LCR liquidity ratio: definition and use in Swiss banks

One of the key regulatory ratios in the financial services sector is the Liquidity Coverage Ratio (LCR). We give you its definition, how it is calculated and the texts that govern it, both Basel Committee and Swiss regulations. We also explain what the other liquidity ratio (NSFR) is and why you should not confuse it with the LCR.

What is the LCR liquidity ratio?

LCR stands for Liquidity Coverage Ratio. It is one of the five most important regulatory indicators for Swiss banks. They are all designed to measure risk sensitivity.

The LCR was introduced after the 2008 financial crisis, at the instigation of the Basel Committee. The aim of this international body is that a high level of High-Quality Liquid Assets (HQLA) should ensure the bank’s survival in the event of a financial crisis over a period of 30 calendar days. This ratio therefore measures short-term liquidity.

What is the purpose of the Liquidity Coverage Ratio (LCR)?

The LCR liquidity ratio is used to check that a banking institution has the permanent capacity to meet its payment obligations, even in the event of a crisis. The liquidity reserves constituted by HQLA must be sufficient to get through a difficult peak, even if the deterioration proves to be brutal.

The process used to ensure that the bank achieves this objective is a uniform liquidity stress test. It is based on standardised assumptions for both cash outflows and inflows over the 30-day period (inflows and outflows). It is therefore a ratio designed to limit the risk of sudden default and to allow comparison between the various players.

What regulatory texts govern the LCR?

Switzerland introduced the LCR liquidity ratio in the Liquidity Ordinance (LiqO). This text sets out both qualitative and quantitative regulatory obligations.

To implement these provisions, Swiss banks also refer to FINMA Circular 15/02. As we approach the end of 2023, Basel III final has not yet been implemented in our country. However, we know that these future regulatory requirements will not change the management of the LCR liquidity ratio for Swiss banks.

How is the short-term liquidity ratio (LCR) calculated?

To calculate a bank’s liquidity ratio, refer to article 13 of the LiqO:

  • (A) amount of high quality liquid assets (HQLA) outstanding ;
  • (B) amount of net cash outflow over 30 days in the event of a crisis;
  • LCR liquidity ratio = (A)/(B).

Note that the assets of banks that fall into the HQLA category must meet the strict criteria set out in the Liquidity Ordinance. Regulatory requirements call for this short-term liquidity ratio to be greater than or equal to 1 (or 100%) at all time.

Another liquidity ratio to be aware of in a Swiss bank

The LCR short-term liquidity ratio should not be confused with another indicator that also measures liquidity risk: the NSFR.

NSFR stands for Net Stable Funding Ratio. In French, this is known as the long-term structural liquidity ratio. You may also come across the expression funding ratio. It is also a concept introduced by the Basel Committee following the 2008-2009 financial crisis. The aim of this indicator is to limit the risk of structural default by banks.

For a Swiss bank, the purpose of this indicator is to measure its ability to finance itself over the long term. The aim is to ensure that banks have sufficiently stable assets and off-balance sheet activities to control the risk of default. The long-term liquidity ratio for banks is also regulated by the Oliq ordinance.

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