LCR is a regulatory
requirement that measures a financial institution’s ability to meet its
short-term liquidity need under stressed market conditions. The LCR requires
the institution to maintain a sufficient stock of high-quality liquid assets (HQLA)
that can be quickly converted into cash to cover its net cash outflows over a
30-day period. The LCR is calculated by dividing the institution’s stock of HQLA
by its expected net cash outflows over the next 30 days.
For example, suppose a bank has a total stock of $100
million in HQLA and is expected to experience net cash outflows of $50 million
over the next 30 days. In that case, the bank’s LCR would be calculated as
LCR = HQLA/Net cash outflows over the next 30
days=$100 million / $50 million= 2.0
In that example the bank’s LCR is 2.0 indicating that it has sufficient liquid assets to cover its expected cash outflows for the next 30 days.
The projected net cash outflows consider potential cash outflows under stress conditions, considering factors such as deposit withdrawals, contractual obligations, and other funding needs. These outflows are typically categorized into different time horizons, with different percentages applied to each category.
The LCR is calculated by dividing the bank’s HQLA by its projected net cash outflow. A minimum LCR threshold us set by regulatory authorities, and banks are required to maintain an LCR equal to or higher than the prescribed minimum. This ensures that banks have enough liquidity to cover their cash outflows for a defined period, typically 30 days,
The LCR serves as a measure of a bank’s liquidity
risk management and its ability to weather short-term liquidity stress. By
maintaining an adequate LCR, banks can enhance their resilience to financial
crises and contribute to overall financial stability.