The LCR is part of the Basel 3 package introduced in 2010 and is intended to promote resilience from potential liquidity disruptions over a thirty-day horizon. The goal of the LCR is to ensure that global banks have sufficient “high-quality” liquid assets to offset any eventual net cash outflows under an acute short-term stress scenario, as experienced in the global financial crisis that began in 2007.
However, when publishing the standard, the Basel Committee stated that it would observe the impact of this ratio on banks and amend them if necessary, which is now the case (see full details of the revisions.
Effective January 1, 2015 banks will be subjected to maintain an LCR of 60% and this is due to increase by 10 percentage point each year until fully implemented at 100 % on January 1, 2019.
These revisions will make it easier for banks to meet the LCR in the following ways:
- Expanding the definition of “high quality” liquid assets to include lower quality corporate securities, equities, and residential mortgage-backed securities;
- Reducing the assumed outflow rates on some types of liability; and
- Phasing in the minimum LCR so that the required LCR is 60% in 2015, rising by 10 percentage points a year until it reaches 100% from 2019 onwards.
Major implications for firms
- The revisions to the LCR will ease banks’ compliance with the ratio. The large extent of the revisions surpassed expectations by banks and will be significant in reducing their funding costs, which in turn will have a positive impact on their lending abilities and the real economy.
- The phasing in of the ratio may also give banks more time to make any necessary adjustments to their balance sheets, but their regulators and market analysts may in practice not provide much scope for this. A bank that can achieve only a 60% LCR in 2015 may be judged to be too risky by both regulators and market analysts.
- Banks will need to assess the impact of these revisions on their LCR positions. The “haircuts” and limits on the inclusion of a wider range of assets in high quality liquid assets may mean that, for many banks, the relaxation of outflow assumptions will have the largest favorable impact on their LCR positions.
- Meeting the LCR will remain a major challenge for many banks, and even after these revisions, many of them will have to make expensive changes to their balance sheets – by holding low-yielding liquid assets and replacing short-term wholesale deposits with retail and longer-term wholesale deposits. Further detail can be found in the publication Liquidity - A bigger challenge than capital of the KPMG network.
- The revisions will not affect all banks to the same extent and the LCR will become more challenging to meet, particularly when banks’ balance sheets starts expanding more rapidly and as central banks reverse the liquidity they provided to banks.
- Banks will also need to consider the inter-play between the LCR requirement and the use of collaterals for other purposes. The high quality liquid assets included in the LCR calculation have to be unencumbered, hence cannot be used as collateral. The expanded list of high quality assets more closely identifies with the suggested pool of assets for collateral against OTC derivatives positions.