Liquidity crisis
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The term liquidity crisis may refer to :
- a "general feeling of mistrust in the banking system"[1] conducting to a temporary disappearance of credit;
- a lack of cash experienced by one particular business;[2]
- the term is sometimes used as a synonym of credit crunch.
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[edit] Liquidity crisis as an economic crisis
Nouriel Roubini describes the crisis of August 2007 as a credit crisis and credit crunch and explains it is not just a liquidity crisis.[3]
A credit crunch is a sharp increase in the interest rates and a strong decrease in allocated credits.[1]
[edit] Liquidity crisis for a business
A liquidity crisis occurs when a business experiences a lack of cash required to grow the business, pay for day-to-day operations, or meet its debt obligations when they are due, causing it to default. When "liquidity crisis" is used to refer to an economy as a whole it means that liquidity crises affecting principal players in the economy are resulting in diminished availability of credit.
Some businesses choose to "trade through" a liquidity crisis in the hope of finding additional cash flow needed to survive the temporary crisis. This often involves delaying payment of creditors, issuing bonds, making additional loans, selling assets, and encouraging more prompt payment from customers. Continuing to trade through a liquidity crisis in circumstances where the underlying business is not viable (or where the market itself is experiencing a prolonged recession or credit crunch) will only delay the inevitable bankruptcy and result in further losses.
When a liquidity crisis occurs, it is vital that the stakeholders accurately and objectively assess whether the business is viable and ultimately can succeed with the injection of further cash to stave off insolvency, or whether it is incapable of surviving long term in the current market. The financier or bank lender is often the ultimate arbiter of whether a business survives a liquidity crisis or not.
The decision whether to "trade through" a liquidity crisis or declare bankruptcy is quite possibly the most difficult and complex decision any business leader can face.
[edit] References
- ^ a b Citi, ‘Rampant inflation’, ‘Credit crunch’, ‘Liquidity crisis’, ‘Chinese economic bubble’ Where’s it all going to end?, December 2007
- ^ Liquidity Crises Management
- ^ Worse than LTCM: Not Just a Liquidity Crisis; Rather a Credit Crisis and Crunch, Nouriel Roubini, August 2007 : "Economists distinguish between liquidity crises and insolvency/debt crises. An agent (household, firm, financial corporation, country) can experience distress either because it is illiquid or because it is insolvent".
