The formula for calculating the LCR is:
LCR = High-Quality Liquid Assets / Total Net Cash Outflows (30 days)
To comply with the standard, the ratio must be equal to or greater than 100%.
Key elements include:
- High-Quality Liquid Assets: Assets that can be easily and quickly converted into cash with little or no loss in value, such as Treasury securities.
- Total Net Cash Outflows: The expected cash outflows minus expected cash inflows over a 30-day period, under stress conditions.
Though the LCR was designed for large financial institutions, the principle of maintaining sufficient liquid assets to cover short-term obligations can be applied to other organizations as a best practice in liquidity management.
What’s important here?
The Liquidity Coverage Ratio measures whether an institution has enough high-quality liquid assets to survive a 30-day financial stress scenario. While originally designed for banks, the LCR concept reinforces the importance of maintaining a strong liquidity position across all organizations.
