Liquidity Coverage Ratio
Executive Summary
Key Takeaways
- ✓ The liquidity coverage ratio tests whether a bank holds enough high-quality liquid assets to survive a defined 30-day acute stress scenario, expressed as HQLA divided by net cash outflows over that period.
- ✓ High-quality liquid assets should be segmented by eligibility tier, since different asset categories are subject to different haircuts and inclusion limits under the framework.
- ✓ Net cash outflows should be built from the same segment-level deposit and funding behavioural assumptions used elsewhere in the model, applying the stress scenario's prescribed run-off rates per segment rather than a single blended outflow assumption.
- ✓ The LCR is a short-term (30-day) liquidity metric, structurally distinct from the longer-term Net Stable Funding Ratio, and the two should be modelled and reported separately rather than treated as interchangeable liquidity indicators.
- ✓ A model does not itself perform or validate the regulatory LCR calculation; it should represent HQLA eligibility and outflow assumptions as visible, sourced model inputs.
Objective¶
This guide covers how to model the liquidity coverage ratio (LCR), within the Banking Financial Modelling pillar, drawing directly on the behavioural assumptions built in Deposit Modelling.
What the LCR Tests¶
The LCR tests whether a bank holds enough high-quality liquid assets to survive a defined 30-calendar-day acute stress scenario without external support.
LCR = High-Quality Liquid Assets (HQLA) ÷ Total Net Cash Outflows (30-day stress scenario)
A minimum ratio, typically 100%, is generally required to be maintained under the applicable regulatory framework.
Modelling High-Quality Liquid Assets¶
HQLA should be segmented by eligibility tier, since different asset categories are subject to different haircuts and inclusion limits — central bank reserves and certain sovereign debt are typically the highest-quality tier with minimal or no haircut, while certain corporate securities may be eligible only at a lower tier subject to a larger haircut and a cap on how much of the total HQLA pool they can represent. Modelling HQLA as a single undifferentiated liquid asset pool loses this tiering structure entirely.
Modelling Net Cash Outflows¶
Net cash outflows should be built from the same segment-level deposit and funding behavioural assumptions already established in Deposit Modelling, applying the stress scenario's prescribed run-off rate to each segment:
Segment Outflow = Segment Balance × Prescribed Stress Run-Off Rate
Total Net Cash Outflows = Σ (Segment Outflows) − Prescribed Inflows (subject to any applicable cap)
Transactional deposits are typically assumed stickier under the stress scenario (a lower run-off rate) than wholesale funding, which is assumed to run off more completely — applying a single blended outflow rate across all liabilities would misrepresent this behavioural difference entirely.
Relationship to the Net Stable Funding Ratio¶
The LCR is a short-term (30-day) stress liquidity metric, structurally distinct from the Net Stable Funding Ratio, which tests structural funding stability over a one-year horizon. The two metrics should be modelled and reported separately, since they test different things — see LCR vs. NSFR for a direct comparison.
Scope of This Guide¶
This guide describes how HQLA eligibility, haircuts, and outflow rate assumptions should be represented as visible, sourced model inputs. It does not describe FMAE performing or validating the underlying regulatory LCR calculation itself.
Common Construction Pitfalls¶
- Modelling HQLA as a single undifferentiated pool without eligibility tiering, haircuts, or inclusion caps.
- Applying a single blended outflow rate to all liabilities rather than segment-specific stress run-off rates consistent with deposit modelling.
- Treating the LCR and Net Stable Funding Ratio as interchangeable, rather than modelling and reporting them as distinct metrics testing different time horizons.
- Presenting the model as validating the regulatory LCR calculation rather than representing its assumptions transparently.
Continue Reading¶
Prerequisites¶
- Banking Financial Modelling — the parent pillar
- Deposit Modelling
Related Technical Guides¶
Related Comparisons¶
Related Glossary¶
How OXXON tests thisRun a free structural check with FMAE
Frequently Asked Questions
What does the liquidity coverage ratio measure?
