Basel III added two liquidity standards to the capital framework, and they answer different questions. The liquidity coverage ratio asks whether a bank survives thirty days of stress. The net stable funding ratio asks whether its funding structure matches its asset structure over a year.
How is the liquidity coverage ratio calculated?
The liquidity coverage ratio is high-quality liquid assets divided by net cash outflows over thirty calendar days under a prescribed stress, and it must be at least 100%.
The numerator is built in tiers, and the tiering is where the arithmetic gets interesting.
Level 1 assets take no haircut and no cap: cash, central bank reserves, and qualifying sovereign debt at a 0% risk weight. Level 2A assets are recognised at 85% of market value and cover certain government and public-sector claims, qualifying covered bonds and high-grade corporate debt. Level 2B assets are recognised at 50% and cover lower-rated corporate bonds and qualifying equities. Level 2 as a whole may be at most 40% of total high-quality liquid assets, and Level 2B at most 15%.
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The 40% cap is stated as a share of the total it helps determine, and that trips people up. If it confuses you at first, you're in good company. Work it the other way. If the cap binds, Level 1 is 60% of the total, so total high-quality liquid assets equal Level 1 divided by 0.60, and the allowable Level 2 is the remainder.
The denominator is total expected outflows less total expected inflows, with inflows capped at 75% of outflows so that a bank can't claim it will fund a run out of loan repayments. Outflow rates rise with how quickly the money can leave: a few percent on insured retail deposits, a quarter on operational wholesale balances that exist because the depositor needs the bank's payment services, forty percent on other corporate deposits, and the whole balance on funding from other financial institutions.
Worked example: Chesapeake Union Bancorp
Chesapeake Union Bancorp holds $3,000 million of cash and reserves and $4,000 million of Treasuries, so Level 1 is $7,000 million. Its agency mortgage-backed securities have a market value of $5,600 million and qualify as Level 2A, contributing 5,600 × 0.85 = $4,760 million. Its corporate bonds of $2,000 million qualify as Level 2B at 50%, contributing $1,000 million. Uncapped, that totals $12,760 million.
Test the cap. Level 2 is $5,760 million against 40% of $12,760 million, which is $5,104 million, so the cap binds. High-quality liquid assets are therefore 7,000 ÷ 0.60 = $11,666.666667 million and allowable Level 2 is $4,666.666667 million. That leaves $1,093.333333 million of the bank's liquid securities that don't count. The Level 2B sub-cap of 15% is $1,750.000000 million against $1,000 million, so it doesn't bind.
Net outflows for this bank work out to $8,660 million, and you'll find the full line-by-line build in worked example 7. The ratio is 11,666.666667 ÷ 8,660 = 134.7190%.
Can the same bank pass and fail the LCR?
Then ask the question the ratio doesn't. The $4,760 million of Level 2A credit comes from mortgage-backed securities the bank holds at amortised cost and has told the market it doesn't intend to sell. Take them out and high-quality liquid assets are $8,000 million, and the ratio is 92.3788%. The same balance sheet is compliant on one reading and non-compliant on the other, and the difference is a classification decision.
So compute the ratio yourself. Don't just read it. The published figure is a fact about the rules. The recomputed figure with your own assumption about what the bank can actually sell is a fact about the bank.