Liquidity Coverage Ratio (LCR):Reserve Bank of India (RBI)
The Reserve Bank of India (RBI) has announced modifications to the Liquidity Coverage Ratio (LCR) framework to enhance the management of liquidity risk by banks. Here is an explanation of the LCR and its recent changes.
What is the Liquidity Coverage Ratio (LCR)?
The LCR is a standard that requires banks to hold a buffer of high-quality liquid assets (HQLAs) that can be quickly converted into cash. This is to ensure banks have enough liquidity to withstand a 30-day period of financial stress. HQLAs include cash, central bank reserves, and certain marketable securities.
Why is the RBI tweaking the LCR framework?
Recent developments, such as the rapid withdrawal of deposits from banks in other countries, have shown the risk of banking runs in the digital age, where large sums can be moved quickly. The RBI is proposing changes to better manage this risk, ensuring banks can meet their obligations even in stressful times.
What changes are being made to the LCR?
The RBI will propose certain modifications to better manage the liquidity risk by banks. This may include altering the mix and levels of HQLAs or the expected outflows during stress periods, thus enhancing banks’ ability to deal with sudden demands for cash.
What does this mean for banks and depositors?
Banks may have to adjust the assets they hold, possibly affecting their investment and lending strategies. For depositors, it means greater assurance that banks are prepared to meet withdrawal demands, even during periods of financial stress.
Example of LCR in action:
Consider a bank with ₹100 crore in net cash outflows over a 30-day stress period. Under the LCR requirements, this bank would need to have at least ₹100 crore in HQLAs. If the LCR requirement is 100%, the bank must have ₹100 crore in high-quality liquid assets that can be easily and quickly converted to cash to cover these outflows.
By revising the LCR framework, the RBI aims to make banks more resilient to such shocks, ensuring that they have enough high-quality liquid assets to survive periods of acute stress without needing central bank intervention.
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