Let's have a look at the sources of liquidity risk within a bank in more detail. The most obvious source of liquidity risk is from a bank's funding sources. Banks are typically financed through a combination of depositors funds, the wholesale lending markets, which involves a bank borrowing from other providers of capital. The capital markets where the bank issues, tradable bonds and equity capital financing. Depositors funds are a source of liquidity risk, since most bank deposits are in the form of on demand deposits, such as a typical checking or current account where the depositors can withdraw their money whenever they want. However, should sufficient customers wish to withdraw their deposits at the same time, sometimes referred to as a run on the bank, the bank may quickly run out of sufficient liquid funds to meet the requested withdrawals. Alternatively, the wholesale funding market could be the source of the liquidity risk if no other lender or bank wants to be a liquidity provider and lend you money. And finally, the capital markets might be closed for business if no one is willing to purchase a new bond the bank is issuing.

However, the banking books and trading books are also sources of liquidity risk. For the banking book, liquidity risk could be created from suffering defaults from customers on either interest payments or loan repayments. This could create liquidity risk since the cash that the bank was expecting to receive might have been allocated to meet certain liabilities, which will now need to be funded from different sources.

If a bank foresees liquidity trouble, it may look to raise its liquidity buffer by selling some of its loans, also referred to as distributing or assigning the loan. This is through a process called securitization. However, the ability of a bank to set up the securitization is dependent on market levels of demand, which might be low in adverse economic situations, potentially cutting this off as a source of liquidity. Within the trading book, liquidity issues can arise in a number of ways. These include the market depth is not sufficient to achieve a good price or even to be able to execute a trade, reducing the ability of the bank to sell a financial asset and turn it into cash. The inability of the bank to close its open derivative positions resulting in cash outflows on loss making positions. When a counterparty defaults and does not meet their obligations, for example, on the settlement of a derivative or securities financing transaction, or when a bank needs to cover a loss making position by posting collateral.

Collateral is most often paid in the form of cash. This cash is now tied up covering the loss making position, meaning it is not available to be used for liquidity purposes if needed.