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. Liquidity Ratios

    A class of financial metrics that is used to determine a company's ...
  2. Liquidate

    Liquidate means to convert assets into cash or cash equivalents ...
  3. Liquidity

    The degree to which an asset or security can be quickly bought ...
  4. Asset Coverage Ratio

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

    The total amount of a company’s quick assets divided by the sum ...
  6. Quick Ratio

    The quick ratio measures a company’s ability to meet its short-term ...
Related Articles
  1. Investing

    Understanding Financial Liquidity

    Understanding how this measure works in the market can help keep your finances afloat.
  2. Investing

    Financial Analysis: Solvency vs. Liquidity Ratios

    Solvency and liquidity are equally important for a company's financial health.
  3. Insights

    What is Liquidity Risk?

    Liquidity risk is the risk of being unable to sell an asset fast enough to avoid loss.
  4. Financial Advisor

    What Is The Quick Ratio?

    Find out about this liquidity indicator and how it's used.
  5. Investing

    How to Calculate a Coverage Ratio

    In broad terms, the higher the coverage ratio, the better the ability of the enterprise to fulfill its obligations to its lenders.
  6. Investing

    Using The Current Ratio

    Find out more on how this liquidity ratio is used to measure a company's ability to pay short-term obligations.
  7. Investing

    What is the Cash Ratio?

    The cash ratio is the ratio of a company's total cash and cash equivalents to its current liabilities.
  8. Investing

    Do Your Investments Have Short-Term Health?

    If a company is strong enough to survive tough times, it is more likely to provide long-term value.
  9. Investing

    What is Reduced Bond Liquidity and Why Does it Matter Now?

    Reduced bond liquidity caused investor concern earlier in the year, but some signs point to a resurgence going forward.
RELATED FAQS
  1. 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 >>
  2. Is liquidity calculated by flow?

    Read about the differences between economic liquidity, financial liquidity and asset liquidity and how each respective type ... Read Answer >>
  3. 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 >>
  4. 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 >>
  5. What is liquidity management?

    Take a look at the different definitions of liquidity, and find out how investors and businesses attempt to reduce exposure ... Read Answer >>
Hot Definitions
  1. Drawdown

    The peak-to-trough decline during a specific record period of an investment, fund or commodity. A drawdown is usually quoted ...
  2. Inverse Transaction

    A transaction that can cancel out a forward contract that has the same value date.
  3. Redemption

    The return of an investor's principal in a fixed income security, such as a preferred stock or bond; or the sale of units ...
  4. Solvency

    The ability of a company to meet its long-term financial obligations. Solvency is essential to staying in business, but a ...
  5. Dilution

    A reduction in the ownership percentage of a share of stock caused by the issuance of new stock. Dilution can also occur ...
  6. Agency Problem

    A conflict of interest inherent in any relationship where one party is expected to act in another's best interests. The problem ...
Trading Center