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FRM Exam Part II · Risk, Regulation and Organizational Structure

Basel III Capital, Leverage, LCR and NSFR Explained

Updated 11 October 2026 · Fact-checked

The Basel framework sets minimum bank capital and liquidity standards. Basel II added risk-sensitive capital and three pillars. Basel 2.5 raised trading book capital. Basel III raised capital quality and added buffers, a leverage ratio, the LCR (30-day liquidity) and the NSFR (one-year stable funding). Solve questions by identifying the ratio, its numerator and denominator, then comparing to the minimum.

Understand Basel Framework: Capital and Liquidity Regulation

Basel standards are set by the Basel Committee on Banking Supervision. They give banks minimum rules so that capital and liquidity are comparable across countries. Think of them as three layers: capital (absorbs losses), leverage (a backstop that ignores risk weights) and liquidity (survives cash outflows).

Basel II introduced three pillars: Pillar 1 minimum capital for credit, market and operational risk; Pillar 2 supervisory review; Pillar 3 market discipline through disclosure. Credit risk could be measured with the standardized approach or internal ratings-based approaches.

Basel 2.5 was a quick fix in 2009 for trading book weaknesses seen in the crisis. It added a stressed VaR, an incremental risk charge for credit-sensitive positions, and a comprehensive risk measure for correlation trading. It also raised capital for securitizations.

Basel III responded to the crisis more broadly. It raised the quantity and quality of capital, with a focus on common equity Tier 1 (CET1). It added a capital conservation buffer, a countercyclical buffer, a G-SIB surcharge, a non-risk-based leverage ratio and two liquidity standards. The conservation buffer is built in good times and used in stress. The countercyclical buffer is set by national authorities when credit growth is excessive, and released in downturns.

LCR vs NSFR: the LCR is short-term. It checks that high-quality liquid assets cover net cash outflows over a 30-day stress. The NSFR is structural. It checks that available stable funding covers required stable funding over a one-year horizon. Both must be at least 100%.

Key formulas to remember

Minimum capital ratios (Basel III)
CET1 ≥ 4.5% of RWA; Tier 1 ≥ 6% of RWA; Total capital ≥ 8% of RWA
Ratios are measured against risk-weighted assets (RWA), before buffers.
Capital conservation buffer
2.5% of RWA, met with CET1
Total CET1 requirement with buffer = 7%. Falling into the buffer restricts distributions.
Countercyclical buffer
0% to 2.5% of RWA, set by national authorities, met with CET1
Applied to credit exposures in the jurisdiction; weighted by where exposures are located.
Leverage ratio
Tier 1 capital ÷ Total exposure measure ≥ 3%
Exposure includes on-balance-sheet assets and off-balance-sheet items and derivatives. No risk weights.
Liquidity Coverage Ratio
LCR = Stock of HQLA ÷ Total net cash outflows over next 30 days ≥ 100%
Net outflows = outflows minus inflows, where inflows are capped at 75% of outflows.
Net Stable Funding Ratio
NSFR = Available stable funding (ASF) ÷ Required stable funding (RSF) ≥ 100%
One-year horizon. Capital and long-term liabilities have high ASF factors.
Basel 2.5 trading book additions
Stressed VaR + Incremental Risk Charge + Comprehensive Risk Measure
Stressed VaR uses a 12-month period of significant financial stress. Both VaR and stressed VaR are 10-day, 99%.

How to solve Basel Framework: Capital and Liquidity Regulation questions

Use this method for any question on Basel capital, leverage or liquidity.

  1. 1Identify which standard is tested: risk-based capital, buffer, leverage ratio, LCR, NSFR or Basel 2.5 market risk.
  2. 2Write the ratio with its exact numerator and denominator.
  3. 3Pull the correct inputs from the question. Check whether the denominator uses RWA, total exposure, net outflows or RSF.
  4. 4Apply any caps, factors or haircuts the question states, such as the 75% inflow cap.
  5. 5Compute the ratio and compare with the minimum. Add buffers where the question asks for full requirements.
  6. 6State the consequence: shortfall amount, distribution restrictions, or which action fixes the ratio.
  7. 7Check the answer: does it match the purpose of the ratio (loss absorption, backstop, 30-day or 1-year liquidity)?

Quickest way: Match the ratio to its time frame and base

When to use it: Use when options mix up ratios or ask which standard addresses a given problem.

