23rd April 2025 (8 Topics)

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Liquidity Coverage Ratio (LCR)

Context

The RBI's recent circular on the Liquidity Coverage Ratio (LCR) aims to improve banks' liquidity resilience while providing them with more resources for lending. By reducing run-off rates on certain deposits, the circular enhances credit growth potential and aligns with global standards, effective from April 2026.

About Liquidity Coverage Ratio (LCR):

The Liquidity Coverage Ratio (LCR) is a measure designed to ensure that banks have enough liquidity to meet short-term obligations in times of financial stress.
It requires banks to hold an adequate amount of high-quality liquid assets (HQLAs) that can easily be converted into cash if needed.
In simpler terms, LCR is about ensuring that banks can survive a period of financial turmoil lasting for 30 days, without running out of cash or selling off assets at a loss.
- HQLA are assets that are easily liquidated without losing value. These include assets like government bonds, Treasury bills, and state development loans.
- Under the Basel III standards, the global banking community was required to maintain an LCR of at least 100%. This means banks should have HQLAs worth at least as much as their expected cash outflows during a 30-day stress scenario.

Key-Concepts

Run-off Rate:

The run-off rate refers to the percentage of deposits that a bank anticipates could be withdrawn (or transferred) during a stressful situation. When there is financial uncertainty or market turmoil, depositors may want to pull their money out of the bank, which could lead to a liquidity crisis.
- The run-off rate determines how much of the bank’s deposits it should consider as being "at risk" of being withdrawn. For instance, if a bank expects 10% of a certain type of deposit to be withdrawn during a stressful period, it assigns a run-off rate of 10% to that category of deposits.
- A higher run-off rate means the bank needs to hold more liquid assets to cover the potential outflow. Conversely, a lower run-off rate means the bank can hold less, freeing up more resources for lending or investment.
High-Quality Liquid Assets (HQLAs):
These are assets that are easily and quickly convertible into cash, without significant loss of value. Examples include:
- Government bonds
- Treasury bills
- State development loans
The key characteristic of HQLAs is that they are very safe and highly marketable, meaning that in times of financial stress, banks can sell them quickly to meet cash demands.
Basel III Framework:
The Basel III standards are global regulatory guidelines set by the Basel Committee on Banking Supervision to strengthen the regulation, supervision, and risk management within the banking sector.
Basel III aims to increase the capital reserves of banks, improve liquidity management, and reduce systemic risks.

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Liquidity Coverage Ratio (LCR)

About Liquidity Coverage Ratio (LCR):

Key-Concepts