A key characteristic of the global financial crisis which had begun in 2008,
was the inadequate/ineffective management of liquidity risk. In recognition
of the need for banks to improve their liquidity risk management and control
their liquidity risk exposures, Basel Committee on Banking Supervision, has
developed 2 internationally consistent regulatory standards for liquidity
risk supervision as a corner stone of a global framework to strengthen
liquidity risk management and supervision.
These two standards namely (a) Liquidity Coverage Ratio and (b) Net Stable
Funding Ratio, are explained briefly below:
Liquidity Coverage Ratio (LCR)
The ratio aims to ensure that a bank maintains an adequate level of
unencumbered, high quality assets that can be converted into cash to
meet its liquidity needs for a 30-day time horizon under an acute liquidity
stress scenario specified by supervisors. At a minimum, the stock of liquid
assets should enable the bank to survive until day 30 of the proposed
stress scenario, by which time (it is assumed) appropriate actions can be
taken by the management /supervisors. The ratio can be calculated as:
LCR = Stock of high quality liquid assets / Net cash outflow over a 30 day period
The specified stress scenario, entails both (a) institution-specific and (b)
systemic shocks built upon actual circumstances experienced in the global
financial crisis. The scenario could arise due to (i) a significant downgrade
of the institution’s public credit rating; (ii) a partial loss of deposits; (iii) a
loss of unsecured wholesale funding; (iv) a significant increase in secured
funding haircuts; and (v) increases in derivative collateral calls and substantial
calls on contractual and non-contractual off-balance sheet exposures,
including committed credit and liquidity facilities.
Net Stable Funding Ratio (NSFR)
To promote more medium and long-term funding of the assets and activities
of banks, the Net Stable Funding Ratio has been developed. This ratio
establishes a minimum acceptable amount of stable funding based on the
liquidity characteristics of an institution’s assets and activities over a one
year time horizon. This standard is designed to act as a minimum enforcement
mechanism to complement the liquidity coverage ratio standard and
reinforce other supervisory efforts by incenting structural changes in the
liquidity risk profiles of institutions away from short-term funding mismatches
and toward more stable, longer-term funding of assets and business activities.
The ratio can be calculated as:
NSFR = Available Stable Funding (ASF) / Required amount of Stable Funding (RSF)
ASF is defined as the total amount of an institution’s: (i) capital; (ii) preferred
stock with maturity of equal to or greater than one year; (iii) liabilities with
effective maturities of one year or greater; and (iv) that portion of “stable”
non-maturity deposits and/or term deposits with maturities of less than
one year that would be expected to stay with the institution for an extended
period in an idiosyncratic stress event.
RSF is calculated as the sum of the value of the assets held and funded by
the institution, multiplied by a specific required stable funding (RSF) factor
assigned to each particular asset type, added to the amount of OBS (offbalance
sheet) activity (or potential liquidity exposure) multiplied by its
associated RSF factor. The RSF factor applied to the reported values of
each asset or OBS exposure is the amount of that item that supervisors
believe should be supported with stable funding.
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