Liquidity Coverage Ratio (LCR)

HQLA are classified as:

• Level 1 assets (cash, government securities) are at full value.

• Level 2A assets (high-quality corporate bonds) at 85% of value.

• Level 2B assets (certain equities) at 50–75% value after haircuts.

Why LCR Matters

Prevents Liquidity Crises: LCR ensures banks can meet obligations during periods of stress. For example, in January 2025, the RBI injected ₹1.5 trillion through open market operations (OMOs) to ease a ₹3.3 lakh crore liquidity shortfall, reinforcing the importance of robust HQLA buffers.

Enhances System Stability: Maintaining strong liquidity pools protects against systemic risk. Institutions like SBI have optimised liquidity using the LCR framework, unlocking funds previously held in excess reserves.

Ensures Regulatory Compliance: Falling below LCR thresholds invites regulatory penalties. Many banks, such as the Bank of Maharashtra, proactively maintain LCRs over 200% by prioritising holdings in government securities and statutory liquidity ratio (SLR) assets.

Limitations of LCR

Short-Term Focus: LCR covers only 30-day periods, overlooking intraday liquidity or long-term funding needs, which require complementary measures like the Net Stable Funding Ratio (NSFR).

Procyclicality: In times of crisis, banks may hoard HQLA, limiting credit availability to the economy. The RBI delayed stricter LCR requirements to 2026 after concerns that stricter norms could divert ₹4 lakh crore from lending to government bonds.

Cost of Compliance: Holding low-yield HQLA, such as government securities, reduces profitability. Smaller banks face higher relative costs, with limited access to diverse funding options.

Critics say LCR downplays risks. They believe it doesn't fully account for retail deposit withdrawals and collateral calls in tough times. This makes some situations seem safer than they truly are.

Practical Strategies for Managing LCR

Optimise HQLA Mix: Focus on Level 1 assets (such as State Development Loans (SDLs)) to maximise liquidity value.

Diversify Funding Sources: Reduce reliance on unstable wholesale deposits. Use alternatives like the RBI’s 56-day repo auctions. These provide short-term liquidity at competitive rates.

Adopt Technology: Use platforms like Oracle’s LCR systems. They automate haircuts and cash flow forecasts. This helps maintain accuracy and compliance.

Engage with Regulators: Collaborate with the RBI to stay updated on regulations. Balance LCR compliance with credit growth, especially with tighter rules coming post-2025.

Conclusion

LCR is vital for shielding the financial system from liquidity crises. However, managing it well means balancing regulatory duties with profitability and growth. Institutions that blend smart liquidity management with technology and active regulatory engagement will thrive as India's financial landscape changes.