FRM Exam Part II · Solvency, Liquidity and Other Regulation After the Global Financial Crisis

Liquidity Coverage Ratio and Net Stable Funding Ratio

Updated 11 October 2026 · Fact-checked

The LCR equals the stock of high-quality liquid assets divided by net cash outflows over a 30-day stress period, and must be at least 100%. The NSFR equals available stable funding divided by required stable funding over one year, and must also be at least 100%. LCR covers short-term risk; NSFR covers structural funding risk.

Understand Liquidity Coverage Ratio and Net Stable Funding Ratio

Banks fail from running out of cash, not only from losing capital. Basel III added two liquidity standards after the global financial crisis. Each targets a different time horizon.

The Liquidity Coverage Ratio (LCR) asks: if a severe stress hits for 30 days, does the bank hold enough liquid assets to cover the net cash that leaves? The numerator is the stock of high-quality liquid assets (HQLA). The denominator is total net cash outflows over 30 calendar days under a prescribed stress scenario.

HQLA must be easy to sell at little loss, even in stress. Level 1 assets include cash, central bank reserves and zero-risk-weighted sovereign securities. They count at 100% of market value with no cap. Level 2A assets (for example some 20% risk-weighted sovereign and public sector debt, and high-quality covered bonds and corporate debt) take a 15% haircut. Level 2B assets (for example some lower-rated corporate bonds and certain equities) take larger haircuts. Level 2 in total cannot exceed 40% of HQLA, and Level 2B cannot exceed 15%.

Net outflows equal expected outflows minus expected inflows, but inflows are capped at 75% of outflows. Outflows are measured by multiplying balances by run-off rates. Stable retail deposits run off at lower rates than unsecured wholesale funding from financial institutions.

The Net Stable Funding Ratio (NSFR) looks at a one-year horizon. It compares available stable funding (ASF), the part of capital and liabilities likely to stay over a year, with required stable funding (RSF), the amount the bank's assets and off-balance-sheet exposures need to be funded stably. It stops banks funding long-term, illiquid loans with short-term wholesale money.

Key formulas to remember

Liquidity Coverage Ratio: LCR = Stock of HQLA ÷ Total net cash outflows over next 30 calendar days ≥ 100%; Outflows are stressed. HQLA is after haircuts and caps.
Net cash outflows: Net outflows = Total expected outflows − MIN(Total expected inflows, 75% × Total expected outflows); Inflows are capped at 75% of outflows, so net outflows are at least 25% of outflows.
Outflow or inflow amount: Amount = Balance × run-off rate (or inflow rate); Each category has its own prescribed rate.
Net Stable Funding Ratio: NSFR = Available stable funding (ASF) ÷ Required stable funding (RSF) ≥ 100%; ASF = Σ(liability or capital × ASF factor). RSF = Σ(asset or exposure × RSF factor).
HQLA composition limits: Level 2 ≤ 40% of HQLA; Level 2B ≤ 15% of HQLA; Caps apply after haircuts. Level 1 has no cap and no haircut.
Horizons: LCR: 30 days. NSFR: 1 year.; LCR is short-term resilience. NSFR limits structural maturity mismatch.

How to solve Liquidity Coverage Ratio and Net Stable Funding Ratio questions

Use this order for any LCR or NSFR calculation or conceptual question.

1Identify which ratio the question asks for. 30-day stress means LCR. One-year stable funding means NSFR.
2For LCR, list the assets and classify each as Level 1, 2A or 2B. Apply the haircut to each.
3Check the Level 2 caps (40% overall, 15% for 2B). Reduce the eligible Level 2 amount if a cap binds.
4Multiply each liability and commitment by its run-off rate to get outflows. Multiply inflows by their inflow rates.
5Apply the inflow cap: net outflows = outflows − the smaller of inflows and 75% of outflows.
6Divide HQLA by net outflows. Compare with 100%.
7For NSFR, multiply each funding source by its ASF factor and each asset by its RSF factor. Sum each side and divide ASF by RSF.
8State the interpretation: a ratio below 100% is a shortfall. Give the size of the gap if asked.

Quickest way: Fast LCR check

When to use it: Use when the question gives HQLA, outflows and inflows and asks for the ratio or whether the bank complies.

