In the past few years, the EBA has introduced a set of new liquidity risk monitoring standards and regulations. More specifically, the LCR and the NSFR are to come into full effect in 2018.
The LCR, or Liquidity Coverage Ratio, is a measure imposed by the Basel III regulations. It requires banks to hold High-Quality Liquid Assets sufficient to cover 100% of the net cash outflow for the next 30 days.
The mathematical formula is:
The High-Quality Liquid Assets (HQLAs) are those assets that are easily converted to cash, with little or no loss in value. There are three categories of HQLAs:
– Level 1 Assets: assets in this class are the most liquid and do not require a haircut under Basel III regulation, but national supervisors may decide to impose haircuts based on, for example, duration or credit/liquidity risk. Level 1 assets include coins and banknotes, central bank reserves, and marketable securities representing claims on or guaranteed by sovereigns or central banks.
– Level 2 Assets exists out of two subclasses, level 2A, and level 2B, and can be included in the HQLA, given that they do not exceed 40% of the total HQLA after haircuts. Furthermore, level 2B assets may not comprise more than 15% of the total HQLA stock.
– Level 2A assets are subject to a 15% haircut and include specific, slightly riskier, but still liquid assets. For example, marketable securities representing claims on or guaranteed by sovereigns or central banks, given specific conditions, or specific corporate debt securities and covered bonds.
– Level 2B assets are subject to a higher haircut, depending on what they are. Residential Mortgage-Backed Securities that satisfy all the conditions are subject to a 25% haircut, while specific (requirement meeting) corporate debt securities or common equity shares are subject to a 50% haircut.
The Net Stable Funding Ratio, or NSFR, is another measure imposed by Basel III regulations. The NSFR is defined as the amount of available stable funding relative to the amount of required stable funding. This ratio should be equal to at least 100% on an on-going basis. “Available stable funding” is defined as the portion of capital and liabilities expected to be reliable over the time horizon considered by the NSFR, which extends to one year. The amount of such stable funding required of a specific institution is a function of the liquidity characteristics and residual maturities of the various assets held by that institution as well as those of its off-balance sheet (OBS) exposures.