Basel3-Liquidity Ratios-RBI

Sumeet Bhardwaj (Sr. Accountant) (861 Points)

17 December 2010  



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.