Compute 75% of gross outflows first. This is the maximum inflow you can count.
Take the smaller of actual inflows and that cap. Subtract from outflows.
Value HQLA after haircuts. Scan for a binding Level 2 cap only if Level 2 looks large.
Divide and compare with 100%. Eliminate options that ignore the inflow cap or haircuts.

Common mistakes in Liquidity Coverage Ratio and Net Stable Funding Ratio

Counting all inflows against outflows without the 75% cap
Net outflows look like a simple subtraction.
Fix: Always compare inflows with 75% of outflows and use the smaller one.
Forgetting haircuts on Level 2 assets
Students use market value for every asset.
Fix: Level 1 has no haircut. Apply 15% to Level 2A and the higher haircuts to Level 2B before summing.
Mixing up the horizons
Both ratios have a 100% minimum and similar names.
Fix: Link LCR with 30 days and NSFR with one year. LCR is stress-based liquidity; NSFR is stable funding structure.
Inverting the NSFR
Required is read as the numerator because it sounds like the requirement.
Fix: The ratio is available over required. Available is what the bank has; required is what its assets need.
Applying the Level 2 cap to the wrong base
Students compute 40% of Level 1 only.
Fix: The cap is that Level 2 cannot exceed 40% of total HQLA. That means Level 2 ≤ (2/3) × Level 1 when only Level 1 and 2 exist.
Treating NSFR as a stress ratio like LCR
Both came from Basel III liquidity reform.
Fix: NSFR is a going-concern structural measure based on asset and liability maturity and quality, not a 30-day stress outflow test.

Worked examples

Example 1

A bank holds Level 1 assets of $600 million and Level 2A assets of $300 million (market value). Level 2A haircut is 15%. Its 30-day stressed gross outflows are $900 million and inflows are $800 million. Compute the LCR.

Show the solution

Level 2A after haircut = 300 × 0.85 = $255 million.
Check the cap: Level 2 may be at most 40% of total HQLA, which means at most 2/3 of Level 1 = 2/3 × 600 = $400 million. 255 is below 400, so no cap binds.
HQLA = 600 + 255 = $855 million.
Inflow cap = 0.75 × 900 = $675 million. Inflows of 800 exceed this, so count 675.
Net outflows = 900 − 675 = $225 million.
LCR = 855 ÷ 225 = 3.80, or 380%.

Answer: LCR = 380%, well above the 100% minimum.

Example 2

A bank has ASF of $540 billion and RSF of $600 billion. How large is the NSFR, and what does it imply?

Show the solution

NSFR = ASF ÷ RSF.
NSFR = 540 ÷ 600 = 0.90, or 90%.
The minimum is 100%, so the bank is short by 600 − 540 = $60 billion of stable funding.
The bank must lengthen funding maturity, raise capital or stable deposits, or shrink long-term illiquid assets.

Answer: NSFR = 90%. The bank fails the requirement by $60 billion of stable funding.

Exam tips

Expect numeric LCR questions with an inflow cap trap. Check it before anything else.
Know which assets are Level 1, 2A and 2B and the 40% and 15% limits. Questions often test classification.
For NSFR, remember the logic: long-term illiquid assets need higher RSF factors, and stable deposits and equity get high ASF factors.
Interpretation items ask which risk each ratio addresses: LCR for short-term liquidity stress, NSFR for structural funding mismatch.

Practice questions from Solvency, Liquidity and Other Regulation After the Global Financial Crisis

Liquidity Coverage Ratio and Net Stable Funding Ratio 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 and Net Stable Funding Ratio: frequently asked questions

What is the difference between LCR and NSFR?

LCR measures whether a bank holds enough HQLA to cover net outflows over 30 stressed days. NSFR measures whether stable funding over one year covers the funding needs of assets and exposures. LCR is about short-term resilience and NSFR about structural balance sheet funding.

What counts as HQLA?

HQLA are assets that can be turned into cash quickly with little loss in stress. Level 1 includes cash, central bank reserves and zero-risk-weight sovereign debt. Level 2A and 2B include lower-quality sovereign, covered bond, corporate and some equity assets with haircuts.

What is the minimum LCR and NSFR?

Both must be at least 100% under Basel III. A ratio below 100% means the bank has a shortfall against the standard.

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

The cap makes banks hold a minimum stock of HQLA and stops them relying fully on inflows that may not arrive in stress. It means net outflows are never below 25% of gross outflows.