During the early “liquidity
phase” of the financial crisis that began in 2007, many banks – despite
adequate capital levels – still experienced difficulties because they did not manage
their liquidity in a prudent manner.
The crisis drove home the importance of
liquidity to the proper functioning of financial markets and the banking
sector. Prior to the crisis, asset markets were buoyant and funding was readily
available at low cost. The rapid reversal in market conditions illustrated how
quickly liquidity can evaporate, and that illiquidity can last for an extended
period of time.
The banking system came under severe stress, which necessitated
central bank action to support both the functioning of money markets and, in some
cases, individual institutions.