What Is a Liquidity Crisis?

Liquidity crisis refers to the depletion of liquidity, which can be specifically manifested as the decline in asset prices below their intrinsic value, or the deterioration of external financing conditions of financial institutions, or the decline in the number of financial market participants, or the difficulty in trading financial assets, etc. . The liquidity crisis is caused by insufficient liquidity.

Liquidity crisis

Right!

Liquidity crisis refers to the depletion of liquidity, which can be specifically manifested as the decline in asset prices below their intrinsic value, or the deterioration of external financing conditions of financial institutions, or the decline in the number of financial market participants, or the difficulty in trading financial assets, etc. . The liquidity crisis is caused by insufficient liquidity.

Chinese name

Liquidity crisis

Foreign name

liquidity crisis

Domestic liquidity crisis

If the financial institution's assets and liabilities do not match, that is, "borrow short and grow long", it will result in insufficient liquidity to repay short-term debt.

2. International liquidity crisis

If the potential short-term foreign exchange performance obligations in a country's financial system exceed the foreign exchange asset model that can be obtained in the short term, international liquidity will be insufficient.

When domestic financial institutions suffer from insufficient liquidity, the central bank can play the role of the lender of last resort to avoid the possible large-scale banking crisis caused by "runs." In the absence of international liquidity, international organizations such as the IMF should take appropriate measures in a timely manner.

Liquidity crisis in Paris sugar futures market in 1974

Between September and November 1974, due to a large number of speculators who lacked risk awareness, the price of Paris sugar futures doubled in just three months. In the face of this situation, some settlement members of the exchange did not take precautionary measures and still traded according to the client's mandate. Eventually, a large number of investors failed to meet the margin requirements, and the settlement member Nataf's white sugar trader made mistakes. Eventually the French commercial sector closed down the sugar market.

The Paris sugar market settlement agency made the following three mistakes in this crisis, which exacerbated the liquidity crisis:

First, in the case of sharp fluctuations in market prices, a fixed margin level is still adopted without adjusting the margin level. Even in September, when the main parties of the market put forward demand for margin adjustment, the settlement institution still insisted on doing it alone.

Second, although the exchange has realized that a single settlement member (Nataf) holds most of the contracts in the sugar futures market, it has not taken corresponding measures.

Third, the loss distribution of exchanges lacks transparency. At that time, the exchange introduced a rule to restart trading, which settled market contracts at the average price of the past 20 trading days (this price is much higher than the price when trading was suspended). The subsequent implementation of this rule caused a series of legal disputes, and the bankruptcy of the clearing institution in performing its contract settlement obligations made it even more difficult to resolve the incident. The sugar market did not resume trading until June 1976 under the new trading rules.

From the liquidity crisis of the Paris sugar market in 1974, the dynamic position monitoring of settlement members' positions, the necessary position limits are very necessary, and in order to prevent further concentration of risks, exchanges and settlement agencies should adjust margins based on market risks.