GMS LiquidityManagement

Background

The objective of the Liquidity Coverage Ratio (LCR) is to promote the short-term resilience of the liquidity risk profile of banks. It does this by ensuring that banks have an adequate stock of unencumbered (unused) high-quality liquid assets (HQLA) that can be converted easily and immediately in the markets to cash in order to meet their liquidity needs for one month liquidity stress scenario.

During the early “liquidity phase” of the financial crisis that began in 2007, many banks – despite adequate capital levels – still experienced difficulties because they did not manage their liquidity in a prudent manner.

The rapid reversal in market conditions illustrated how quickly liquidity can evaporate, and that illiquidity can last for an extended period of time. The banking system came under severe stress, which necessitated central bank action to support both the functioning of money markets and, in some cases, individual institutions.

Two standards have been developed by the Basel III committee to achieve two separate but complementary objectives. The first objective is to promote short-term resilience of a bank’s liquidity risk profile by ensuring that it has sufficient HQLA to survive a significant stress scenario lasting for one month. The Committee developed the LCR to achieve this objective. The second objective is to promote resilience over a longer time horizon by creating additional incentives for banks to fund their activities with more stable sources of funding on an ongoing basis. The Net Stable Funding Ratio (NSFR), which is not covered by this article, supplements the LCR and has a time horizon of one year. It has been developed to provide a sustainable maturity structure of assets and liabilities.