Banks required to apply
the Liquidity Coverage Ratio

Decision is part of Basel III requirements

The Central Bank (BDL) has instructed banks to apply the Liquidity Coverage Ratio (LCR) on their local and overseas operations, according to a new basic circular.

The LCR, which is one of the Basel III requirements, must be calculated separately for each significant currency. A currency is considered significant if it represents five percent or more of a bank’s total liabilities.

According to the circular, BDL’s Banking Control Commission (BCCL) will issue the relevant instructions for implementing the provisions of the decision.

The LCR is the ratio of a bank’s stock of high-quality liquid assets (HQLA) over its total net cash outflows during the coming 30 days at any given time.

The HQLA consists of total unencumbered assets that are characterized by their low risk and low volatility, and the ease and certainty of their valuation. They must also enjoy quick convertibility into cash without impacting the bank’s profitability and solvency, and they should be listed or traded on an active market. The HQLA stock must not include the statutory reserve requirements and the mandatory placements with BDL or the mandatory placements made by a bank’s overseas subsidiary with the central bank of the host country.

Total net cash outflows for 30 calendar days are calculated by subtracting the total expected cash inflows over the next 30 days from the total expected cash outflows during the same period. Overall cash inflows must not exceed 75 percent of total cash outflows.

The LCR should exceed 100 percent. If it falls below the 100 percent threshold in any significant currency, whether at the bank’s local or overseas operations, the bank must submit a compliance plan to BCCL within one week. The plan must show how the bank plans to adhere to the threshold in the near future and must specify the time required to do so.

Amine Awad, General Manager at BLOM Bank, said the banks will not face any problems in applying the LCR and in reaching the required 100 percent ratio. He said that calculating the LCR is, however, a complex operation.

The banks are required to adopt additional scenarios for the LCR such as calculating net cash outflows for 90 days instead of 30 days.

They have “to develop any necessary complementary liquidity tools, and to set internal liquidity limits in a way to ensure the sound management and monitoring of risk liquidity at the level of each subsidiary and of the banking group as a whole, while preserving the self-sufficiency of each subsidiary and restricting reliance on the parent bank,” BDL said in the circular.

The banks are also required to carry out stress tests to determine the impact on their existing liquidity ratios.

If a subsidiary of a local bank operates in a country where another methodology is used for calculating the LCR, the bank may request BDL’s approval to allow its overseas subsidiary to apply that methodology.

According to the circular, Islamic banks are not governed by the LCR provisions.

Awad said that the LCR is used for measuring short term liquidity coverage as it has a one-month time horizon. He said that in the coming weeks BDL is expected to ask the banks to apply the Net Stable Funding Ratio (NSFR), which has a longer term horizon.