Liquidity Gap

A “liquidity gap” is basically the difference between our liquid assets (i.e. cash or things that can quickly be converted to cash) and our liabilities.

For example, if a person owes $120,000 in student loans but has $600,000 in the bank, their liquidity gap is positive: they owe a lot less than they have. (Which kind of makes us wonder why they haven’t just paid off the loan already, but that’s none of our business.) On the flip side, if we owe $120,000 and don’t have any liquid assets, our liquidity gap is negative: we owe more than we’ve got on hand to pay it off.

It’s not just individuals who should mind the liquidity gap, though. For example, if banks don’t have enough cash on hand to fund their customers’ requests, whether we’re talking loans or ATM withdrawals, they have a liquidity gap. And if an organization takes out a loan to, say, fund the development of a new product line, and then that product ends up being super lame and they can’t sell it, they might find themselves in a negative liquidity gap.

Speaking of banks and loans, though, if we apply for a loan and have a significant negative liquidity gap that doesn’t show any signs of shrinking soon, we might end up paying a higher interest rate on what we borrow, since the bank might be a little skeptical that we’ll be able to pay them back.