Loading the player...

What is the 'Liquidity Coverage Ratio - LCR'

The liquidity coverage ratio (LCR) refers to highly liquid assets held by financial institutions to meet short-term obligations. The ratio is a generic stress test that aims to anticipate market-wide shocks. The liquidity coverage ratio is designed to ensure financial institutions have the necessary assets on hand to ride out short-term liquidity disruptions.

BREAKING DOWN 'Liquidity Coverage Ratio - LCR'

The liquidity coverage ratio applies to all banking institutions with $10 million or more in on-balance sheet foreign exposure and subsidiary depository institutions with $10 billion or more in assets. Additionally, the ratio applies to all banking institutions with $250 billion or more in total consolidated assets. Banks are required to hold an amount of highly liquid assets, such as cash, Treasury bonds or corporate debt, equal to or greater than their net cash outflow less the projected cash inflows over a 30-day stress period, having at least 100% coverage.

The liquidity coverage ratio started to be regulated and measured in 2011, but the full 100% minimum was not enforced until 2015. The liquidity coverage ratio is an important part of the Basel Accords, as they define how much liquid assets have to be held by financial institutions. Because banks are required to hold a certain level of highly liquid assets, they are less able to lend out short-term debt.

High-Quality Liquid Asset Categories

The high-quality liquid assets include only those with a high potential to be converted easily and quickly into cash. There are three categories of high-quality liquidity assets with decreasing levels of quality: level 1, level 2A and level 2B assets.

Under Basel III, level 1 assets have no haircut, while level 2A and level 2B assets have a 15% and 50% haircut, respectively. Level 1 assets include Federal Reserve bank balances, foreign withdrawable resources, securities issued or guaranteed by specific sovereign entities and multilateral development banks, and U.S. government issued or guaranteed securities. Level 2A assets include securities issued or guaranteed by specific multilateral development banks or sovereign entities, and securities issued or guaranteed by U.S. government-sponsored enterprises. Level 2B assets include specific publicly traded common stock and investment-grade corporate debt securities issued by nonfinancial sector corporations.

Liquidity Coverage Ratio Calculation Example

The LCR is calculated by dividing a bank's stock of high-quality liquid assets by its total net cash outflows over a 30-day stress period. Assume bank ABC has stock of high-quality liquid assets worth $55 million and $35 million in anticipated net outgoing cash flows over a 30-day stress period. Therefore, bank ABC has an LCR of 1.57, or 157%, which meets the requirement under Basel III.

RELATED TERMS
  1. Liquid Asset

    An asset that can be converted into cash quickly and with minimal ...
  2. Liquidity Ratios

    A class of financial metrics that is used to determine a company's ...
  3. Net Liquid Assets

    Net liquid assets are a strict measure of an immediate or near-term ...
  4. Asset Coverage Ratio

    A test that determines a company's ability to cover debt obligations ...
  5. Current Ratio

    The current ratio is a liquidity ratio that measures a company's ...
  6. Quick Liquidity Ratio

    The total amount of a company’s quick assets divided by the sum ...
Related Articles
  1. Investing

    Financial Analysis: Solvency vs. Liquidity Ratios

    Solvency and liquidity are equally important for a company's financial health.
  2. Investing

    Key Financial Ratios to Analyze Tech Companies

    Understand the technology industry and the companies that operate in it. Learn about the key financial ratios used to analyze tech companies.
  3. Investing

    Dynamic Current Ratio: What It Is And How To Use It

    Learn why this ratio may be a good alternative to the current, cash and quick ratios.
  4. Investing

    Liquidity Measurement Ratios

    Learn about the current ratio, quick ratio, cash ratio and cash conversion cycle.
  5. Investing

    Analyze Investments Quickly With Ratios

    Make informed decisions about your investments with these easy equations.
  6. Financial Advisor

    Why Liquidity Matters in the Corporate Bond Market

    Professional analysis and constant monitoring of liquidity risk when investing in corporate bonds is highly important.
  7. Investing

    Financial Ratios to Spot Companies Headed for Bankruptcy

    Obtain information about specific financial ratios investors should monitor to get early warnings about companies potentially headed for bankruptcy.
  8. Investing

    What Is the Best Measure of a Company's Financial Health?

    Discover the single best financial metric that investors can use for determining the financial health and long-term sustainability of a company.
RELATED FAQS
  1. What is the minimum liquidity coverage ratio that a bank must have from 2016 to 2 ...

    Learn the purpose of the new liquidity coverage ratio requirements under the Basel III standards, and see the phase-in of ... Read Answer >>
  2. What's the difference between the coverage ratio and the liquidity coverage ratio?

    Understand the difference between coverage ratios and the liquidity coverage ratio and why the liquidity coverage ratio rule ... Read Answer >>
  3. Are a bank's current assets counted as liquidity?

    Find out how bank assets are defined and how the Federal Reserve controls the definitions of, requirements for, and availability ... Read Answer >>
  4. What is the Difference Between Liquidity and Liquid Assets?

    Liquid assets can easily be converted into cash. Liquidity is the ability of a business to pay its debts using its liquid ... Read Answer >>
  5. Is there a downside to having a high liquidity ratio?

    Find out why it might be disadvantageous for a company to have liquidity ratios that are too high, and learn how to find ... Read Answer >>
  6. What affects an asset's liquidity?

    Learn about what affects an asset's liquidity, including examples of liquid and fixed assets, and how a company's liquidity ... Read Answer >>
Hot Definitions
  1. Swap

    A swap is a derivative contract through which two parties exchange financial instruments, such as interest rates, commodities, ...
  2. Yield Curve

    A yield curve is a line that plots the interest rates, at a set point in time, of bonds having equal credit quality, but ...
  3. Gross Profit

    Gross profit is the profit a company makes after deducting the costs of making and selling its products, or the costs of ...
  4. Risk Tolerance

    The degree of variability in investment returns that an individual is willing to withstand. Risk tolerance is an important ...
  5. Donchian Channels

    A moving average indicator developed by Richard Donchian. It plots the highest high and lowest low over the last period time ...
  6. Consumer Price Index - CPI

    A measure that examines the weighted average of prices of a basket of consumer goods and services, such as transportation, ...
Trading Center