In a move aimed at creating liquidity buffers in banks, the Reserve Bank of India (RBI) has mandated the lenders to maintain 60 per cent liquidity coverage ratio (LCR) from January 1, 2015. Also, the central bank suggested a phased manner in which the ratio will have to increase to 100 per cent by January 1, 2019. Equal quantum of increase has been suggested for every year, till 2019.
The LCR promotes short-term resilience of banks to potential liquidity disruptions by ensuring that they have sufficient high-quality liquid assets (HQLAs) to survive an acute stress scenario lasting for 30 days.
LCR is defined as the proportion of high-quality liquid assets to the total net cash outflows in the next 30 calendar days.
Typically, banks face two types of liquidity risks — funding liquidity risk and market liquidity risk. Funding liquidity risk is the one in which the bank is unable to meet expected and unexpected future cash flows and collateral needs without affecting its financial condition.
Market liquidity risk is the one when a bank cannot easily offset or eliminate a position at the prevailing market price because of inadequate market depth or market disruption.
“The LCR would be binding on banks from January 1, 2015; with a view to provide a transition time for banks, the LCR requirement would be minimum 60 per cent for the calendar year 2015, i.e. with effect from January 1, 2015 and rise in equal steps to reach 100 per cent on January 1, 2019,” RBI said in a statement on Monday.
Banks, however, has been asked to achieve a higher ratio than the minimum prescribed above as an effort towards better liquidity risk management.
The move from the Indian banking regulator comes after the Basel Committee on Banking Supervision proposed certain reforms to strengthen capital and liquidity regulations in the aftermath of the global financial crisis of 2008.
The central bank had conducted a Quantitative Impact Study (QIS) as on December 2013 on a sample of banks to assess their preparedness for the Basel III Liquidity ratios, which indicated that the average LCR for these banks varied from 54 per cent to 507 per cent.
In the draft guidelines on liquidity risk management of banks, released on November 2012, the board of the bank has been given the overall mandate to ensure liquidity coverage.
RBI had said that the banks’ boards should develop strategy, policies and practices to manage liquidity risk in accordance with the risk tolerance and ensure that the bank maintains sufficient liquidity. The boards were also asked to review the strategy, policies and practices at least annually.