What is LCR (Liquidity Coverage Ratio)?
Liquidity Coverage Ratio (LCR) Definition
Liquidity coverage ratio or LCR refers to the percentage amount of cash, cash equivalents, or short-term securities that large banks are required to hold as reserves to meet their short-term financial obligations during a crisis event.
The LCR is calculated by dividing a bank’s most liquid assets by its cash outflows over a 30-day period.
Bank LCR Requirements
As of 2019, banks were required to have an LCR of 100%, meaning they should have sufficient liquid assets to cover 100% of their cash outflows for at least 30 days, although the requirement has been phased-in gradually since 2015.
The Federal Reserve and banks’ own senior management conduct periodic stress tests in order to ensure compliance with LCR requirements.
The concept and requirements of LCR were devised by the Basel Committee of Banking Supervision in 2009 as a response to the 2008 financial crisis, which was caused by banks issuing risky loans and other egregious banking activities.
While LCR ensures that banks have buffers against a financial crisis like the one that occurred in 2008, it is difficult to predict whether its requirements are sufficient for a crisis that is different in scope and severity.
Classification of Assets
The formula to calculate LCR is:
HQLA = assets that can be easily converted to cash.
Net cash flow = the financial institution’s estimated cash flow during a 30-day stress period.
For example, if a bank has high quality liquid assets worth $150 million and its projected cash outflows for a 30-day stress period is $100 million, then its LCR is said to be 150 percent.
100% Liquidity Coverage Ratio
While requiring a Liquidity Coverage Ratio of 100% ensures banks have enough money on hand in the event of a crisis, it also inhibits banks from lending money it’s required to keep on hand.