Whether a bank holds enough high-quality liquid assets (HQLA) to survive a defined 30-day acute stress scenario, expressed as HQLA divided by total net cash outflows over that period.
How is the LCR calculated?
LCR = High-Quality Liquid Assets ÷ Total Net Cash Outflows (over a 30-calendar-day stress scenario), with a minimum ratio typically required to be maintained at or above 100%.
How should HQLA be modelled?
Segmented by eligibility tier, since different asset categories (central bank reserves, sovereign debt, certain corporate securities) are subject to different haircuts and inclusion limits under the framework, rather than treated as a single undifferentiated liquid asset pool.
How should net cash outflows be modelled?
From the same segment-level deposit and funding behavioural assumptions built in deposit modelling, applying the stress scenario's prescribed run-off rate to each segment (transactional deposits typically assumed stickier than wholesale funding, for example) rather than a single blended outflow rate applied to total liabilities.
How is the LCR different from the Net Stable Funding Ratio?
The LCR is a short-term, 30-day stress liquidity metric; the Net Stable Funding Ratio is a longer-term (one-year horizon) structural funding metric — the two test different things and should be modelled and reported separately rather than treated as interchangeable — see Net Stable Funding Ratio and LCR vs. NSFR.
Does a model validate the actual regulatory LCR calculation?
No — a model represents HQLA eligibility, haircuts, and outflow rate assumptions as visible, sourced inputs; it does not itself perform or validate the underlying regulatory LCR calculation, which remains outside the structural audit engine's scope.
Related Articles
Banking Financial Modelling
Banking financial modelling is structurally distinct from a standard corporate model: it is built balance-sheet-first, with earnings derived from asset and liability volumes and spreads rather than a top-line revenue forecast, and it must represent loan portfolio and deposit dynamics, credit loss provisioning, and a set of bank-specific KPIs that a generic corporate model has no equivalent for. This page is the hub for the Knowledge Centre's banking modelling content: how the bank business model translates into a model's architecture, how the three financial statements are structured for a bank, how interest income and the net interest margin bridge are built, and how loan portfolios, deposits, and credit loss provisions should be modelled.
Deposit Modelling
Deposit modelling is the liability-side counterpart to loan portfolio modelling: deposits should be segmented by product type — transactional, savings, and term — each carrying its own volume, cost, and behavioural assumptions. Behavioural modelling matters more on the deposit side than almost anywhere else in a bank model, since a deposit's contractual maturity (or lack of one, for transactional accounts) frequently does not match its actual behavioural stickiness, and that gap is central to both funding and liquidity risk management.
Net Stable Funding Ratio
The net stable funding ratio (NSFR) tests whether a bank's longer-term assets are backed by a stable enough funding profile over a one-year horizon, complementing the short-term liquidity coverage ratio. This guide covers how to model the NSFR's two components — available stable funding, weighted by the behavioural stability of each funding source, and required stable funding, weighted by the tenor and liquidity of each asset — and how it connects to the balance sheet forecast and deposit modelling already built elsewhere in the model.
LCR vs. NSFR
The liquidity coverage ratio (LCR) and net stable funding ratio (NSFR) are the two Basel III liquidity standards, but they test fundamentally different things: the LCR tests short-term survival under a 30-day acute stress scenario, while the NSFR tests structural funding stability over a one-year horizon. This comparison sets out the differences a modeller needs to understand to build and report both correctly, as distinct outputs rather than a single blended liquidity metric.
Loan-to-Deposit Ratio
The loan-to-deposit ratio compares total loans to total deposits, giving a core indicator of how much of a bank's lending is funded from its deposit base versus wholesale or other funding sources. A ratio above 100% means the bank is lending more than it holds in deposits, funding the difference through wholesale markets — a funding structure that carries more refinancing and liquidity risk than deposit-funded lending.