Liquidity Coverage Ratio
The Liquidity Coverage Ratio is a regulatory requirement that ensures banks hold sufficient high-quality liquid assets to cover short-term net cash outflows.
Meaning in Practice
In practice, the Liquidity Coverage Ratio (LCR) requires banks to maintain enough liquid assets to withstand a 30-day stress scenario. It is calculated by dividing high-quality liquid assets by projected net cash outflows. The ratio must remain at or above 100 percent under regulatory standards.
Why It Matters
The LCR strengthens short-term resilience against liquidity shocks. It reduces the likelihood of bank failures caused by sudden funding disruptions. The requirement enhances confidence in the stability of the banking system.
Market Impact
Higher liquidity requirements can influence asset allocation toward government bonds and other liquid securities. They may affect funding costs and lending capacity. Strong LCR compliance supports overall market stability during periods of stress.
Example
If a bank expects significant cash outflows during a stress period, it must hold an equivalent or greater amount of high-quality liquid assets to satisfy the 100 percent LCR requirement.