How to Calculate the Liquidity Coverage Ratio (LCR)

Could a bank survive 30 days without access to new funding? The Liquidity Coverage Ratio (LCR) aims to answer precisely that question. This key metric not only measures resilience to short-term liquidity shocks but has also become one of the cornerstones of modern banking regulation. But do you know how to calculate it and what it really means?

Since its introduction over a decade ago, the Basel III framework has placed the LCR at the heart of efforts to strengthen the financial system. Alongside the Net Stable Funding Ratio (NSFR), it forms part of a dual standard designed to safeguard liquidity under stress. In this article, we’ll focus on understanding the LCR in depth. We'll cover the NSFR in a future article.

What is the Liquidity Coverage Ratio (LCR)

The Liquidity Coverage Ratio (LCR) is one of the key pillars of prudential regulation under the Basel III framework. It aims to protect the banking system from short-term liquidity shocks.

So, how does it work?

The LCR sets a minimum ratio that strengthens a bank’s short-term liquidity risk profile. It ensures that a bank maintains a sufficient stock of High-Quality Liquid Assets (HQLA) to cover net cash outflows during a significant stress scenario over 30 days.

The HQLA buffer should enable the institution to survive for at least 30 days during a liquidity stress event. By this time, remedial measures from the bank or its supervisor are expected to be in place.

International standards require banks to maintain an LCR at or above 100% under normal conditions. This means that available liquid assets must fully cover projected net cash outflows over a month. Although initially designed for internationally active banks, the LCR has been adapted to suit various jurisdictions and risk profiles.

The LCR Formula

So, how is the LCR calculated?

The LCR formula is structurally simple but operationally demanding:

Let’s break down its components:

The LCR Numerator: HQLA (High-Quality Liquid Assets)

High-Quality Liquid Assets (HQLA) are the core buffer that banks must hold to meet liquidity demands. These assets can be quickly and easily converted into cash with little or no loss in value—even under stressed market conditions—making them the cornerstone of the LCR.

So, what makes a liquidity asset “high quality”?

Basel III uses strict criteria to ensure that these assets are genuinely liquid, even under extreme conditions. An asset qualifies as HQLA if it meets the following:

In short, “high quality” means these assets remain reliable sources of liquidity—whether sold or used as secured borrowing—even during market-wide or idiosyncratic crises. In such scenarios, they often benefit from a “flight to quality” effect.

Basel classifies HQLA into two levels based on the assets held on the first day of the stress period:

In summary, Basel III requires HQLA to be high-quality, low-volatility, and easily monetizable assets. In a crisis, there’s no room for experimentation—only instruments that deliver cash without compromising stability count.

Together, the LCR enhances financial stability by reducing banks’ vulnerability to stress, reinforcing market confidence, and protecting depositors and investors.

The LCR Denominator: Net Cash Outflows over 30 days

The LCR is calculated as:

Net Cash Outflows = Gross Cash Outflows – Adjusted Cash Inflows

It reflects the total expected cash outflows minus expected cash inflows over the next 30 calendar days in a stressful scenario.

• Gross Outflows: Calculated by multiplying the outstanding amounts of liabilities and off-balance-sheet commitments by the expected drawdown or withdrawal rates.

• Adjusted Inflows: Calculated by multiplying the amounts of receivables by the expected inflow rates—capped at 75% of total expected cash outflows.

Important: An asset cannot be counted both as part of the HQLA stock (numerator) and as a projected cash inflow (denominator).

Also note: The defined LCR stress scenario is a supervisory minimum. Banks are expected to conduct additional internal stress tests using longer time horizons and institution-specific risks.

Can you calculate the LCR using financial statements?

Spoiler alert: Not quite. But here’s what you can and can’t do.

While financial statements offer a solid overview of a bank’s balance sheet, calculating the LCR from them is like solving a puzzle with missing pieces. It all comes down to the depth and granularity of what’s disclosed. You’ll get a rough picture, but not the precision required by regulation.

1. What do you need to calculate the LCR?

As shown earlier, the LCR has two main components:

• High-Quality Liquid Assets (HQLA): Cash, central bank reserves, and readily marketable securities like government bonds.
• Net Cash Outflows over 30 days: Expected outflows (e.g., deposit withdrawals) minus projected inflows (e.g., loan repayments, operating income) under a stress scenario. 

2. What financial statements don’t reveal

Traditional liquidity statements - like cash flow statements or financial position reports - weren’t designed with Basel III in mind. The consequence is that it leads to several limitations:

• Lack of detail: They don’t differentiate between Level 1, 2A, or 2B HQLAs, nor do they apply regulatory haircuts.
• No stress assumptions: These are based on normal conditions, while the LCR requires severe stress scenarios (e.g., a 25% deposit run-off).
• Hidden regulatory exclusions:  Some assets may appear liquid but are ineligible because they’re pledged or already counted as inflows. From the outside, this can’t be known.

3. What you can glean from financial reports

Despite limitations, these reports can offer hints:

• Basic liquidity: Cash, short-term investments, or marketable securities provide a rough (though incomplete) proxy for HQLA.
• Short-term liabilities: Details on upcoming maturities, demand deposits, or short-term funding help estimate potential outflows.

4. Partial calculation example

Say a bank reports:

• Cash + central bank reserves: $200 million
• Government bonds: $300 million
• Demand deposits: $400 million

A basic LCR estimate:

LCR = HQLA (Level 1) / Net Outflows = (200 + 300) / 400 × 100 = 125%

But caution: this figure is misleading. In practice, you would need to:

• Apply haircuts
• Include stress factors (e.g., 25% additional outflows)
• Remove ineligible or already encumbered assets

Conclusion

Financial statements are a good starting point, but they are far from sufficient for a regulatory LCR calculation. To get a reliable estimate, you need:

• Internal bank data

• Stress-adjusted figures by liability class

• Official HQLA classifications by level

• Supervisor-adjusted parameters for each jurisdiction

In short, financial reports tell you what the bank holds, but not how it will perform under stress. To assess true resilience, you need to look under the hood.

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