What Is the Liquidity Coverage Ratio? (2024)

FAQs

What Is the Liquidity Coverage Ratio? ›

Banks and financial institutions should attempt to achieve a liquidity coverage ratio of 3% or more. In most cases, banks will maintain a higher level of capital to give themselves more of a financial cushion.

The liquidity coverage ratio is the requirement whereby banks must hold an amount of high-quality liquid assets that's enough to fund cash outflows for 30 days. 1 Liquidity ratios are similar to the LCR in that they measure a company's ability to meet its short-term financial obligations.

What Is a Good LCR? Experts say that a bank should have an LCR ratio of 1:1, but this is difficult to achieve and set as it requires a bank to keep enough liquid assets or cash at any one time for the next thirty days. As such, the Financial Stability Board (FSB) recommends having a liquidity coverage ratio of 100%.

The value of the ratio should be no lower than 100% (i.e. the stock of HQLA should at least equal total net cash outflows) on an ongoing basis as the stock of unencumbered HQLA is intended to serve as a defense against the potential onset of liquidity stress.

Generally, a good Liquidity Ratio should be above 1.0. This indicates the company has enough current assets to cover its short-term liabilities. A higher Liquidity Ratio (above 2.0) shows the company is in a stronger financial position and may have spare cash available for investments or other opportunities.

For instance, a quick ratio of 1.5 indicates that a company has $1.50 of liquid assets available to cover each $1 of its current liabilities. While such numbers-based ratios offer insight into the viability and certain aspects of a business, they may not provide a complete picture of the overall health of the business.

During a period of financial stress, however, banks may use their stock of HQLA, thereby falling below 100%, as maintaining the LCR at 100% under such circ*mstances could produce undue negative effects on the bank and other market participants.

A good liquidity ratio is anything greater than 1. It indicates that the company is in good financial health and is less likely to face financial hardships.

The absolute liquidity ratio pits marketable securities, cash and equivalents against current liabilities. Businesses should strive for an absolute liquidity ratio of 0.5 or above.

Overall, an interest coverage ratio of at least two is the minimum acceptable amount. In most cases, investors and analysts will look for interest coverage ratios of at least three, which indicate that the business's revenues are reliable and consistent.

Is a higher liquidity coverage ratio better? ›

Banks and financial institutions should attempt to achieve a liquidity coverage ratio of 3% or more. In most cases, banks will maintain a higher level of capital to give themselves more of a financial cushion.

The Company's average LCR decreased between the second quarter of 2023 and the third quarter of 2023, from 129.18% to 118.63%, primarily driven by a decrease in cash held in client brokerage accounts and increase in margin loans and its corresponding impact on the broker-dealer segregated account inflows.

Current ratio

If the ratio is higher, 4:1 it could mean that the firm is inefficient and has too much money tied up in stock. On the other hand, a lower ratio value of 1:1 would mean that it may not be able to meet its debts quickly. Ways of improving this is to: increase current assets.

The current ratio formula measures whether a company can meet short-term debts with assets on hand. Current assets are considered to be assets that can quickly be turned into cash, like accounts receivable, short-term deposits and securities, and cash. An ideal current ratio is around 1.2-1.5.

Ideal Liquid Ratio is 1 : 1.

A liquidity ratio is important because it states how much cash a bank to meet the request of its depositors. Therefore, a bank with a liquidity ratio of less than 30% is not a good sign and may be in bad financial health. Above 30% is a good sign.

The interest coverage ratio is a debt and profitability ratio used to determine how easily a company can pay interest on its outstanding debt. The times interest earned (TIE) ratio is a measure of a company's ability to meet its debt obligations based on its current income.

Liquidity Coverage Ratio

Specifically, it measures the ability of a bank to meet short-term (within 30 days) obligations without having to access any outside cash. The 30-day period was chosen as it is the estimated amount of time it takes for the government to step in and help a bank during a financial crisis.