Another explanation, which might be called “liquidity risk,” is that traders at one
bank are reluctant to expose the traders’
bank’s funds during a period of time where those
funds might be needed to cover the bank’s own shortfalls.
Effectively, the trader may not be given as much “balance sheet” to invest, which is perceived as a shortage of liquidity to the trader. While it is difficult to distinguish counterparty risk from liquidity risk, we note that the interest rate on CDs, which are also held by individuals and non-banks,follows Libor closely during this period. Hence, it is not only banks that are getting, premiums when lending to banks, indicating that once counterparty risk is taken into
account there is little additional role for liquidity risk as defined here