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Measuring and Managing Liquidity Risk by Francesco Fede, Antonio Castagna

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5

Know thyself!

5.1 INTRODUCTION

When the ancient Greeks went into the forecourt of the temple of Apollo at Delphi they would read the aphorism “Know thyself” inscribed on the wall. This maxim likely derives from an Egyptian proverb, which called on initiates to prove their worth so that they could acquire higher knowledge (“Man, know thyself … and thou shalt know the gods”).

In the dialogue Philebus, Plato argues that gaining more knowledge of ourselves would lead us to a greater understanding of the nature of human beings. Gods and human beings are beyond the scope of this analysis but, focusing on the financial sector, it is obvious that knowing our own financial institution better is a prerequisite to being better equipped to cope with the liquidity risk associated with it.

As argued in the previous chapter, the main contribution provided by the new international regulatory framework on liquidity risk is not the two binding ratios, which are a simple combination and evolution of existing liquidity measures already used by the industry, but the comprehensive development of sound management and supervision practices about liquidity risk. This moves away from the definition of specific liquidity risk tolerance, defined by top management according to their business strategy, and calls for an articulate system of risk management, product pricing, performance measurement to warrant full consistency between risk-taking incentives for business lines and the related liquidity risk ...

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