FRM Exam Part II · Monitoring Liquidity

Liquidity Coverage Ratio (LCR) for FRM Part II

Updated 11 October 2026 · Fact-checked

The Basel III Liquidity Coverage Ratio equals the stock of high-quality liquid assets divided by total net cash outflows over a 30-day stress period. It must be at least 100%. To solve it, apply haircuts and caps to HQLA, apply run-off rates to outflows, apply inflow rates with the 75% cap, then divide.

Understand Liquidity Coverage Ratio (LCR)

The Liquidity Coverage Ratio (LCR) tests whether a bank can survive a severe 30-day liquidity stress without outside help. The idea is simple. Hold enough assets that can be turned into cash quickly and reliably, so that cash outflows during the stress are covered.

The numerator is the stock of high-quality liquid assets (HQLA). These are assets that are easy to sell, hold value in stress and are unencumbered. They are split into Level 1, Level 2A and Level 2B. Level 1 includes cash, central bank reserves and zero-risk-weight sovereign debt, and has no haircut. Level 2A includes certain 20% risk-weight sovereign or public sector debt and high-quality covered bonds and corporate debt, with a 15% haircut. Level 2B includes lower-rated corporate bonds, residential mortgage-backed securities and qualifying common equity shares, with higher haircuts (25% for RMBS, 50% for corporate bonds and equities).

The denominator is total net cash outflows over 30 days. You estimate outflows by multiplying each liability or commitment by a run-off rate: the share assumed to leave in stress. Stable retail deposits run off at 5% (3% under certain deposit insurance conditions), less stable retail at 10% or more, unsecured wholesale funding from non-financial corporates at 40% (operational deposits 25%), and from financial institutions at 100%. Inflows come from amounts owed to the bank, multiplied by inflow rates, for example 50% for fully performing loans from retail and corporate counterparties and 100% for inflows from financial institutions.

Two limits matter. Level 2 assets can be at most 40% of the HQLA stock after haircuts, and Level 2B at most 15%. Inflows are capped at 75% of total gross outflows, so net outflows are never below 25% of gross outflows. The minimum LCR is 100%.

Key formulas to remember

Liquidity Coverage Ratio: LCR = Stock of HQLA ÷ Total net cash outflows over the next 30 calendar days ≥ 100%; Both parts are measured under the prescribed stress scenario.
Total net cash outflows: Net outflows = Total expected outflows − MIN(Total expected inflows, 75% × Total expected outflows); Inflows are capped, so net outflows are at least 25% of gross outflows.
Expected outflows or inflows: Amount × run-off rate (outflows) or Amount × inflow rate (inflows); Use the category-specific rate prescribed by Basel.
HQLA haircuts: Level 1: 0%. Level 2A: 15%. Level 2B: RMBS 25%; corporate debt and equities 50%; Haircut is applied to market value before adding to the stock.
HQLA composition caps: Level 2 ≤ 40% of HQLA; Level 2B ≤ 15% of HQLA; Caps are measured after haircuts. Equivalent form: Level 2 ≤ 2/3 × Level 1; Level 2B ≤ 15/85 × (Level 1 + Level 2A).
Typical run-off rates: Stable retail 5%; less stable retail 10%; non-financial corporate unsecured 40%; financial institution unsecured 100%; Operational deposits are 25%; undrawn credit facilities vary by counterparty.

How to solve Liquidity Coverage Ratio (LCR) questions

Use this order for any LCR calculation or conceptual question.

1Classify each asset as Level 1, Level 2A, Level 2B or non-HQLA. Check it is unencumbered.
2Apply haircuts to market values to get adjusted values.
3Check the caps: Level 2 at 40% and Level 2B at 15% of the total HQLA stock. Reduce excess if needed.
4Sum the capped values to get the HQLA stock.
5Multiply each liability and commitment by its run-off rate. Sum to get total outflows.
6Multiply each inflow by its inflow rate. Cap total inflows at 75% of total outflows.
7Compute net outflows = outflows − capped inflows.
8Divide HQLA by net outflows and compare with 100%. State the surplus or shortfall.

Quickest way: Haircut, cap, run-off, then divide

When to use it: Use when time is short and numbers are given in a table.

Write the 75% inflow cap value first: 0.75 × outflows. Compare with inflows immediately.
Apply the 15% haircut to Level 2A mentally (multiply by 0.85).
Check the Level 2 cap only if Level 2 looks large relative to Level 1.
Compute LCR and eliminate options that are on the wrong side of 100%.

