FRM Exam Part II · Liquidity Risk

Liquidity Risk Regulation: LCR and NSFR Explained

Q: What is the difference between LCR and NSFR?

LCR tests short-term resilience: HQLA against net outflows over 30 days under stress. NSFR tests structural funding: stable funding against the liquidity of assets over one year. Both must be at least 100%.

Q: What are the HQLA levels in the LCR?

Level 1 is cash, central bank reserves and zero-risk-weight sovereign debt, with no haircut. Level 2A has a 15% haircut. Level 2B has larger haircuts. Level 2 is capped at 40% of HQLA and Level 2B at 15%.

Q: How do you calculate the NSFR?

Multiply each funding item by its ASF factor and sum. Multiply each asset and off-balance-sheet item by its RSF factor and sum. Divide ASF by RSF.

Q: Why are inflows capped at 75% of outflows in the LCR?

The cap makes sure a bank always holds some HQLA and does not rely only on expected inflows during stress. It sets net outflows to at least 25% of gross outflows.

Updated 11 October 2026 · Fact-checked

LCR and NSFR are Basel III liquidity standards. LCR = stock of HQLA ÷ total net cash outflows over 30 days, and must be at least 100%. NSFR = available stable funding ÷ required stable funding over one year, also at least 100%. To solve questions, weight each item by its factor, then divide.

Understand Liquidity Risk Regulation: LCR and NSFR

Banks fail from running out of cash, not only from losses. Basel III added two liquidity standards after the 2007-2009 crisis. They test two different time horizons.

The Liquidity Coverage Ratio (LCR) is a short-term test. It asks: if a severe stress hits for 30 days, does the bank hold enough unencumbered high-quality liquid assets (HQLA) to cover net cash outflows? HQLA must be easy to sell at little loss, even in stress.

HQLA has levels. Level 1 assets are cash, central bank reserves and zero-risk-weight sovereign debt, with no haircut and no cap. Level 2A assets (for example some 20% risk-weight sovereign and covered bonds, high-rated corporate bonds) take a 15% haircut. Level 2B assets (for example lower-rated corporate bonds, some equities, RMBS) take larger haircuts. Level 2 in total cannot exceed 40% of HQLA, and Level 2B cannot exceed 15% of HQLA, after haircuts and adjustments.

Net cash outflows are stressed outflows minus stressed inflows over 30 days. Outflows come from run-off rates on liabilities: stable retail deposits run off at a low rate (a minimum of 3%), less stable retail at a higher rate (a minimum of 10%), and unsecured wholesale funding at higher rates. Inflows are capped at 75% of total outflows, so net outflows are never below 25% of gross outflows.

The Net Stable Funding Ratio (NSFR) is a structural, one-year test. It asks whether long-term funding matches the liquidity profile of assets and off-balance-sheet items. Available stable funding (ASF) weights liabilities and capital by how stable they are: regulatory capital gets 100%, stable retail deposits 95% (90% for less stable), and short-term wholesale funding from financial institutions 0%. Required stable funding (RSF) weights assets by how hard they are to liquidate: cash 0%, Level 1 assets 5%, and loans with higher risk weights or long maturities get higher factors, up to 100%. In short, LCR is about surviving a month; NSFR is about not funding long assets with short money.

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 measured after haircuts and the Level 2 caps.
Net cash outflows: Net outflows = Total stressed outflows − min(Total stressed inflows, 75% × Total stressed outflows); Each outflow = balance × run-off rate. Each inflow = balance × inflow rate.
HQLA composition limits: Level 2 ≤ 40% of HQLA; Level 2B ≤ 15% of HQLA; Level 1 has no cap. Level 2A haircut is 15%. Level 2B haircuts are larger.
Net Stable Funding Ratio: NSFR = Available stable funding (ASF) ÷ Required stable funding (RSF) ≥ 100%; Horizon is one year. Both sides are weighted sums of balance sheet items.
ASF and RSF weighting: ASF = Σ (liability or capital × ASF factor); RSF = Σ (asset or off-balance-sheet item × RSF factor); High ASF factor means stable funding. High RSF factor means illiquid asset.

How to solve Liquidity Risk Regulation: LCR and NSFR questions

Use the same routine for any LCR or NSFR numerical or conceptual question.

1Identify the ratio asked: 30-day LCR or one-year NSFR. Note the 100% minimum.
2For LCR, list HQLA by level. Apply haircuts to Level 2A and 2B first.
3Check the caps: Level 2 at most 40% of HQLA and Level 2B at most 15%. Cut any excess.
4Multiply each liability by its run-off rate to get outflows. Multiply each inflow by its inflow rate.
5Cap inflows at 75% of outflows, then compute net outflows and divide HQLA by them.
6For NSFR, multiply each funding item by its ASF factor and each asset by its RSF factor. Sum both sides.
7Divide ASF by RSF. Compare with 100% and state the shortfall or surplus.
8Interpret: say what the result means for survival over 30 days (LCR) or for funding mismatch (NSFR).

