FRM Exam Part II · Liquidity Stress Testing

LCR, NSFR and Supervisory Liquidity Stress Tests Explained

Updated 11 October 2026 · Fact-checked

The LCR (liquidity coverage ratio) = stock of HQLA ÷ total net cash outflows over 30 stress days, and must be at least 100%. The NSFR = available stable funding ÷ required stable funding over one year, also at least 100%. Supervisors expect internal stress tests to complement both ratios.

Understand Regulatory Frameworks: LCR, NSFR and Supervisory Stress Tests

Banks fail from liquidity shortages even when they are solvent. Basel III added two global liquidity standards after the 2007-2009 crisis. Each one targets a different time horizon.

The Liquidity Coverage Ratio (LCR) is a short-term test. It asks: if a severe stress hits for 30 calendar days, does the bank hold enough high-quality liquid assets (HQLA) to cover net outflows? HQLA must be unencumbered and easy to sell at little loss. Level 1 assets (cash, central bank reserves, qualifying sovereign debt) count at full value with no haircut. Level 2A and 2B assets carry haircuts and caps.

The Net Stable Funding Ratio (NSFR) is a structural, one-year test. It compares the stable funding a bank has with the stable funding its assets and off-balance-sheet activities need. Long-term equity and long-term debt get high stable-funding factors. Illiquid long-dated loans need a lot of stable funding. The aim is to limit reliance on short-term wholesale funding to finance long-term assets.

The standards are a minimum, not a full picture. Supervisors, using the Basel principles for sound liquidity risk management and supervision, expect banks to run their own internal liquidity stress tests. These cover bank-specific, market-wide and combined scenarios, several horizons, and risks the ratios miss, such as intraday needs, currency mismatches and concentrated funding. Results should feed the liquidity buffer size, limits, the contingency funding plan and the risk appetite. Supervisors also review these tests and can ask for action.

The Basel monitoring tools (contractual maturity mismatch, funding concentration, available unencumbered assets, LCR by significant currency, market-related monitoring tools) give supervisors extra views. They are not pass/fail ratios.

Key formulas to remember

Liquidity Coverage Ratio: LCR = Stock of HQLA ÷ Total net cash outflows over next 30 calendar days ≥ 100%; Short-term, stress-based. HQLA is measured after haircuts and caps.
Total net cash outflows: Net outflows = Total expected outflows − MIN(total expected inflows, 75% of total expected outflows); Inflows are capped at 75% of outflows, so net outflows are never below 25% of gross outflows.
Net Stable Funding Ratio: NSFR = Available stable funding (ASF) ÷ Required stable funding (RSF) ≥ 100%; Structural, covers a one-year horizon. Each item is weighted by an ASF or RSF factor.
ASF and RSF weighting: ASF = Σ (liability or capital amount × ASF factor); RSF = Σ (asset or off-balance-sheet amount × RSF factor); Regulatory capital and liabilities of one year or more get a 100% ASF factor. Cash and central bank reserves get a 0% RSF factor in Basel's standard.
Outflow amount: Outflow = Balance × run-off rate; Stable retail deposits have a lower run-off rate than unsecured wholesale funding from financial institutions.
HQLA after haircut: Eligible HQLA = Market value × (1 − haircut); Level 1 has no haircut. Level 2A has a 15% haircut. Level 2B has haircuts of 25% or 50% depending on asset type.

How to solve Regulatory Frameworks: LCR, NSFR and Supervisory Stress Tests questions

Use this method for any LCR, NSFR or supervisory stress test question.

1Identify the ask: ratio calculation, definition, comparison, or supervisory expectation.
2Name the standard and horizon. LCR is 30 days and stress based. NSFR is one year and structural.
3For LCR, build the numerator: apply haircuts to each HQLA level, then sum.
4For LCR, build the denominator: balance × run-off rate for outflows, balance × inflow rate for inflows, then apply the 75% cap on inflows.
5For NSFR, multiply each funding item by its ASF factor and each asset by its RSF factor, then sum each side.
6Divide and compare to 100%. State the surplus or shortfall in currency terms if asked.
7For qualitative questions, link to supervisory expectations: scenarios, governance, use of results, and complementing ratios.
8Check the answer: does the direction of change make sense (more HQLA raises LCR, more long-term funding raises NSFR)?

Quickest way: Horizon-first shortcut

When to use it: Use it for MCQs that compare LCR and NSFR or ask what changes a ratio.

