We are independent & ad-supported. We may earn a commission for purchases made through our links.
Advertiser Disclosure
Our website is an independent, advertising-supported platform. We provide our content free of charge to our readers, and to keep it that way, we rely on revenue generated through advertisements and affiliate partnerships. This means that when you click on certain links on our site and make a purchase, we may earn a commission. Learn more.
How We Make Money
We sustain our operations through affiliate commissions and advertising. If you click on an affiliate link and make a purchase, we may receive a commission from the merchant at no additional cost to you. We also display advertisements on our website, which help generate revenue to support our work and keep our content free for readers. Our editorial team operates independently of our advertising and affiliate partnerships to ensure that our content remains unbiased and focused on providing you with the best information and recommendations based on thorough research and honest evaluations. To remain transparent, we’ve provided a list of our current affiliate partners here.
Finance

Our Promise to you

Founded in 2002, our company has been a trusted resource for readers seeking informative and engaging content. Our dedication to quality remains unwavering—and will never change. We follow a strict editorial policy, ensuring that our content is authored by highly qualified professionals and edited by subject matter experts. This guarantees that everything we publish is objective, accurate, and trustworthy.

Over the years, we've refined our approach to cover a wide range of topics, providing readers with reliable and practical advice to enhance their knowledge and skills. That's why millions of readers turn to us each year. Join us in celebrating the joy of learning, guided by standards you can trust.

What Is a Liquidity Coverage Ratio?

By Osmand Vitez
Updated: May 17, 2024
Views: 12,020
References
Share

The liquidity coverage ratio is a measurement required of banks so they can meet short-term financial obligations. Most countries heavily regulate banks and other financial institutions through a central bank or other source of laws and requirements. The liquidity coverage ratio is meant to cover short-term disruptions in a bank’s normal activities. For example, a central bank may require a specific amount of liquid assets in banks so these assets can cover copious withdrawals at one time. This coverage prevents the bank from being unable to meet these obligations and also prevents the government or central bank from having to bail it out.

Banks in most economies do not have to keep all the money they receive from deposits and other sources in their coffers. A central bank or other government regulations only require a small percentage to remain, with all other monies being available for loans and other financially rewarding investments. In the past, this caused trouble as bank runs — frantic periods when individuals attempt to pull all their money out of a bank — quickly depleted the cash assets. This panic can make it seem like a bank is failing, even when it is financially viable, as its money is placed into many types of investments. The liquidity coverage ratio helps prevent banks from experiencing these difficulties and others through retaining cash in the institution.

Countries may use any number of formulas to create a standard liquidity ratio for banks and other financial institutions. For example, the coverage ratio in the United States may require cash or Treasury bonds sufficient to meet withdrawals or other needs for a 30-day period. Banks and other financial institutions may only need this cash and short-term bonds to cover all deposits from customers at the institution. Other times, there may be another figure that is the base amount for the liquidity coverage ratio to meet in terms of potential cash withdrawals. Again, countries have the ability to design their own requirements for this ratio based on the current setup of its financial or capital markets.

In some cases, the liquidity coverage ratio may not be able to stop all bank runs or massive withdrawals in a short-term period. For example, if a bank or other financial institution has sufficient coverage for its normal deposits, it may lack enough cash for loans, which may be called by other institutions. When another bank calls a loan, the lack of cash may be a particular problem. In this scenario, banks may still need a lifeline from a central bank in order to meet these demands.

Share
WiseGeek is dedicated to providing accurate and trustworthy information. We carefully select reputable sources and employ a rigorous fact-checking process to maintain the highest standards. To learn more about our commitment to accuracy, read our editorial process.
Link to Sources

Editors' Picks

Discussion Comments
Share
https://www.wisegeek.net/what-is-a-liquidity-coverage-ratio.htm
Copy this link
WiseGeek, in your inbox

Our latest articles, guides, and more, delivered daily.

WiseGeek, in your inbox

Our latest articles, guides, and more, delivered daily.