What's the difference between the LCR and NSFR under Basel III?
Both the Liquidity Coverage Ratio and Net Stable Funding Ratio deal with liquidity, but they seem to measure different things over different horizons. Can someone break down the key differences and give a calculation example for each?
The LCR and NSFR are Basel III's two pillars of liquidity regulation, but they address fundamentally different risks:
Liquidity Coverage Ratio (LCR)
LCR = High-Quality Liquid Assets (HQLA) / Total Net Cash Outflows over 30 days >= 100%
HQLA is tiered:
- Level 1 (no haircut): Cash, central bank reserves, government bonds
- Level 2A (15% haircut): Corporate bonds rated AA- or higher, covered bonds
- Level 2B (25-50% haircut): Lower-rated corporates, certain equities, RMBS
Level 2 assets are capped at 40% of total HQLA.
Example — Thornfield National Bank:
- Level 1 HQLA: $80B (cash + treasuries)
- Level 2A HQLA: $20B corporate bonds x 85% = $17B
- Total HQLA: $97B
- Gross outflows (30-day stress): $120B
- Expected inflows (capped at 75% of outflows): $40B
- Net outflows: $120B - $40B = $80B
- LCR = $97B / $80B = 121% (above 100% minimum)
Net Stable Funding Ratio (NSFR)
NSFR = Available Stable Funding (ASF) / Required Stable Funding (RSF) >= 100%
ASF weights reflect funding stability:
- Tier 1 capital: 100% ASF
- Stable retail deposits: 95% ASF
- Wholesale funding > 1 year: 100% ASF
- Wholesale funding < 6 months: 0% ASF
RSF weights reflect liquidity of assets:
- Cash: 0% RSF (no stable funding needed)
- Unencumbered government bonds: 5% RSF
- Corporate loans > 1 year: 85% RSF
- Mortgages: 65% RSF
Example — Thornfield National Bank:
- ASF: $200B (capital + long-term funding + stable deposits)
- RSF: $185B (weighted illiquid assets)
- NSFR = $200B / $185B = 108% (above 100% minimum)
| Feature | LCR | NSFR |
|---|---|---|
| Horizon | 30 days | 1 year |
| Focus | Acute stress survival | Structural funding stability |
| Numerator | HQLA | Available stable funding |
| Denominator | Net cash outflows | Required stable funding |
| Minimum | >= 100% | >= 100% |
Exam tip: FRM Part II frequently tests whether you can classify specific assets into HQLA levels or assign the correct ASF/RSF factors.
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