Liquidity gap is a term used in several types of financial situation to describe a discrepancy or mismatch in the supply or demand for a security or the maturity dates of securities. Banks deal with liquidity risks and potential liquidity gaps to the extent that they need to make sure they have enough cash on hand at all times to meet requests for funds. When the maturity of assets and liabilities differ, or there is higher than expected demand for funds, the bank might experience a shortage of cash and therefore, a liquidity gap.
Breaking Down Liquidity Gap
A firm might also experience a liquidity gap when they don't have enough cash on hand to meet operational needs and have assets and liabilities maturing at different times. Liquidity gaps can also occur in the markets when there is an insufficient number of investors to take the opposite side of a trade, and people are looking to sell their securities are unable to do so.
For banks, the liquidity gap can change over the course of a day as deposits and withdrawals are made. This means that the liquidity gap is more of a quick snapshot of a firm's risk, rather than a figure that can be worked over for a long period of time. To compare periods of time, banks, calculate the marginal gap, which is the difference between gaps of different periods.
During the early months of the global financial crisis, some bond and structured product investors found they could not sell their investments. There was a liquidity gap in that there weren't parties that were willing to take the other side of the trade and purchase the securities at depressed prices. This lack of liquidity caused markets in some securities to dry up for several weeks.