Understanding Liquidity Risk

By 
DAVID R. HARPER

Updated May 31, 2021

Reviewed by 
CHARLES POTTERS
Before the global financial crisis (GFC), liquidity risk was not on everybody's
radar. Financial models routinely omitted liquidity risk. But the GFC prompted
a renewal to understand liquidity risk.1 One reason was a consensus that the
crisis included a run on the non-depository, shadow banking system—
providers of short-term financing, notably in the repo market—systematically
withdrew liquidity. They did this indirectly but undeniably by increasing
collateral haircuts.

After the GFC, all major financial institutions and governments are acutely

aware of the risk that liquidity withdrawal can be a nasty accomplice in
transmitting shocks through the system—or even exacerbating contagion.