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FRM Exam Part II · Liquidity Risk Management

Basel III Liquidity Ratios: LCR and NSFR Explained

Updated 11 October 2026 · Fact-checked

The Liquidity Coverage Ratio (LCR) is stock of HQLA ÷ total net cash outflows over 30 days of stress, and must be at least 100%. The Net Stable Funding Ratio (NSFR) is available stable funding ÷ required stable funding over one year, also at least 100%. Solve questions by weighting each item with its factor, then dividing.

Understand Basel III Liquidity Ratios: LCR and NSFR

Basel III added two liquidity standards after the 2007-2009 crisis showed that solvent banks can fail when funding dries up. Each ratio targets a different time horizon.

The Liquidity Coverage Ratio (LCR) is a short-term test. It asks: if the bank faces a severe 30-day stress, does it hold enough unencumbered, high-quality liquid assets to cover its net cash outflows without outside help? The numerator is the stock of HQLA. The denominator is total net cash outflows over 30 calendar days.

HQLA has two levels. Level 1 assets are cash, central bank reserves and zero-risk-weighted sovereign or central bank securities. They count at 100% of market value with no cap. Level 2A assets (for example certain 20% risk-weighted sovereign or public sector entity debt and high-quality covered bonds and corporate bonds) carry a 15% haircut. Level 2B assets (for example lower-rated corporate bonds, certain residential mortgage-backed securities and certain equities) carry larger haircuts, 25% to 50%. Level 2 assets cannot exceed 40% of the HQLA stock after haircuts, and Level 2B cannot exceed 15%.

Net cash outflows = total expected outflows − total expected inflows, where inflows are capped at 75% of outflows. Outflows come from running off liabilities at set rates: for example, stable retail deposits at a minimum of 3% and less stable retail deposits at 10% or more. Unsecured wholesale funding from non-financial corporates is run off at 40% (operational deposits at 25%), and from financial institutions at 100%.

The Net Stable Funding Ratio (NSFR) is a structural one-year test. It compares available stable funding (ASF) with required stable funding (RSF). ASF weights the bank's capital and liabilities by how stable they are: regulatory capital and liabilities of one year or more get 100%, stable retail deposits 95%, less stable retail deposits 90%, and wholesale funding from non-financial corporates under one year 50%. RSF weights assets by how illiquid they are: cash 0%, Level 1 assets 5%, Level 2A 15%, Level 2B and many performing loans 50% to 85%, and non-performing or long-term illiquid assets up to 100%. The NSFR limits reliance on short-term wholesale funding to finance long-term assets.

Key formulas to remember

Liquidity Coverage Ratio
LCR = Stock of HQLA ÷ Total net cash outflows over next 30 days ≥ 100%
HQLA must be unencumbered and is measured after haircuts and caps.
Net cash outflows
Net outflows = Total outflows − min(Total inflows, 75% × Total outflows)
Inflows are capped at 75% of outflows, so net outflows are at least 25% of gross outflows.
Net Stable Funding Ratio
NSFR = Available stable funding ÷ Required stable funding ≥ 100%
Horizon is one year. ASF and RSF are each the sum of balances × factors.
HQLA composition
HQLA = Level 1 + Level 2A × (1 − 15%) + Level 2B × (1 − haircut)
Level 2B haircuts are 25% to 50% depending on the asset. Level 2 ≤ 40% of HQLA; Level 2B ≤ 15%.
Level 2 cap
Max Level 2 = (2 ÷ 3) × Level 1
Equivalent to Level 2 being 40% of total HQLA. Ignores adjustments for unwinding secured transactions.

How to solve Basel III Liquidity Ratios: LCR and NSFR questions

Use the same sequence for any LCR or NSFR calculation, and watch which ratio the question asks for.

  1. 1Identify the ratio and horizon: LCR is 30 days; NSFR is one year.
  2. 2For LCR, classify each asset as Level 1, 2A or 2B and apply the haircut.
  3. 3Check the caps: Level 2 ≤ 40% of HQLA and Level 2B ≤ 15%. Reduce the excess if breached.
  4. 4Multiply each liability by its run-off rate and each inflow by its inflow rate.
  5. 5Cap inflows at 75% of outflows, then compute net outflows and divide HQLA by them.
  6. 6For NSFR, multiply each funding item by its ASF factor and each asset by its RSF factor, then sum each side.
  7. 7Divide ASF by RSF, compare with 100% and state the surplus or shortfall.
  8. 8Interpret: say what the result means for the bank and which lever (more HQLA or longer funding) would fix it.

Quickest way: Factor-and-divide shortcut

When to use it: Use when the question gives balances and factors and asks only for the ratio or a pass/fail.

