Liquidity Coverage Ratio
The Liquidity Coverage Ratio (LCR) is a Basel III prudential standard that requires banks to hold a sufficient stock of High-Quality Liquid Assets to survive a 30-day period of severe liquidity stress without central bank assistance.
The LCR was introduced by the Basel Committee on Banking Supervision as a direct response to the 2008 global financial crisis, during which several institutions collapsed because they could not meet short-term cash demands despite being technically solvent. The metric forces banks to pre-position liquid assets against potential outflows, creating a self-insurance buffer.
The formula is: LCR = Stock of HQLA ÷ Total Net Cash Outflows over the next 30 calendar days, with the minimum ratio set at 100 percent. This means banks must hold HQLA at least equal to projected net outflows during a month-long stress scenario. In India, the RBI phased in LCR requirements from January 2015, reaching the full 100 percent minimum by January 2019.
High-Quality Liquid Assets (HQLA) are divided into Level 1 and Level 2 assets. Level 1 assets — which carry no haircut — include cash, central bank reserves, and central government securities such as G-Secs and T-Bills. Level 2 assets are subject to haircuts: Level 2A assets (e.g., state government securities, high-rated corporate bonds) face a 15 percent haircut, while Level 2B assets (lower-rated corporate bonds, equities) face haircuts ranging from 25 to 50 percent. Level 2 assets may not exceed 40 percent of HQLA, and Level 2B assets are capped at 15 percent.
On the outflow side, the RBI prescribes standardised run-off rates for different liability categories under the 30-day stress scenario. Retail deposits secured by deposit insurance attract a 3–5 percent run-off, less stable retail deposits attract 10 percent, wholesale funding from non-financial corporates attracts 40 percent, and interbank funding attracts higher run-off assumptions reflecting contagion risk. Committed credit facilities to corporates attract a 10 percent draw-down rate.
In India, the RBI proposed tightening LCR norms in July 2024, suggesting higher run-off rates for retail internet and mobile banking deposits on the grounds that digital channels enable faster fund withdrawal during stress. The proposal envisaged adding a 5 percent run-off surcharge on retail deposits linked to internet and mobile banking. This reflected lessons from the 2023 Silicon Valley Bank failure in the US, where digital-era depositors withdrew funds at unprecedented speed.
The LCR impacts bank profitability because HQLA — primarily G-Secs — typically yield less than equivalent risk-weighted loans. A higher LCR requirement crowds out earning assets and compresses net interest income. Banks must therefore balance regulatory compliance against return on assets, which is why LCR management is closely watched in the treasury departments of large banks. For equity investors, changes to LCR norms can affect the proportion of bank assets deployed in loans versus securities, influencing NIM trajectory and overall return ratios.