What is LCR (Liquidity Coverage Ratio)?
Liquidity Coverage Ratio (LCR) Definition
The purpose of the liquidity coverage ratio is to ensure that financial institutions have enough liquid assets to survive a short-term market wide disruption.
It is calculated by dividing the amount of highly liquid assets held by a bank or other institution by its total net cash outflow.
Liquidity Coverage Ratio in Simple Terms
The liquidity coverage ratio applies to all financial institutions with more than $250 billion in total assets or more than $10 billion in on-balance sheet foreign exposure.
As of 2015, these banks must have an LCR of at least 100%, meaning that they must have enough liquid assets to cover 100% of their cash outflows for at least 30 days.
Classification of Assets
There are three categories of assets that are considered high quality and highly liquid that count towards the LCR.
They may be classified as Level 1, 2A, or 2B, in descending order of quality.
Level 1 assets include:
- Federal Reserve bank balances
- Easily withdrawn foreign resources
- Securities issued or guaranteed by the US government or other sovereign entities
Level 2A assets include:
- Securities issued by certain multilateral development bank or sovereign entities
- Securities issued by US government sponsored enterprises
Level 2B assets include:
- Publicly traded common stock
- Investment grade debt securities issued by institutions outside the financial sector
For example, say that a bank has high quality liquid assets totaling $120 million and projected cash flows of $100 million over a 30 day period. Its LCR is $120 million / $100 million, or 120%.