The liquidity coverage ratio (LCR) is a financial metric used in the banking industry to assess a bank’s short-term liquidity risk. It measures the adequacy of a bank’s liquid assets to cover its potential net cash outflows over a 30-day period under stressed conditions.
The liquidity coverage ratio is calculated as follows:
Liquidity coverage ratio = (high−quality liquid assets / net cash outflows) x 100
The LCR serves as a safeguard to ensure that a bank has sufficient liquid assets to cover its short-term cash outflows in case of a severe financial or economic stress event. This reduces the risk of a bank facing a liquidity crisis.
The LCR is a regulatory requirement established by the Basel Committee on Banking Supervision (BCBS) as part of the Basel III framework. As per Basel III standards, banks are required to maintain a minimum LCR of 100%, meaning that they should hold enough high-quality liquid assets to cover their net cash outflows over a 30-day stress period.