Basel III - Liquidity Risk Standards

This video discusses the two liquidity standards developed by the Basel Committee for internationally active banks as a part of Basel III Liquidity Risk Framework. Both these standards have separate but complimentary objectives for supervisors to use in liquidity risk supervision.

Basel III is a global standard for capital adequacy, and liquidity risk developed by the Basel Committee on Banking Supervision. As a part of the Basel III framework, the Basel committee published the Liquidity Risk Measurement Framework.

In this article we will discuss the two liquidity standards developed by the Basel Committee for internationally active banks. Both these standards have separate but complimentary objectives for supervisors to use in liquidity risk supervision.

The first objective is to promote the short-term resilience of the liquidity risk profile of banks by ensuring that they have sufficient high-quality liquid assets to survive a significant stress scenario lasting 30 calendar days. The Committee developed the Liquidity Coverage Ratio to achieve this objective.

The second objective is to promote resilience over a longer time horizon by creating additional incentives for banks to fund their activities with more stable sources of funding on an ongoing basis. The Net Stable Funding Ratio has a time horizon of one year and has been developed to capture structural issues to provide a sustainable maturity structure of assets and liabilities.

Let’s look at these two ratios in more detail.

Liquidity Coverage Ratio: The objective of this standard is to ensure that a bank maintains an adequate level of high-quality liquid assets that can be converted into cash to meet its liquidity needs for 30 days under a significantly severe liquidity stress scenario specified by supervisors.

This standard requires that the ratio of high-quality liquid assets to total net cash outflow over the next 30 days is more than or equal to 100%.

Net Stable Funding Ratio: The Net Stable Funding Ratio NSFR standard is structured to ensure that long term assets are funded with at least a minimum amount of stable liabilities in relation to their liquidity risk profiles. The NSFR aims to limit over-reliance on short-term wholesale funding during times of buoyant market liquidity and encourage better assessment of liquidity risk across all on- and off-balance sheet items. In addition, the NSFR approach offsets incentives for institutions to fund their stock of liquid assets with short-term funds that mature just outside the 30-day horizon for that standard.

The NSFR is defined as the ratio of available amount of stable funding to the amount of required stable funding. This ratio must be greater than 100%. “Stable funding” is defined as the portion of those types and amounts of equity and liability financing expected to be reliable sources of funds over a one-year time horizon under conditions of extended stress.