Question

W)at are the advantages and disadvantages of large banks having to meet LCR requirements

Answer 1

The Liquidity Coverage Ratio (LCR) is a financial raito intended to enable a bank to survive a severe stress scenario like a market crash and continue its normal operations for a period of 30 days. It is calculated as:

LCR= value of High Quality Liquid Assets / Total net liquidity outflows for 30 days

It is often expressed in percentages and Basel III standards expect any large bank to maintain it above 100%.

Advantages of enforcing LCR requirements:

1. Banks exposure to liquidity risk reduces. Even if markets crash or if a financial crisis looms, banks are able to maintain stability and continue their operations for a whole month, which would normally be enough for government and policy makers to weather the crisis.

2. Chances of "run on the bank" scenarios are reduced by adherence to the stricter Basel III standards.

Disadvantages:

1. Reduced lending may cause economic inefficiencies in terms of productive investments.

2. For banks, their funding costs increase and interest margins decrease. Banks will demand more interest on loans and pay less on deposits to their customers. This can cause an increase in cost of capital for households and therefore, a decrease in credit demand and overall spending in economy, often hurting economic growth.

3. Capital surplus decreases, credit supply volume decreases, banks will try to impose more covenants on lending, credit availability will get stricter, also hurting economic growth.