Liquidity Coverage Ratio (LCR)

The Liquidity Coverage Ratio (LCR) is a regulatory measure of a bank's ability to meet its liquidity needs over a 30-day time horizon. It is calculated as the ratio of high-quality liquid assets to total net cash outflows over the next 30 days. The LCR is designed to ensure that banks have sufficient liquid assets to meet their obligations to depositors and other creditors in the event of a financial crisis.

The LCR was introduced by the Basel Committee on Banking Supervision in 2010 as part of the Basel III capital adequacy framework. The LCR is one of three liquidity ratios that banks are required to meet under Basel III. The other two ratios are the Net Stable Funding Ratio (NSFR) and the Leverage Ratio.

The LCR is calculated as follows:

LCR = High-quality liquid assets / Total net cash outflows over the next 30 days

High-quality liquid assets are assets that are readily convertible into cash and are not subject to significant credit or market risk. Examples of high-quality liquid assets include cash, cash equivalents, and government securities.

Total net cash outflows over the next 30 days is the sum of all cash outflows expected to occur over the next 30 days, less the sum of all cash inflows expected to occur over the same period. Cash outflows include payments to depositors, creditors, and other counterparties. Cash inflows include interest payments, dividends, and other income.

The LCR is a critical measure of a bank's liquidity risk. A bank with a high LCR is more likely to be able to meet its liquidity needs in the event of a financial crisis. The LCR is also used by regulators to assess the safety and soundness of banks.

The LCR has been criticized by some for being too complex and for not taking into account all of the factors that affect a bank's liquidity risk. However, the LCR is an important tool for regulators and banks to manage liquidity risk.

The LCR is a dynamic ratio, which means that it is adjusted over time to reflect changes in the financial markets. The LCR is also subject to a number of exemptions and adjustments. For example, banks are allowed to include certain assets in their calculation of high-quality liquid assets, and they are allowed to make certain deductions from their calculation of total net cash outflows.

The LCR is an important part of the Basel III capital adequacy framework. The LCR is designed to ensure that banks have sufficient liquid assets to meet their obligations to depositors and other creditors in the event of a financial crisis.