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Liquidity risk measures

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Published: 25th March 2017 by William Webster

Banks are required to measure the inflows and outflows of cash over a designated period (30 days). This is undertaken for business as usual and stressed conditions. To make stress testing relevant the scenarios are designed by the individual bank.

This analysis leads to banks holding High Quality Liquid Assets (HQLA). These are used to cover liquidity shortfalls in times of stress.

The Liquidity Coverage Ratio (LCR) is the key measure. It compares the HQLA held with the net cash outflows under stressed condition and thereby indicates whether the bank is sufficiently liquid.

By calculating the LCR banks undertake a detailed examination of their balance sheets. This involves evaluating all the factors that affect cash inflows and outflows. The process needs regular (at least annual) updating.

Regulators review and evaluate how a bank has undertaken the assessment. Should the assessment be insufficiently detailed a regulatory “add-on” may result.

The following explanation is high level and the rules and methods vary between different banks and different jurisdictions.

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