Survive the droughts, I wish you well: Principles and cases of liquidity risk management

Short-term, liquid assets are highly valued by lenders, but pose liquidity risk management challenges to borrowers. Basic principles to meet those challenges are to conduct liquidity stress scenario analysis; to form business plans for each stress scenario; to hold enough capital to sustain the planned, post-shock balance sheet; and to hold a large enough liquidity reserve to survive the transition from the pre- to the post-shock balance sheet. Historical failures, like Northern Rock, Bear Stearns, and MF Global have a lot to teach about implementing these principles. While regulatory frameworks constrain liquidity positions, they are no substitute for firm-specific liquidity risk management.