  1. Write HQLA (or ASF) and outflows (or RSF) as two columns of balance × factor.
  2. Apply the 75% inflow cap first: if inflows exceed 75% of outflows, net outflows = 25% of outflows.
  3. Test the Level 2 cap using Level 2 ≤ (2 ÷ 3) × Level 1.
  4. Divide, compare with 100%, and eliminate options that treat the ratio as below or above that line wrongly.

Common mistakes in Basel III Liquidity Ratios: LCR and NSFR

  • Mixing up the horizons, using 1 year for LCR or 30 days for NSFR.

    Both are 100% minimum ratios with similar names.

    Fix: Remember LCR = 30 days, liquidity under stress; NSFR = 1 year, funding structure.

  • Counting Level 2 assets at full value or ignoring the 40% cap.

    Students apply haircuts but skip the composition limits.

    Fix: Haircut first, then test Level 2 ≤ 40% of HQLA and Level 2B ≤ 15%.

  • Letting inflows reduce outflows without the 75% cap.

    Net outflows seems like a simple subtraction.

    Fix: Net outflows = outflows − min(inflows, 75% of outflows).

  • Applying run-off rates to assets or ASF factors to the LCR.

    Factors are confusingly similar across the two ratios.

    Fix: LCR uses run-off and inflow rates; NSFR uses ASF (liabilities and capital) and RSF (assets).

  • Reading a higher RSF as good.

    Students forget RSF is a requirement in the denominator.

    Fix: More illiquid assets raise RSF and lower NSFR. More long-term funding raises ASF and lifts NSFR.

Worked examples

Example 1

A bank holds Level 1 assets of $600 million and Level 2A assets of $200 million (haircut 15%). Total outflows over 30 days are $900 million and inflows are $500 million. Compute the LCR.

Show the solution
  1. Level 2A after haircut = 200 × 0.85 = $170 million.
  2. Cap check: maximum Level 2 = (2 ÷ 3) × 600 = $400 million. 170 is within the cap.
  3. HQLA = 600 + 170 = $770 million.
  4. Inflow cap = 75% × 900 = $675 million. Inflows of $500 million are below it, so use 500.
  5. Net outflows = 900 − 500 = $400 million.
  6. LCR = 770 ÷ 400 = 192.5%.

Answer: LCR = 192.5%, well above the 100% minimum.

Example 2

A bank has ASF items: capital $80 million (100%), stable retail deposits $300 million (95%), and wholesale funding from corporates under one year $200 million (50%). RSF items: cash $50 million (0%), Level 1 securities $100 million (5%), and loans at 85% RSF of $450 million. Compute the NSFR.

Show the solution
  1. ASF = 80 × 1.00 + 300 × 0.95 + 200 × 0.50 = 80 + 285 + 100 = $465 million.
  2. RSF = 50 × 0 + 100 × 0.05 + 450 × 0.85 = 0 + 5 + 382.5 = $387.5 million.
  3. NSFR = 465 ÷ 387.5 = 1.2.
  4. As a percentage, NSFR = 120%.

Answer: NSFR = 120%, above the 100% minimum, so funding is sufficiently stable.

Exam tips

  • Expect applied questions: compute the ratio, then say whether the bank complies and what would fix a shortfall.
  • Memorise the anchor numbers: 30 days, one year, 100%, 40%, 15%, 75%, and the 15% Level 2A haircut.
  • If options include a ratio above 100% when HQLA is clearly smaller than net outflows, eliminate it quickly.
  • Know the intent: LCR guards against a short liquidity shock; NSFR guards against structural maturity mismatch.
  • Read whether assets are unencumbered. Pledged assets do not count as HQLA.

Practice questions from Liquidity Risk Management

Basel III Liquidity Ratios: LCR and NSFR in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Basel III Liquidity Ratios: LCR and NSFR: frequently asked questions

What is the difference between LCR and NSFR?

LCR measures whether HQLA covers net cash outflows in a 30-day stress. NSFR measures whether stable funding supports the liquidity profile of assets over one year. LCR is short-term; NSFR is structural.

What counts as Level 1 HQLA?

Cash, central bank reserves and certain zero-risk-weighted sovereign and central bank securities. They count at full market value with no cap.

What is the minimum LCR and NSFR?

Both must be at least 100% under Basel III. An LCR below 100% means HQLA is smaller than the stressed net outflows.

Why are inflows capped at 75% of outflows?

The cap forces banks to hold a minimum HQLA stock instead of relying only on expected inflows during stress. Net outflows are therefore at least 25% of gross outflows.