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Liquidity coverage requirement for credit institutions

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Liquidity coverage requirement for credit institutions

SUMMARY OF:

Delegated Regulation (EU) 2015/61 supplementing Regulation (EU) No 575/2013 with regard to liquidity coverage requirement for Credit Institutions

WHAT IS THE AIM OF THE REGULATION?

This delegated regulation sets out in detail how to apply the general principle introduced in Regulation (EU) No 575/2013, the Capital Requirements Regulation, that credit institutions must have enough funds to meet withdrawal demands over a 30-day period.

Known as the LCR (liquidity coverage ratio) delegated regulation, it specifies which assets are to be considered as liquid assets*. It sets out how expected cash outflows and inflows over a 30-day period should be calculated.

KEY POINTS

Credit institutions must maintain a liquidity coverage ratio of at least 100%. This is equal to the ratio between its liquidity buffer* and net liquidity outflows* over 30 days.

A credit institution is under stress* in the following situations (non-exhaustive list):

run-off of a significant amount of its retail deposits;
partial or total loss of its unsecured wholesale funding capacity or its secured short-term funding;
additional liquidity outflows from credit rating downgrade;
impact of increased market volatility on the value of its collateral;
unscheduled drawing on its liquidity and credit facilities;
potential obligation to buy back debt or honour non-contractual obligations.

Liquid assets must:

be a property, right, entitlement or interest, held by a credit institution, that may provide cash within 30 days;
not be issued by the credit institution itself or by other bodies such as investment firms, insurance undertakings or financial holding companies;
be able to have their value determined on the basis of easily available market prices;
be listed on a recognised exchange, or tradable by a direct sale or simple repurchase agreement*;

Liquid assets are divided into various categories:

Level 1 (the most liquid), such as coins and banknotes or assets guaranteed by the European Central Bank, national central banks or regional governments and local authorities;
Level 2A, such as assets guaranteed by regional governments, local authorities or public sector bodies in the EU with a weighted risk of 20%;
Level 2B, such as asset-backed securities, corporate debt securities, shares provided they meet certain requirements and certain securitisations* which must satisfy a range of strict conditions to be accepted as a Level 2B asset.

Credit institutions must ensure:

the assets in their liquidity buffer are always sufficiently diversified, readily accessible and can be turned into cash within 30 days;
they hold a minimum of 60% of the buffer in level 1 assets and a maximum of 15% in level 2B assets;
within 30 days, they do not treat as liquid assets those that no longer meet the criteria.

Detailed rules and calculations are used to determine and measure liquidity outflows and inflows and the procedures to be taken.

Commission Delegated Regulation (EU) 2018/1620 made certain amendments to the 2015 legislation to improve its practical application. The most important are:

align fully the calculation of expected liquidity outflows and inflows on repurchase agreements, reverse repurchase agreements* and collateral swap transactions* with the Basel Committee on Banking Supervision’s international liquidity standard;
specify the treatment of central banks’ reserves held by subsidiaries or branches;
adjust the waiver of the minimum issue size for certain non-EU-country assets;
improve the unwind mechanism* for calculating the liquid buffer;
integrate the new simple, transparent and standardised criteria for securitisation.

Commission Delegated Regulation (EU) 2018/1620 applies from 30 April 2020.

FROM WHEN DOES THE REGULATION APPLY?

It has applied since 1 October 2015.

BACKGROUND

For more information, see:

Prudential requirements (European Commission).

KEY TERMS

Liquid asset: an asset that can be easily converted into cash.

Liquidity buffer: amount of liquid assets a credit institution holds.

Net liquidity outflows: amount that remains after subtracting incoming from outgoing cash.

Stress: sudden or severe deterioration in a credit institution’s solvency or liquidity.

Repurchase agreement: also known as ‘repo’, this is a short-term loan whereby the seller of the security agrees to buy it back at a specified price and time.

Securitisation: a procedure where various financial assets or contractual debts, such as car loans or mortgages, are repackaged and sold to investors.

Reverse repurchase agreements: also known as 'reverse repo', purchase of securities with agreement to sell them at a higher price at a specific future date.

Collateral swap transactions: loan of liquid assets in return for less liquid collateral. The borrower pays a fee to the lender for the risks involved.

Unwind mechanism: closing down of transactions (such as repurchase or reverse repurchase transactions) which mature in the next 30 days.

MAIN DOCUMENT

Commission Delegated Regulation (EU) 2015/61 of 10 October 2014 to supplement Regulation (EU) No 575/2013 of the European Parliament and the Council with regard to liquidity coverage requirement for Credit Institutions (OJ L 11, 17.1.2015, pp. 1-36)