Deposit risk is one type of liquidity risk of a financial institution that is generated by deposits with the defined maturity dates (then such deposits are called time or term deposits) or without the ones (then such deposits are called demand or non-maturity deposits).
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Types of deposit risk
Deposit risk is a risk of probable cash outflows from a financial institution that is caused by changes in depositors’ behavior. In its turn, it consists of early withdrawal or redemption risk, rollover risk and run risk.
As a result, these risks might lead to dropping or even losing a liquidity of a financial institution if it cannot to attract new deposits instead of withdrawn ones. Wherein, the impossibility of the financial institution to refinance by borrowing in order to repay existing deposits is called a refinancing risk.
Exposures to deposit risk
An early withdrawal risk affects a rollover risk through decrease of cash flows that will be repaid in the future. The early withdrawal and rollover risks depend on a term to maturity of deposits. The more maturity, the more early withdrawal risk, and the lower rollover risk, and vice versa. The main financial determinants of the early withdrawal and rollover risks are interest rates of the financial institution and its competitors, term to maturity and age of deposit, credit rating of the financial institution, and amount of deposit insurance.
Evaluation of deposit risk
The considered types of deposit risk are usually evaluated by ‘Cash Flow at Risk’ (also CFaR) approach. Thus, ‘Cash Flow at Deposit Risk’ is possible cash outflows from a financial institution over a fixed period of time that are predicted with chosen confidence level.