Short horizon (30 days) and stress outflows points to LCR. One year and stable funding points to NSFR.
Write the ratio as asset-side quality over outflows for LCR, and funding supply over funding need for NSFR.
For a calculation, compute the cap first: inflows cannot exceed 75% of outflows.
Test each option for direction: a ratio below 100% means a shortfall.
Eliminate options that mention the wrong horizon or call the ratio a risk-weighted measure.

Common mistakes in Regulatory Frameworks: LCR, NSFR and Supervisory Stress Tests

Mixing up horizons: calling the NSFR a 30-day measure.
Both are Basel III liquidity ratios with a 100% minimum.
Fix: Remember: LCR = liquidity in a 30-day storm; NSFR = funding structure over a year.
Forgetting the 75% cap on inflows in the LCR denominator.
Students subtract all inflows from outflows.
Fix: Net outflows = outflows − MIN(inflows, 0.75 × outflows). Always compute the cap.
Counting HQLA at market value without haircuts.
Level 1 has no haircut, so it feels like a general rule.
Fix: Apply 15% to Level 2A and the stated haircut to Level 2B before summing.
Treating the ratios as a substitute for internal stress testing.
Compliance with 100% sounds like enough.
Fix: Supervisory principles expect internal tests covering bank-specific, market-wide and combined scenarios, plus intraday and currency risk.
Putting short-term wholesale funding in a high-ASF bucket for the NSFR.
Confusing funding that is large with funding that is stable.
Fix: ASF depends on expected tenor and behaviour. Funding under six months from financial institutions gets a low or zero factor; one year or more gets 100%.
Using the monitoring tools as pass/fail requirements.
They are listed next to the ratios in the Basel documents.
Fix: They are supervisory information tools with no fixed minimum.

Worked examples

Example 1

A bank holds Level 1 assets of $400 million and Level 2A assets of $200 million (market value). Level 2A has a 15% haircut. Expected 30-day stress outflows are $700 million and expected inflows are $300 million. Assume the Level 2 cap is not binding. Calculate the LCR.

Show the solution

Eligible Level 2A = 200 × (1 − 0.15) = $170 million.
HQLA = 400 + 170 = $570 million.
Inflow cap = 0.75 × 700 = $525 million. Inflows of $300 million are below the cap, so all count.
Net outflows = 700 − 300 = $400 million.
LCR = 570 ÷ 400 = 142.5%.

Answer: LCR = 142.5%, above the 100% minimum.

Example 2

A bank has available stable funding of €820 billion. Its required stable funding is €900 billion. How much additional stable funding does it need to reach an NSFR of exactly 100%, and what is its current NSFR?

Show the solution

NSFR = 820 ÷ 900 = 0.9111, about 91.1%.
This is below 100%, so there is a shortfall.
Shortfall = 900 − 820 = €80 billion of additional ASF (or a reduction in RSF of the same size).
Check: 900 ÷ 900 = 100%.

Answer: Current NSFR is about 91.1%. The bank needs €80 billion more available stable funding (or an equivalent cut in required stable funding).

Exam tips

Expect side-by-side comparison questions. Learn horizon, purpose and numerator/denominator for both ratios.
In LCR calculations, check for haircuts and the 75% inflow cap before dividing.
For supervisory questions, pick answers that stress governance, multiple scenarios and use of results in the contingency funding plan.
Be careful with phrases like 'complements' versus 'replaces'. Internal tests complement the ratios.
If the question gives both a ratio and a currency amount, check whether it asks for a ratio or a shortfall.

Practice questions from Liquidity Stress Testing

Regulatory Frameworks: LCR, NSFR and Supervisory Stress Tests 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

Regulatory Frameworks: LCR, NSFR and Supervisory Stress Tests: frequently asked questions

What is the difference between LCR and NSFR?

The LCR tests whether HQLA covers net cash outflows over 30 stressed days. The NSFR tests whether stable funding over a one-year horizon covers the stable funding that assets and activities need. LCR is short-term liquidity resilience; NSFR is structural funding.

What is the minimum LCR and NSFR under Basel III?

Both must be at least 100%. For the LCR this means HQLA at least equals net 30-day outflows. For the NSFR it means ASF at least equals RSF.

Why does the LCR cap inflows at 75% of outflows?

The cap makes sure a bank always holds a liquid buffer and does not rely only on inflows that may not arrive in stress. Net outflows are therefore at least 25% of gross outflows.

What do supervisors expect from internal liquidity stress tests?

They expect tests for bank-specific, market-wide and combined scenarios across several horizons. Tests should be governed by senior management and the board, and results should shape buffers, limits and the contingency funding plan. The tests should also cover risks the ratios do not capture, such as intraday and currency liquidity.