gap can change over the course of a day as deposits and 澳洲幸运5开奖号码历史查询:withdrawals are made. This means that the liquidity gap is more of a quick snapshot of a firm's risk, rather than a figure that can be worked over for a long period of time. To compare periods of time, banks calculate the marginal gap, which is the difference between g🌱aps of different periods.

During the early months of the 澳洲幸运5开奖号码历史查询:global financial crisis, some bond and structured product investors found they could not sell their investments. There was a liquidity gap in that there weren't parties that were willing to take the other side of the trade and purchase the securities at depressed prices. This lack of liquidity caus🙈ed markets in some securities to dry up for several weeks.

Example of a Liquidity Gap

Hedge Fund ABC purchases $100 million worth of 澳洲幸运5开奖号码历史查询:mortgage-backed securities (MBS) in February as the outlook of the housing market is strong and it believes that the asse🌜ts it purchased w🐬ill provide a steady stream of income for the foreseeable future. ABC also believes that if it ever needs to sell its MBSs then it will have no problem doing so because liquidity in the market is high, with a significant amount of traded volume, with many buyers and sellers transacting on a daily basis.

As the year progresses, the economy takes a downturn due to an intense hurricane season destroying crops and many important shipping ports. This in turn causes significant job losses. Due to the job losses, many laid-off individuals 🔜are not able to pay ꦆtheir mortgages on time, causing defaults on their home loans.

Because no payments are being made on these home loans, which are the underlying assets of the MBSs, the MBSs start defaulting, meaning n♒o income stream is coming in. This causes the value of these MBSs to fall. Hedge Fund ABC decides to sell its portfolio of MBSs, which is now valued at $70 million rather than $100 million, resulting in a loss of $30 million.

However, ABC is only able to sell off $20 million of its portfolio and cannot find buyers for the remainder of its MBS portfolio. It tries to sell the portfolio at a discount, however, buyers are not interested because the 澳洲幸运5开奖号码历史查询:housing market is in a free fall and no one knows how low it will go and if the value of the MBS portfolio will fall further. Hedge Fund ABC is experiencing a liquidity gap where it has a portfolio of assets to sell but no buyers to sell it to.