What are the Liquidity Standards/Ratios Suggested by Basel-III? Explain
The global financial crisis of 2008 showed that many banks suffered due to weaknesses in liquidity risk management. Therefore, Basel-III introduced internationally harmonized global liquidity standards to strengthen banks’ liquidity position.
The two important liquidity standards under Basel-III are:
1. Liquidity Coverage Ratio (LCR)
2. Net Stable Funding Ratio (NSFR)
1. Liquidity Coverage Ratio (LCR)
LCR measures the short-term liquidity position of a bank. It ensures that a bank has sufficient high-quality liquid assets to survive a stressed situation for 30 days.
Formula:
The calculation of LCR requires:
Total stock of high-quality liquid assets
Total cash outflows during next 30 days
Total cash inflows during next 30 days
LCR requirement is fulfilled when high-quality liquid assets exceed net cash outflows under a stressed scenario for the next 30 days.
2. Net Stable Funding Ratio (NSFR)
NSFR measures the long-term liquidity position of a bank. It encourages banks to use stable funding sources and reduce dependence on short-term wholesale funding.
Formula:
The calculation of NSFR requires:
Available Stable Funding (ASF)
Required Stable Funding (RSF)
NSFR is satisfied when available stable funding exceeds required stable funding.
