Liquidity Coverage Ratio

Indian Economy glossary

Also called: LCR · Topic: Banking Regulation, NPAs and Financial Stability · NCERT: Beyond NCERT

Meaning

The Liquidity Coverage Ratio (LCR) is a Basel III rule (the global banking standards that set how much capital and liquid money a bank must keep). It requires a bank to hold enough High-Quality Liquid Assets (HQLA) to pay all its expected net cash outflows during 30 days of severe stress.

Formula: LCR = Stock of HQLA ÷ Total net cash outflows over the next 30 days ≥ 100%

It matters because a bank can fail from a sudden rush of withdrawals even when its loans are good. The LCR makes sure the bank already holds its own cash buffer before a crisis starts.

Explanation

Why banks need it: the asset-liability mismatch

  • Liquidity means having cash, or assets that quickly turn into cash, to pay people when they ask.
  • A bank has an asset-liability mismatch (ALM). Its liabilities and its assets come due at very different speeds:
  • Liabilities (money the bank owes, mainly deposits) can be withdrawn at short notice.

  • Assets (money owed to the bank, mainly loans) come back slowly, over years.

  • How a bank run happens:

  • A rumour spreads, so many depositors withdraw at the same time.
  • The bank cannot recall its loans fast enough.

  • The result is a bank run (a rush of withdrawals that can break even a solvent bank).

  • Basel III added two liquidity rules on top of the capital rules:

  • LCR covers the short term (30 days).
  • NSFR covers the long term (1 year).

The numerator: High-Quality Liquid Assets (HQLA)

  • HQLA are cash and government securities that can be turned into cash quickly, with little loss of value, even in a crisis.
  • Level 1 HQLA are counted at full value, with no haircut. They include:
  • cash
  • excess CRR: cash kept with the RBI above the required Cash Reserve Ratio
  • G-secs (government securities) held above the SLR. The Statutory Liquidity Ratio is the share of deposits a bank must hold in safe liquid assets.

  • G-secs inside the SLR, allowed under FALLCR (Facility to Avail Liquidity for LCR). The RBI lets banks count this part of their SLR bonds because banks can borrow against them from the RBI in stress.

  • April 2025 update: Level 1 G-secs must be valued at no more than their current market value, minus haircuts. These haircuts match the margins the RBI applies under LAF (Liquidity Adjustment Facility) and MSF (Marginal Standing Facility) [1].

  • Level 2 HQLA are certain corporate bonds and equities. They count only after a haircut (a cut in their counted value, because they may sell below price in a crisis).
  • Example: Rs 100 crore of eligible corporate bonds with a 15% haircut count as only Rs 85 crore of HQLA.

The denominator: net cash outflows and run-off factors

  • Net cash outflows = expected outflows under stress − expected inflows.
  • Expected outflows = each type of liability × its run-off factor (the share of it assumed to leave in a crisis).
  • What moves the LCR:
  • LCR rises when HQLA goes up, or when the bank's funding becomes more stable (lower run-off).
  • LCR falls when HQLA shrinks, or when the RBI raises run-off factors. A higher run-off factor means more money is assumed to leave, so the bank needs more HQLA.

Worked example

  • HQLA = Rs 120 crore
  • Stressed outflows = Rs 200 crore; inflows = Rs 100 crore, so net outflows = Rs 100 crore
  • LCR = 120 ÷ 100 = 120%, so the bank complies.
  • If HQLA fell to Rs 90 crore, LCR = 90 ÷ 100 = 90%, which is a breach.

In India

  • Regulator: the RBI applies the Basel III LCR to banks.
  • Level: the 100% minimum has applied since January 2019. It was phased in before that.
  • India-specific carve-out: under FALLCR, banks can count part of the G-secs they hold for the SLR as Level 1 HQLA.
  • Revised LCR norms (circular RBI/2025-26/27, 21 April 2025) [1]:
  • Retail deposits that can be withdrawn through internet and mobile banking (IMB) get an extra 2.5% run-off factor [1].
  • Stable retail deposits: run-off rises from 5% to 7.5% [1].
  • Less stable retail deposits: run-off rises from 10% to 12.5% [1].
  • Effective 1 April 2026 [1].

