Explain what a liquidity coverage ratio (LCR) is and its purpose.

• A. High-quality liquid assets to cover net outflows for 30 days.
• B. Total assets to liabilities ratio of 2:1.
• C. Net income to expenses ratio.
• D. Tier 1 capital to risk-weighted assets.

Answer: (A)

The liquidity coverage ratio focuses on a bank’s ability to meet short-term cash needs during stress. It measures how much high-quality liquid assets the bank holds relative to the net cash outflows it expects over the next 30 days. The point is to ensure the bank has enough liquid assets to cover those outflows for a month, so it can weather a funding squeeze without needing to quickly raise new funds. High-quality liquid assets are assets that can be quickly converted to cash with little value loss, such as cash, central-bank reserves, and certain government securities. This liquidity-focused ratio is distinct from other measures like solvency (assets to liabilities), profitability (net income to expenses), or capital adequacy (Tier 1 capital to risk-weighted assets).