The past few years have seen a pattern of non-bank financial institutions facing liquidity crises. This happened at the start of the pandemic, among commodity traders following the spike in energy prices after the Russian invasion of Ukraine and during the mini-budget crisis in the UK when pension funds faced a liquidity crunch.

What is somewhat odd about these episodes is that the asset price movements should have been a positive step for the institutions involved. For example, pension funds should benefit from rising interest rates. The cause is that these institutions hedge risk, and when the hedge moves against them – which notionally means they are better off – they need to make immediate payments to their counterparty. This generates strange situations where institutions become illiquid even as their solvency improves. This form of risk-taking liquidity after solvency hedging is labelled as LASH risk.

In Saleem’s paper, he investigates LASH risk from interest rates movements in the UK and shows that this risk is large: a 100-basis point movement in yields - enough to wipe out the free cash of the affected sectors. It co-moves negatively with interest rates: low rates, more liquidity risk.  Last, it explains a substantial portion of the selling pressure seen in bond markets as part of the mini-budget crisis of September 2022.

Read the full Financial Times article or explore Saleem’s research.