LIQUIDITY COVERAGE RATIO (LCR) (Syllabus: GS Paper 3 – Economy)

Context: The RBI has issued draft guidelines for banks on the Liquidity Coverage Ratio (LCR), requiring them to maintain a higher stock of liquid securities as a buffer against deposits.

Liquidity Coverage Ratio (LCR)

• About: It refers to the proportion of highly liquid assets held by financial institutions to ensure that they maintain an ongoing ability to meet their short-term obligations (i.e., cash outflows for 30 days).
• Purpose: It is intended to make sure that banks and financial institutions have a sufficient level of capital to ride out any short-term disruptions to liquidity.
• Basel III Origin: LCR in banking resulted from the Basel III agreement, which is a series of measures undertaken by the Basel Committee on Bank Supervision (BCBS).
• Implementation in India: In India, RBI issued Basel III liquidity guidelines in 2012. RBI implemented LCR in January 2015, and as per a circular in 2020, banks should maintain sufficient HQLA at all times to meet unexpected withdrawals.
• Calculation Formula: LCR = (High Quality Liquid Assets (HQLA)) / (Total net cash outflows over the next 30 calendar days).

Related Terms

• Capital Adequacy Ratio (CAR): It is a regulatory measure that assesses banks' ability to pay liabilities and withstand credit and operational risks. 
• Statutory Liquidity Ratio (SLR): It is the minimum percentage of deposits that commercial banks are required to keep in the form of liquid cash, gold, or other securities.
• Cash Reserve Ratio (CRR): It is one of the main components of the RBI's monetary policy, which is used to regulate the money supply, level of inflation and liquidity in the country.
• High Quality Liquid Assets (HQLA): Every asset that can be easily and instantly converted into cash at minimal or no cost of value is a HQLA. 

oThese assets include cash, reserves with central banks, and central government bonds, which can easily be converted into cash.