A type of transformation that involves the use of short-term debts like deposits to finance long-term investments like loans. In other words, it is an intermediation process used by banks and similar intermediaries to mitigate the so called “run problem” or “liquidity run”. In banking practice, this involves the issuance of liquid direct financial claims and the acceptance of less liquid indirect claims- i.e., the financing of liquid investments with even more liquid deposits. Banks give depositors instant or short-term access to their funds while they provide borrowers with long-term funds. Depositors usually dispose of their funds by transfer or withdrawal for their own liquidity requirements and as such don’t consider the bank’s position of liquidity. Therefore, banks pursue sufficient levels of liquidity for frequent requests of payment (both expected and unexpected).

Customarily, banks hold a small fraction of cash reserves to meet withdrawals on the assumption that only a small number of depositors will want to dispose of their funds at any point in time. In simple terms, liquidity intermediation is a bank’s attempt to generate returns through liquidity mismatches between assets and liabilities.

Liquidity transformation is one of the bank’s core functions.