Common mistakes in Liquidity Coverage Ratio (LCR)

Applying the 75% cap to inflows as a percentage of HQLA or net outflows.
The cap wording is easy to misread.
Fix: Cap inflows at 75% of gross outflows. Net outflows therefore cannot go below 25% of gross outflows.
Forgetting haircuts before applying the Level 2 cap.
Students check caps on market values.
Fix: Haircut first, then test the 40% and 15% caps on the adjusted values.
Treating inflows and outflows with the same rate logic, for example using 100% run-off on all wholesale funding.
Rates for financial and non-financial counterparties get blurred.
Fix: Remember: financial institution unsecured funding is 100%; non-financial corporates 40%; stable retail 5%.
Counting encumbered or non-marketable assets in HQLA.
Students focus on asset type, not status.
Fix: Only unencumbered assets under operational control of the treasury count.
Using a 12-month horizon.
Confusion with the Net Stable Funding Ratio.
Fix: LCR covers 30 days of stress. NSFR covers one year of stable funding.

Worked examples

Example 1

A bank holds Level 1 assets of $600 million, Level 2A assets of $200 million (market value) and Level 2B corporate bonds of $100 million (market value). Haircuts are 0%, 15% and 50%. Ignoring the Level 2 and 2B caps for now, compute the HQLA stock and check whether the caps bind.

Show the solution

Level 1 = 600 × (1 − 0) = $600 million.
Level 2A = 200 × 0.85 = $170 million.
Level 2B = 100 × 0.50 = $50 million.
Total before caps = 600 + 170 + 50 = $820 million.
Level 2 total = 170 + 50 = $220 million. As a share of 820 it is 26.8%, below 40%.
Level 2B = 50 ÷ 820 = 6.1%, below 15%.
No caps bind.

Answer: HQLA stock = $820 million.

Example 2

A bank has HQLA of $820 million. Its 30-day stress outflows are: stable retail deposits $1,000 million at 5%, non-financial corporate unsecured funding $500 million at 40%, and financial institution unsecured funding $200 million at 100%. Expected inflows are: fully performing corporate loans of $300 million at 50% and inflows from financial institutions of $100 million at 100%. Compute the LCR.

Show the solution

Outflows: 1,000 × 5% = 50; 500 × 40% = 200; 200 × 100% = 200. Total = $450 million.
Inflows: 300 × 50% = 150; 100 × 100% = 100. Total = $250 million.
Cap = 75% × 450 = $337.5 million. Inflows of 250 are below the cap, so use 250.
Net outflows = 450 − 250 = $200 million.
LCR = 820 ÷ 200 = 4.10 = 410%.

Answer: LCR = 410%, well above the 100% minimum.

Exam tips

Memorise the haircuts and the main run-off rates: they are tested directly in many questions.
Always check the 75% inflow cap. Questions often give inflows larger than the cap.
Check Level 2 and Level 2B caps when the asset mix is heavy in lower-quality assets.
Know why LCR and NSFR differ: LCR is a 30-day stress test of liquid assets; NSFR is a one-year structural funding measure.
In conceptual items, link LCR to its purpose: surviving a 30-day stress, giving time for management or supervisory action.

Practice questions from Monitoring Liquidity

Liquidity Coverage Ratio (LCR) in other exams

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

Liquidity Coverage Ratio (LCR): frequently asked questions

What is the minimum LCR under Basel III?

The minimum is 100%. It means HQLA at least equals net cash outflows over a 30-day stress period. Banks may use the stock in stress, which can take the ratio below 100%, but supervisors expect prompt action.

What is the difference between Level 1, Level 2A and Level 2B assets?

Level 1 assets are the most liquid, such as cash, central bank reserves and zero-risk-weight sovereign debt, with no haircut. Level 2A assets carry a 15% haircut. Level 2B assets carry larger haircuts and are subject to a 15% cap on the HQLA stock.

Why are inflows capped at 75% of outflows?

The cap stops a bank relying only on expected inflows to meet its requirement. It forces the bank to hold at least some HQLA, equal to 25% of gross outflows.

How is LCR different from NSFR?

LCR measures short-term resilience over 30 days using liquid assets. NSFR compares available stable funding with required stable funding over one year to limit structural funding mismatches.