![]() Cashflow shortfalls may thus be an important cause of credit risk. If the liquidity shortfall is very serious, an induced default on other contracts, or even bankruptcy, may result. ![]() Indeed, liquidity shortfalls may be costly, forcing the party expecting a payment to engage in relatively expensive borrowing or unprofitable asset sales. The distinction may, however, not always be clear in practice. Liquidity risk principally entails a cashflow shortfall. Credit risk entails the probability of a loss of principal and implies the possibility of associated liquidity risk. ![]() The distinction between credit and liquidity risk is important. Liquidity risk is the risk that the counterparty that owes funds will not be able to meet its payment obligation on time, thus adversely affecting the expected liquidity position of the recipient of funds at the time the funds are due. Credit risk typically arises when one of the participants becomes insolvent. These participants include the counterparties themselves, the issuer of the settlement medium, and, if any, intermediaries involved in the delivery of goods, services, etc. The counterparties face two fundamental types of risk:Ĭredit risk is the risk that participants in the transaction will not be paid for an outstanding claim. It explains systemic risk, describes the risks that arise in netting arrangements, and deals with control of risk in net settlement and real-time gross settlement systems. ![]() It outlines the basic steps and the types of risks that can arise in a financial transaction and shows how an intermediary providing payment services also takes on risks. This chapter describes and analyzes the risks borne by participants in payment systems. It is in these markets in particular that interrelationships between counterparties create the potential that disturbances in payment flows will have wider repercussions for the financial system and the economy as a whole. These risks are greatest in large-value interbank funds and securities transfer systems that support trading in financial markets. Financial transactions generate a range of risks for counterparties that undertake them, their bankers and other intermediaries that process the transactions, and central banks through which final interbank settlement occurs. ![]()
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