  • Applies to all commercial banks except Payments Banks, RRBs and Local Area Banks [1].

  • Why the RBI made this change:

  • UPI and net banking let money leave at the tap of a phone.

  • So bank runs are now faster. An example is Silicon Valley Bank, USA (2023).

  • Worked example of the change:

  • A bank has Rs 1,000 crore of stable retail deposits with IMB access.
  • Old assumed outflow: 5% = Rs 50 crore. New assumed outflow: 7.5% = Rs 75 crore.
  • The bank must hold Rs 25 crore more HQLA to keep the same LCR.

Don't confuse with

  • Net Stable Funding Ratio (NSFR): NSFR = Available Stable Funding ÷ Required Stable Funding over one year ≥ 100%. It has been in force in India since October 2021. It tests the bank's long-term funding structure. LCR tests survival through a sudden 30-day run.
  • Statutory Liquidity Ratio (SLR): SLR is a fixed share of deposits that a bank must hold in safe liquid assets. LCR is a stress test: it compares HQLA with the outflows expected in a crisis. They connect only through FALLCR, which lets part of SLR G-secs count as HQLA.
  • Cash Reserve Ratio (CRR): CRR is cash a bank must keep with the RBI. Only the excess above the required CRR counts as Level 1 HQLA.
  • Capital adequacy (CRAR / CET1): capital rules protect a bank against losses (solvency). LCR protects it against a cash shortage (liquidity). A bank can meet one rule and still fail the other.

Prelims Hooks

  • LCR = Stock of HQLA ÷ Total net cash outflows over the next 30 days ≥ 100%. It has applied at 100% in India since January 2019. Trap: the LCR horizon is 30 days, not one year. One year is the NSFR.
  • Level 1 HQLA (no haircut): cash, excess CRR, G-secs above SLR, and SLR G-secs allowed under FALLCR. Level 2 HQLA (corporate bonds, equities) count only after haircuts.
  • Revised LCR norms (RBI circular of 21 April 2025, effective 1 April 2026): an extra 2.5% run-off on retail deposits reachable through internet and mobile banking. Stable deposits go from 5% to 7.5%; less stable deposits go from 10% to 12.5% [1].
  • The revised norms do not apply to Payments Banks, RRBs and Local Area Banks [1].
  • Level 1 G-secs must be valued at no more than current market value, minus haircuts matching RBI's LAF/MSF margins [1].
  • A higher run-off factor raises the denominator. So the bank must hold more HQLA to keep the same LCR.

Mains Points

  • Digital bank runs and liquidity rules: UPI and mobile banking let deposits leave in hours, not days, as in the SVB collapse of 2023. The RBI's extra 2.5% run-off on digitally accessible deposits [1] makes banks hold more HQLA before stress hits. This updates the Basel III rule for India's digital payments system.
  • Stability vs growth trade-off:
  • More HQLA means more money parked in low-yield G-secs.
  • That leaves less money for lending, so credit may become costlier, especially for MSMEs.

  • The policy task is to keep enough buffer against runs without starving growth of credit.

  • LCR is one layer of the safety net, not all of it: LCR handles short-term liquidity. NSFR handles long-term funding structure. Capital rules and PCA handle solvency. Deposit insurance (DICGC) calms small depositors and so reduces the chance of a panic. A strong answer shows how these layers work together to prevent and contain a bank run.

Related concepts

Read more

Sources

  1. 1RBI Notification RBI/2025-26/27 — Basel III Framework on Liquidity Standards – LCR: review of HQLA haircuts and deposit run-off rates (21 April 2025)rbi.org.in · tier 1