A type of risk redistribution (financial transformation) which involves the funding of illiquid assets (long-term loans) with liquid liabilities (short-term deposits). Liquidity transformation and maturity transformation lead to similar results but each uses its own means. For example, a bank can create a liquid security from a pool of illiquid collateral assets by playing on credit rating to lessen the information asymmetry between deficit units (borrowers) and surplus units (lenders).

Banks and similar intermediaries embark on liquidity transformation in order 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.