How is the Liquidity Coverage Ratio (LCR) calculated and what qualifies as High-Quality Liquid Assets?

The Liquidity Coverage Ratio (LCR) was introduced under Basel III to ensure banks hold enough liquid assets to survive a 30-day liquidity stress scenario. The intuition is simple: if there's a run on the bank lasting 30 days, can it meet its obligations without selling illiquid assets at fire-sale prices?

The Formula:

LCR = Stock of HQLA / Total Net Cash Outflows over 30 days ≥ 100%

High-Quality Liquid Assets (HQLA):

HQLA are assets that can be easily and immediately converted to cash with little or no loss of value, even during times of stress.

Level 1 Assets (No Haircut — Count at 100%):

• Cash
• Central bank reserves (excess reserves)
• Government securities with 0% risk weight (US Treasuries, German Bunds, JGBs)
• Certain multilateral development bank securities

Level 2A Assets (15% Haircut — Count at 85%):

• Government securities with 20% risk weight
• Corporate bonds rated AA- or better
• Covered bonds rated AA- or better

Level 2B Assets (25-50% Haircut — Limited to 15% of Total HQLA):

• Corporate bonds rated A+ to BBB- (50% haircut)
• Certain equities in major stock indices (50% haircut)
• Residential mortgage-backed securities rated AA or better (25% haircut)

Cap: Level 2 assets combined cannot exceed 40% of total HQLA. Level 2B cannot exceed 15% of total HQLA.

Total Net Cash Outflows:

Outflows are calculated by multiplying each liability category by its assumed run-off rate under stress:

Inflows (amounts the bank expects to receive) are also calculated, but capped at 75% of total outflows — the bank cannot assume it will receive enough inflows to avoid needing any HQLA.

Numerical Example:

Pacific Coast Bank holds:

• $80B in Level 1 HQLA
• $30B in Level 2A HQLA (after 15% haircut = $25.5B)
• Total HQLA = $105.5B (Level 2 share = 24.2%, within 40% cap)

Total outflows = $120B. Total inflows = $30B (capped at 75% × $120B = $90B, so $30B is within cap).

Net outflows = $120B - $30B = $90B

LCR = $105.5B / $90B = 117.2% (above the 100% minimum)

Exam Tip: Know the HQLA levels, haircuts, and caps, plus the key run-off rates for retail vs wholesale deposits.

Practice LCR calculations in our FRM Part II question bank.