05. LCR and NSFR: the two liquidity ratios
Capital is not enough. SVB had a CET1 ratio around 15%, well above requirements, and still failed.
#BankingRegulation #BaselIII #Liquidity #LCR #NSFR #BankingMetricsSeries
This is the gap that capital ratios do not cover. CET1 tells you whether the bank can absorb losses. It tells you nothing about whether the bank has cash when depositors show up tomorrow morning.
Silicon Valley Bank, March 2023, had a CET1 ratio around 15%, well above requirements. The bank failed because 42 billion dollars in deposits left in a single day. Long-dated bonds on the asset side could not be sold without realising large losses. The collapse was a liquidity event on a balance sheet that still looked solvent. That is the reason these two ratios matter.
Two ratios monitors this:
LCR (Liquidity Coverage Ratio) - 30 days
HQLA / Net Cash Outflows >= 100%. Survives a one-month stress scenario.
HQLA = High Quality Liquid Assets. Banks do not park cash in a vault, because earns nothing. They invest in assets safe enough and traded enough to be sold for cash in a single day with little or no loss.
Net Cash Outflows = the cash the bank expects to lose over 30 days in a stressed market. If HQLA covers those outflows for 30 days, the bank passes.
NSFR (Net Stable Funding Ratio) - 12 months
Available Stable Funding / Required Stable Funding >= 100% Funds long-term assets with long-term liabilities.
The intuition is the mortgage. A bank grants a 30-year mortgage of 100,000 euros to a customer. It will see that money back slowly, over 30 years. It cannot fund that mortgage with a 5-year wholesale bond. When the bond expires, the bank needs to refinance the remaining 25 years, and there is no guarantee the market is open or still competitive. In a crisis, the market closes, the bond cannot be rolled, and the bank is stuck with a 25-year asset and no funding.
LCR is the short-term test. NSFR is the structural test. They need to be above 100%,every day, by regulation.
SVB was below the US asset threshold for full LCR and NSFR calculation, a tailoring choice that does not exist in the EU. The collapse showed the cost of that exemption..
How each is built, in the carousel 👇
