How Credit, Liquidity and Market Risk Feed Each Other
Why the three financial risks rarely arrive alone, traced through two company cases.
11 min
Activities: 0 of 2
You already know the risk families and how a risk register works. The next step is to see how three of those families behave together inside a real company. Credit risk is the risk that a customer or other counterparty does not pay what it owes. Liquidity risk is the risk that the company cannot pay its own obligations when they fall due, even if it is profitable. Market risk is the risk that changes in market prices — exchange rates, interest rates, commodity prices — change the value of cash flows, assets or debts.
In a bank, separate departments manage each of these with large models. In a contractor, a trading company or a manufacturer, the same few people manage all three, often in the same week. That is why it matters to see the links. A problem that starts as credit risk very often ends as a liquidity problem. A market move very often creates a credit problem, because it weakens a customer.
Case 1: a mid-sized construction contractor
- 1
Week 1
A large customer pays late
A developer that owes 2,000,000 (in the company’s currency) on certified work says payment will be 60 days late. This is a credit event, but no loss has happened yet. - 2
Week 3
The cash forecast turns negative
Payroll and supplier payments continue. The 13-week cash forecast shows a low point of minus 900,000 in week 6. Now the credit event is a liquidity problem. - 3
Week 4
The company draws on its facility
Treasury draws 1,000,000 from a floating-rate revolving facility. The cost of this borrowing depends on market rates, so the company now carries more interest-rate exposure. - 4
Week 8
Rates rise and a covenant tightens
Benchmark rates rise by 1 percentage point. Finance costs go up and the interest cover covenant moves close to its limit. One late payment has touched all three risks.
Case 2: an importer of steel products
A trading company buys steel in euros and sells to local construction firms in its own currency on 60-day terms. Three exposures sit in one transaction:
- Market risk: the euro may strengthen before the supplier is paid, so the local-currency cost rises. Steel prices may also fall while stock sits in the warehouse.
- Credit risk: the construction customers may pay late or not at all, and they tend to struggle at the same time when the building sector slows.
- Liquidity risk: the company pays the supplier in 30 days but collects from customers in 60 days or more, so it must fund the gap.
If the building sector slows, steel prices fall, customers pay later, and the bank becomes more careful about lending. All three risks move in the same bad direction at once. This is called correlation between risks, and it is the main reason a company cannot manage them in separate boxes.
The question each risk asks
Who owes us money, how much, and how likely are they to pay on time? Typical tools: credit assessment, credit limits, security, credit insurance, ageing reports, expected credit loss.
A profitable logistics company has large receivables from one oil services customer and a covenant that is close to its limit. The customer delays payment by 90 days. Which description is most accurate?
Where do you look first?