This is a crucial distinction to understand the concept of liquidity in banking. What @mark_dow describes in his post can be best explained in terms of "funding liquidity (FL)" and "asset liquidity (AL)". 1/8
AL refers to the degree to which an asset can be quickly bought or sold in the market without affecting its price. It means how easily an asset can be turned into the most liquid good in the market: money/cash. Liquidation of assets = making assets more liquid. 2/8
FL refers to the easiness an entity can find sources of financing. An asset can have a high degree of saleability but be rather illiquid. Some authors name this "shiftability": an asset can be shifted from bank to bank (balance sheet to balance sheet) with relative ease. 3/8
The longer an asset duration the more illiquid it will be. In times of market stress, this is exacerbated. Through maturity transformation, modern banks fund illiquid assets (mortgages, longer-term bonds) with short-term debt (deposits). 4/8
And since there's a lender of last resort in place to provide funding liquidity whenever a crisis hits, asset-based liquidity has been constantly relegated, year after year. 5/8
Charles Goodhart points out how the banking practice shifted heavily from AL to FL in the last decades. During the formative years of the Basel Committee for Banking Supervision (BCBS), asset-based liquidity was a high priority. 6/8
Nowadays, not so much. That means modern banks are systemically illiquid. And because the final source of liquidity (ie.: cash) can be manufactured discretionarily by central banks, there's no end in sight for this state of affairs. 7/8
This is a direct outcome of our current inconvertible paper-money experiment, initiated in 1971. How to reform this system, though, no one knows. What's worse, there's not even a consensus its needs reformation. {fin}
Goodhart paper on "liquidity management" citeseerx.ist.psu.edu/viewdoc/downlo…
