Calculate What is liquidity? – this is a basic concept in finance, is one of the criteria that investors prefer when choosing an investment portfolio. A highly liquid asset is often preferred over an illiquid asset.
What Is Liquidity?
Liquidity is a term to express the flexibility of an asset when it is bought and sold in the market without much impact on the market price of that asset. An asset's liquidity is its ability to convert into currencies or assets that have a price.
A highly liquid asset that is characterized by being sold quickly without a significant decrease in the selling price, with a large number of transactions.
Liquidity in English is Liquidity.
Liquidity Asset Classification
The level of liquidity from high to low of assets and currencies is evaluated from high to low as follows:
- Short term investment
- Accounts Receivable
- Short-term advance
In the above list, cash is considered the most liquid asset because it is a tool used directly for payment, circulation, and easy storage of goods and assets.
For the same reason, cash also becomes a measure of the liquidity of assets.
The more easily an asset can be converted to cash, the more liquid it is.
Inventory is the most liquid asset class, i.e. it is not easy to convert to cash. Normally, inventory must go through distribution, consumption, and collection from customers before it becomes cash.
What Is The Meaning Of Liquidity?
The meaning of liquidity for investors is reflected in the ability to quickly convert, the level of safety when converting assets:
- Shows the dynamic and efficient level of the market. The more vibrant the market, the higher the liquidity because there are many organizations and individuals participating.
- Ability to easily switch portfolios.
The meaning of liquidity for businesses
In a business, the assessment of liquidity plays a very important role for the financial situation. Specifically:
- Shows the liquidity of the company so that the organizational apparatus can perceive problems and offer the most appropriate course of action.
- Helping businesses discover potential problems and solve them definitively. Thereby, ensuring loans are paid on time and maintaining trust in the eyes of investors and partners.
- The leadership team will come up with appropriate management options to help optimize financial resources and increase liquidity. This is to promote healthy and resilient cash flow, to grow when opportunities arise and save needed when situations get tough.
- Through the introduction of appropriate management plans from the leadership team, it is possible to help businesses increase liquidity and optimize financial resources. When the business situation turns tough, this awareness of liquidity will help save and create opportunities for growth to promote healthy cash flow for the business.
What liquidity means for a business's banks, creditors and investors
For investors, banks and creditors of an enterprise, the assessment of the liquidity of that enterprise has certain meanings as follows:
- Evaluating the liquidity situation of an organizational unit will help lenders and investors to recognize the liquidity risks of the business. From there, you can consider and make a decision whether to lend or invest.
- If the business has a debt with the bank, it must liquidate assets to meet the payment of that debt. At that time, the bank can help the business by lending through the form of collateral for that property.
- Based on this liquidity index, investors can identify whether to invest in that business or not.
Liquidity in Banks
Liquidity is an important criterion when evaluating a bank. Banks need to be able to respond immediately to disbursement and cash withdrawal needs as committed to customers. This shows that the bank has good liquidity.
Features of Bank Liquidity
A bank's liquidity possesses important characteristics that affect service quality:
- Cash supply and demand are not balanced. Banks can hardly control the needs of customers to withdraw, deposit and borrow capital, so they are often in a state of surplus or deficit.
- The higher the amount of capital retained to meet the bank's liquidity needs, the lower the bank's profit and vice versa.
Credit Institutions Liquidity Assessment Criteria
To assess liquidity, it will normally be based on the following quantitative and qualitative criteria:
- Quantitative indicators ratios can be calculated for: Average liquid assets to average total assets; Short-term funds are used for medium and long-term loans; Outstanding loans compared to total deposits; Customer deposits have large deposit balances compared to total deposits.
- Qualitative indicators including compliance with the law on: solvency ratio, maximum ratio of short-term capital used for medium- and long-term loans, ratio of outstanding loans to total deposits; issue, review, amend, supplement and report internal regulations on liquidity management and comply with other legal regulations on liquidity risk management.
The source of liquidity for the bank comes from:
- Deposits received
- Fees collected from the provision of services
- Credits earned
- Sale of assets that are in business and in use
- Borrowing from the money market
The Need To Create Liquidity
Activities that create demand for liquidity for banks include:
- Customers withdraw money from deposits
- Customers requesting a loan
- Payment of other payables
- Cost of creating banking products and services
- Payment of dividends to shareholders
Causes of Liquidity Risk
Causes of liquidity risk for the bank in case the bank does not or is slow to meet the liquidity needs of the customer. Bank short of funds, or short-term assets. Therefore, the bank lacks cash reserves and cannot raise capital immediately.
Point c, Clause 2, Article 8 of Circular 08/2017/TT-NHNN has clearly stated that liquidity risk is the risk caused by:
Credit institutions, foreign bank branches are unable to fulfill their debt repayment obligations when they are due; or
Credit institutions, foreign bank branches are capable of performing debt repayment obligations when they are due, but must pay high costs to fulfill such obligations.”
Liquidity Risk Loss
Loss from liquidity risk affects both banks and customers. Detail:
- For banks: forced to raise interest rates to mobilize more capital. Meanwhile, lending interest rates remain unchanged, which may cause the bank's revenue to decrease or increase lending rates.
- For customers: may have to borrow at a higher interest rate.
- For economy: indirectly affect the quality of investment activities, affecting the activities of borrowing enterprises.
Recommendations for Liquidity Risk Management Solutions
Measures to manage liquidity risk:
- Using open market operations to diversify and attract capital.
- Use refinancing tools.
- Manage and strictly implement regulations on credit activities of the State.
- The structure of mobilized capital sources and loans is reasonable between medium and short term.
- Maintain the ratio of cash reserves, bank deposits at a reasonable rate.
- Well managed liquidity risk.
The liquidity of securities is reflected in the ability to easily buy and sell, and the price is relatively stable in the short term. Through the stock market, investors easily convert from securities to cash and vice versa. This shows the flexibility and safety of capital.
Risks in Securities Liquidity
The liquidity of a security is measured by the time and cost to convert into cash.
The risk in securities liquidity is when it takes a long time and costs to recover investors' capital. This means it is difficult to find a buyer at the expected price, or to accept a lower price in exchange for cash. In this case, the investor will bear a certain loss.
Factors Affecting Securities Liquidity
Factors affecting the liquidity of Securities
- Financial ratios reflect the business performance of an enterprise. There are many financial indicators that reflect the results of using capital of enterprises such as P/E ratio, profit, etc.
- Government policies affect businesses. Depending on the general development policy of the country, the Government may issue administrative regulations applicable to business lines and industries.
- Regulations on foreign investment.
- Investor sentiment. There are always short-term and long-term investors in the market. The performance of short-term investors often depends on the general market fluctuations. Thereby affecting the liquidity of the market.
How to Limit Risks
Financial investment products such as securities depend a lot on the internal factors of the business and the general market situation. Therefore, ways to limit securities liquidity risk include:
- Consider the long-term development of the business.
- Assess the trend of fluctuations of the industry, of the market in general.
- Implement reasonable resource allocation.
Some questions about liquidity
What is a liquidity trap?
A liquidity trap refers to a market condition where interest rates are so low that people hold more liquid assets (non-yielding assets) than other profitable assets.
What is liquidity risk?
Liquidity risks are potential financial and brand losses that may occur due to the inability or inability of the bank to fulfill its payment and payment obligations in full and on time as committed. proposed conclusion.
Calculate What is liquidity? has been answered quite fully by the post above. Securities and bank deposits are fairly liquid investments, so they are preferred by investors.