Basel III: The Liquidity Coverage Ratio and liquidity risk monitoring tools

Date Published 1/7/2013
Author Marja Hoek-Smit

January 7, 2013

The Basel Committee issued the full text of the revised Liquidity Coverage Ratio (LCR) following endorsement on 6 January 2013 by its governing body - the Group of Central Bank Governors and Heads of Supervision (GHOS). The LCR is an essential component of the Basel III reforms, which are global regulatory standards on bank capital adequacy and liquidity endorsed by the G20 Leaders.

The LCR promotes the short-term resilience of a bank's liquidity risk profile. It does this by ensuring that a bank has an adequate stock of unencumbered high-quality liquid assets (HQLA) that can be converted into cash easily and immediately in private markets to meet its liquidity needs for a 30 calendar day liquidity stress scenario.

The LCR was first published in December 2010. At that time, the Basel Committee put in place a rigorous process to review the standard and its implications for financial markets, credit extension and economic growth. It committed to address unintended consequences as necessary.

The revisions to the LCR incorporate amendments to the definition of HQLA and net cash outflows, the two components of the LCR. HQLA are comprised of Level 1 and Level 2 assets. Level 1 assets generally include cash, central bank reserves, and certain marketable securities backed by sovereigns and central banks, among others. These assets are typically of the highest quality and the most liquid, and there is no limit on the extent to which a bank can hold these assets to meet the LCR.

Level 2 assets are comprised of Level 2A and Level 2B assets. Level 2A assets include, for example, certain government securities, covered bonds and corporate debt securities. Level 2B assets include lower rated corporate bonds, residential mortgage backed securities (excluding RMBS based on "walk away" or non-recourse mortgages) and equities that meet certain conditions. Level 2 assets may not in aggregate account for more than 40% of a bank’s stock of HQLA. Level 2B assets may not account for more than 15% of a bank’s total stock of HQLA.
Link to summary report

The LCR will be introduced as planned on 1 January 2015, but the minimum requirement will begin at 60%, rising in equal annual steps of 10 percentage points to reach 100% on 1 January 2019. This graduated approach is designed to ensure that the LCR can be introduced without disruption to the orderly strengthening of banking systems or the ongoing financing of economic activity.

The GHOS agreed that, since deposits with central banks are the most - indeed, in some cases, the only - reliable form of liquidity, the interaction between the LCR and the provision of central bank facilities is critically important. The Committee will therefore continue to work on this issue over the course of 2013.

Link to Full Report: Click here

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