  1. Short stress, 30 days, liquid assets: LCR.
  2. One-year funding structure: NSFR.
  3. Capital against unweighted exposure: leverage ratio (3%).
  4. Capital against RWA: CET1 4.5%, plus 2.5% conservation buffer, plus CCyB 0-2.5%.
  5. Trading book fix before Basel III: Basel 2.5 (stressed VaR, IRC, CRM).
  6. Eliminate options that use the wrong denominator first.

Common mistakes in Basel Framework: Capital and Liquidity Regulation

  • Confusing LCR and NSFR horizons

    Both are 100% minimums and both involve liquid or stable items.

    Fix: LCR is 30 days of stressed net outflows. NSFR is one year of stable funding against asset liquidity.

  • Using risk-weighted assets in the leverage ratio

    Other capital ratios use RWA, so students carry it over.

    Fix: The leverage ratio uses total exposure with no risk weights, so it is a backstop.

  • Adding buffers to Tier 1 or total capital only

    Students forget buffers are met with CET1.

    Fix: Conservation buffer and CCyB must be held in CET1, on top of the minimum.

  • Ignoring the 75% cap on inflows in the LCR

    Questions list inflows and students subtract them fully.

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

  • Treating Basel 2.5 as the full Basel III

    Both followed the crisis and both raised capital.

    Fix: Basel 2.5 changed trading book and securitization capital only. Basel III reformed capital definition, buffers, leverage and liquidity.

  • Thinking the countercyclical buffer is fixed

    Other buffers are fixed percentages.

    Fix: The CCyB ranges from 0% to 2.5% and national authorities raise it in credit booms and release it in downturns.

Worked examples

Example 1

A bank holds HQLA of $90 billion. Its 30-day stressed cash outflows are $120 billion and inflows are $70 billion. What is its LCR, and does it meet the requirement?

Show the solution
  1. Inflows are capped at 75% of outflows: 0.75 × 120 = $90 billion.
  2. Actual inflows of $70 billion are below the cap, so use $70 billion.
  3. Net outflows = 120 − 70 = $50 billion.
  4. LCR = 90 ÷ 50 = 180%.
  5. 180% is at least 100%.

Answer: LCR = 180%, which meets the 100% minimum.

Example 2

A bank has Tier 1 capital of €24 billion, on-balance-sheet assets of €700 billion, and off-balance-sheet and derivative exposures of €100 billion (after conversion). Its RWA are €300 billion with CET1 of €18 billion. Compute the leverage ratio and the CET1 ratio, and say whether it meets a 3% leverage ratio and the 7% CET1 level including the conservation buffer.

Show the solution
  1. Total exposure = 700 + 100 = €800 billion.
  2. Leverage ratio = 24 ÷ 800 = 3.0%.
  3. 3.0% is equal to the 3% minimum, so it just meets it.
  4. CET1 ratio = 18 ÷ 300 = 6.0%.
  5. With the buffer the CET1 target is 4.5% + 2.5% = 7%.
  6. 6.0% is above the 4.5% minimum but below 7%, so it is inside the buffer.

Answer: Leverage ratio is 3.0% (meets the minimum). CET1 ratio is 6.0%: above the 4.5% minimum but inside the conservation buffer, so distributions would be restricted.

Exam tips

  • Memorize the numbers: 4.5%, 6%, 8%, 2.5%, 0-2.5%, 3%, 100% and the 30-day and one-year horizons.
  • Read the denominator carefully. Many wrong options just swap RWA and total exposure.
  • For LCR items, apply the 75% inflow cap before computing the ratio.
  • When asked about Basel 2.5, think stressed VaR, incremental risk charge and the comprehensive risk measure.
  • Questions on the CCyB often test who sets it and when it is released: national authorities, released in downturns.

Practice questions from Risk, Regulation and Organizational Structure

Basel Framework: Capital and Liquidity Regulation in other exams

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

Basel Framework: Capital and Liquidity Regulation: frequently asked questions

What is the difference between LCR and NSFR?

The LCR requires enough high-quality liquid assets to cover net outflows over 30 days of stress. The NSFR requires stable funding to cover the liquidity profile of assets over one year. Both must be at least 100%.

How do you calculate the Basel III leverage ratio?

Divide Tier 1 capital by the total exposure measure, which includes on- and off-balance-sheet items without risk weights. The minimum is 3%.

What changed from Basel 2.5 to Basel III?

Basel 2.5 added stressed VaR, the incremental risk charge and higher securitization charges for the trading book. Basel III reformed capital quality, added buffers and the leverage ratio, and introduced the LCR and NSFR.

What is the countercyclical capital buffer?

It is an extra CET1 buffer of 0% to 2.5% of RWA set by national authorities when credit growth is excessive. It is released in downturns so banks can keep lending.