Liquidity Coverage Ratio (LCR)
The Liquidity Coverage Ratio (LCR) is a key regulatory requirement under the Basel III framework, designed to ensure banks maintain sufficient high-quality liquid assets (HQLA) to withstand short-term liquidity stresses lasting for 30 days. This aims to enhance the banking sector's resilience and prevent systemic crises triggered by liquidity shortages.
LCR = High-Quality Liquid Assets (HQLA) / Total Net Cash Outflows over the Next 30 Calendar Days
-
High-Quality Liquid Assets (HQLA) (numerator): These are assets readily convertible into cash with minimal loss of value during times of stress. Basel III classifies HQLA into three levels based on their liquidity characteristics:
- Level 1: The most liquid assets, including cash, central bank reserves, and certain sovereign debt securities.
- Level 2: Assets with slightly lower liquidity than Level 1, such as certain corporate bonds and mortgage-backed securities.
- Level 3: The least liquid HQLA category, including some equities and securitised products.
-
Total net cash outflows (denominator): This represents the expected cash outflows a bank faces during a 30-day stress scenario. The calculation considers various factors:
- Unsecured wholesale funding withdrawals.
- Retail deposit outflows.
- Potential draws on committed credit lines.
- Collateral requirements for derivative contracts.
Basel III standards set a target minimum LCR of 100%, meaning banks must hold enough HQLA to cover their projected net cash outflows for 30 days under a stress scenario.
The LCR plays a crucial role in strengthening a bank's short-term liquidity resilience and complements the Net Stable Funding Ratio (NSFR). While the NSFR focuses on longer-term funding stability over a one-year horizon, the LCR specifically addresses the immediate liquidity needs that could arise during a sudden crisis.