Liquidity Coverage Ratio (LCR)
The LCR is a requirement under Basel III and is designed to ensure that banks hold a sufficient reserve of high-quality liquid assets (HQLA) to allow them to survive a period of significant liquidity stress lasting 30 calendar days. The supervisory scenario capturing the period of stress combines elements of bank-specific liquidity and market-wide stress and includes many of the shocks experienced between 2007 and 2012. This 30-calendar-day stress period is considered the minimum time needed for the bank’s management or supervisors to take corrective measures.
Internationally active banks are required to maintain a minimum liquidity coverage ratio of 100%, meaning the bank’s stock of high-quality assets must be at least equal to the projected total net cash outflows during the 30-day stress period.
Key Features of the LCR
Estimating net cash outflows
Total net cash outflows are calculated as the difference between the total expected cash outflows and the total expected cash inflows during a stress scenario. Expected outflows are derived by multiplying the outstanding balances of different types of liabilities and off-balance sheet commitments by the supervisory rates at which they are likely to be withdrawn. Expected cash inflows are estimated by applying inflow rates to the outstanding balances of various contractual receivables. The difference between the stressed outflows and inflows needs to be less than the size of the weighted HQLA stock.
HQLA
HQLAs are cash or assets that can be monetised quickly through sales or repurchase agreements. An asset qualifies as HQLA if it is unencumbered, meets certain minimum liquidity standards, and its operational characteristics show it can be readily sold to generate liquidity when required. HQLAs include Level 1 assets, which can be included without limit, and Level 2 assets, which cannot exceed 40% of the liquidity reserve. Level 2 assets are themselves subdivided into Level 2A and 2B assets, which are subject to higher haircuts but cannot exceed 15% of the stock of HQLA.