Bank capital and liquidity perform different functions. Equity capital is provided by shareholders and is the first buffer against losses in a downturn. Equity enables banks to shrink the liabilities side of their balance sheets to match a shrinking asset base caused by losses. Liquidity can be deployed to meet short-term obligations such as large-scale sudden deposit withdrawals. Withdrawals reduce the liabilities side of the balance sheet; the liquidity portfolio can be shrunk to match that change.
Key learning objectives:
Explain the difference between capital and liquidity
Explain the role of capital in a property downturn
Explain how a bank uses it liquidity portfolio to deal with deposit withdrawals