Credit risk is incurred whenever a firm is exposed to loss if another party fails to perform its financial obligations to the firm. This includes issuer risk, which could potentially result in a firm losing the full price of its investments, since default by the issuer could result in their value falling to nil.
Liquidity is the ability of a firm to meet its liabilities at the time they fall due. Adequate liquidity is vital to the continuing viability of a firm and to maintaining the stability of the financial system as a whole. If consumers could not rely on being able to redeem their e-money in full in a timely fashion, they would lose confidence in the sector.
The purpose of the liquidity requirements of this chapter is to help to enable a firm to be able to do the following in particular:
to meet maturing obligations in the normal course of business (business liquidity);
to maintain an additional cushion of liquidity to cope with unexpected events such as the failure of a significant counterparty or debtor (contingent liquidity); and
to survive in a wider market-generated crisis (market liquidity).
Where the firm's exposure to its counterparty is large, it risks a large loss should the counterparty default. Such a loss may be enough on its own to threaten the solvency of the firm and its ability to redeem e-money when required to do so. The purpose of the large exposure requirements is to help to ensure that a firm manages and diversifies its exposures to counterparties relating to its e-money float within suitable limits related to its capital resources.
The purpose of the foreign exchange risk requirements in this chapter is to help to ensure that the e-money float is not put at risk by foreign exchange exposures.