Quickest way: Weight, sum, divide

When to use it: Use for numerical MCQs when the question gives factors and balances and time is short.

Read the factors in the question. Do not rely on memory if they are given.
Compute the numerator and denominator separately on paper.
Check caps and the 75% inflow limit before dividing. These are the usual traps.
Eliminate options that are on the wrong side of 100% or that ignore a cap.
For concept questions, remember: LCR is 30 days and HQLA; NSFR is one year and stable funding.

Common mistakes in Liquidity Risk Regulation: LCR and NSFR

Counting all inflows against outflows in LCR.
Students think net means outflows minus inflows only.
Fix: Cap inflows at 75% of outflows. Net outflows are at least 25% of gross outflows.
Ignoring the 40% and 15% limits on Level 2 assets.
The haircuts feel like the only adjustment.
Fix: Test the caps after haircuts every time. Excess Level 2 assets do not count.
Applying haircuts to Level 1 assets.
Students apply the Level 2 haircut to all HQLA.
Fix: Level 1 is counted at market value with no haircut and no cap.
Mixing up ASF and RSF direction.
Both are weights, but they apply to opposite sides of the balance sheet.
Fix: ASF weights liabilities and capital. RSF weights assets. Put ASF on top.
Saying NSFR is a 30-day or stress measure.
Students blend the two ratios.
Fix: NSFR is a one-year structural ratio. LCR is the 30-day stress ratio.

Worked examples

Example 1

A bank holds Level 1 assets of $60 million and Level 2A assets of $30 million (before haircut). Level 2A takes a 15% haircut. Total stressed outflows are $90 million and stressed inflows are $50 million. Compute the LCR. Ignore Level 2B.

Show the solution

Level 2A after haircut = 30 × 0.85 = $25.5 million.
Check cap: Level 2 must be ≤ 40% of HQLA, which means Level 2 ≤ (2/3) × Level 1 = $40 million. 25.5 < 40, so no cut.
HQLA = 60 + 25.5 = $85.5 million.
Inflow cap = 75% × 90 = $67.5 million. Inflows of 50 are below the cap, so use 50.
Net outflows = 90 − 50 = $40 million.
LCR = 85.5 ÷ 40 = 213.75%.

Answer: LCR = 213.75%, well above the 100% minimum.

Example 2

A bank has ASF items: regulatory capital $20 billion (factor 100%), stable retail deposits $50 billion (95%), short-term wholesale funding from financial institutions $30 billion (0%). RSF items: cash $10 billion (0%), Level 1 securities $20 billion (5%), loans $60 billion (85%). Compute the NSFR.

Show the solution

ASF = 20 × 1.00 + 50 × 0.95 + 30 × 0 = 20 + 47.5 + 0 = $67.5 billion.
RSF = 10 × 0 + 20 × 0.05 + 60 × 0.85 = 0 + 1 + 51 = $52 billion.
NSFR = 67.5 ÷ 52 = 1.298, or about 129.8%.

Answer: NSFR ≈ 129.8%, above 100%, so stable funding exceeds required stable funding.

Exam tips

Know the numbers cold: 30 days, one year, 100% minimum, 75% inflow cap, 40% and 15% HQLA limits.
In calculation questions, read whether Level 2 amounts are given before or after haircuts.
For interpretation items, link a low NSFR to reliance on short-term wholesale funding for long-term assets.
Expect questions on which assets are Level 1 versus Level 2 and on run-off rates ranking: stable retail below less stable retail below wholesale.
Do not confuse the LCR with internal stress tests; LCR is a fixed regulatory scenario.

Practice questions from Liquidity Risk

Liquidity Risk Regulation: 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.

CMA FinalBasel III Liquidity Standards: LCR and NSFR

Liquidity Risk Regulation: LCR and NSFR: frequently asked questions

What is the difference between LCR and NSFR?

LCR tests short-term resilience: HQLA against net outflows over 30 days under stress. NSFR tests structural funding: stable funding against the liquidity of assets over one year. Both must be at least 100%.

What are the HQLA levels in the LCR?

Level 1 is cash, central bank reserves and zero-risk-weight sovereign debt, with no haircut. Level 2A has a 15% haircut. Level 2B has larger haircuts. Level 2 is capped at 40% of HQLA and Level 2B at 15%.

How do you calculate the NSFR?

Multiply each funding item by its ASF factor and sum. Multiply each asset and off-balance-sheet item by its RSF factor and sum. Divide ASF by RSF.

Why are inflows capped at 75% of outflows in the LCR?

The cap makes sure a bank always holds some HQLA and does not rely only on expected inflows during stress. It sets net outflows to at least 25% of gross outflows.