Bank Liquidity Management: LCR, NSFR and Stress Testing

Why liquidity fails faster than capital

A bank can look healthy on paper and still fail in days. Capital measures whether a bank can absorb losses. Liquidity measures whether it can pay people who want their money back today. The two are linked, since doubts about solvency start runs, but they break differently and on different timescales.

Silicon Valley Bank made that clear in March 2023. Its deposits were concentrated among a narrow group of technology firms and venture-backed companies, and the great majority were above the insured limit. When the bank disclosed losses on securities it had sold, customers began withdrawing at once. Around 42 billion US dollars left in a single day, and withdrawals expected for the next morning were more than twice as large. Messaging apps and social media let a run unfold in hours, not weeks, which is exactly the speed that older liquidity assumptions did not plan for.

The two Basel liquidity standards

After the 2008 crisis the Basel Committee on Banking Supervision introduced two global minimum standards. They look at the same problem from different angles and are designed to be used together.

	Liquidity Coverage Ratio (LCR)	Net Stable Funding Ratio (NSFR)
Question it answers	Can the bank survive a severe 30-day stress?	Is funding stable enough for the assets it holds over one year?
Formula	High-quality liquid assets divided by net cash outflows over 30 days	Available stable funding divided by required stable funding
Minimum	100 percent	100 percent
Main target	Short-term resilience	Structural funding mismatch

How the LCR works

The numerator is a stock of high-quality liquid assets (HQLA), which are sorted into levels by how reliably they can be sold or pledged:

• Level 1: cash, central bank reserves and certain government bonds. No haircut applies.
• Level 2A: for example some covered bonds and lower-risk corporate debt, with a 15 percent haircut and a cap of 40 percent of the total stock.
• Level 2B: a narrower group, including some equities and lower-rated debt, with larger haircuts and a combined cap of 15 percent.

The denominator assumes outflows under stress, and the assumed run-off rate depends on who the depositor is. Stable retail deposits are assumed to leave at a low rate, typically 3 to 5 percent, less stable retail deposits at 10 percent or more, unsecured funding from non-financial companies at around 40 percent, and unsecured funding from other financial institutions at 100 percent. Those numbers are the reason a bank funded by other banks and funds needs far more liquid assets than one funded by households.

How the NSFR works

The NSFR looks further out. Equity, long-term debt and stable deposits count as stable funding; loans and long-dated assets need stable funding in proportion to how hard they are to sell. The standard is meant to discourage a bank from funding long loans with overnight money.

What the standards leave out

Ratios describe a bank on a given day. They do not replace judgement, and the 2023 failures showed three gaps:

• Deposit behaviour. Uninsured, concentrated deposits behaved far more like wholesale funding than the retail assumptions allow. Banks should test their own deposit base by customer type, size and industry rather than rely on standard run-off rates.
• Unrealised losses. Securities carried at amortised cost can hide large losses that become real the moment the bank has to sell. Liquidity planning should use market values, not book values.
• Interest rate risk. Rising rates hurt the value of fixed-rate assets and also change depositor behaviour, as customers move money to higher-paying options. Liquidity and interest rate risk in the banking book need to be assessed together.

Managing liquidity day to day

Intraday liquidity

Payments settle during the day, not only at close. The Basel Committee's monitoring tools for intraday liquidity (2013) ask banks to track metrics such as daily maximum usage, available intraday funds and the time-of-day pattern of payments. A bank that waits for money to come in before it sends money out can delay payments across the system.

Contingency funding plan

A contingency funding plan names who decides, in what order, and with what authority, when funding comes under strain. It should list early-warning indicators, sources of emergency funding, the collateral available and the time needed to mobilise each source. Pre-positioning collateral at the central bank's lending facility, and testing the operational steps to use it, is more useful than discovering the paperwork during a crisis.

Stress testing

Good stress tests combine several scenarios: a bank-specific event such as a ratings downgrade, a market-wide event such as a funding freeze, and a combination of both. Reverse stress testing, which starts from a failure and works backwards to what would cause it, often reveals vulnerabilities that forward scenarios miss. Results should be expressed as a survival horizon, the number of days the bank can keep paying under each scenario.

Funds transfer pricing

Funds transfer pricing charges each business line for the liquidity it uses and credits it for the stable funding it brings. Without it, business lines can profit from taking liquidity risk that the bank as a whole bears.

A practical dashboard

• LCR and NSFR, with the drivers behind each movement
• Share of uninsured deposits, and the top 20 depositors as a share of total deposits
• Survival horizon under each stress scenario
• Collateral pre-positioned and available at the central bank, by asset type
• Intraday peak usage and payment timing
• Maturity ladder of wholesale funding for the next 12 months
• Unrealised gains and losses on securities, at market value

Frequently asked questions

What is the difference between liquidity risk and solvency risk?

Solvency risk is the risk that assets are worth less than liabilities. Liquidity risk is the risk of being unable to pay obligations as they fall due, even if assets exceed liabilities. A solvent bank can still fail if it cannot raise cash fast enough.

Why are uninsured deposits a liquidity concern?

Insured depositors have little reason to run, since the guarantee protects them. Uninsured depositors may move quickly at the first sign of trouble, particularly when they are concentrated in one sector and share information.

Does a high LCR guarantee a bank is safe?

No. It shows resilience to a defined 30-day scenario using fixed assumptions. A bank also needs to test its own scenarios, particularly for concentrated deposits and for assets that may be hard to sell at book value.

What is the role of the central bank?

As lender of last resort, it can provide funding against collateral. That support depends on the bank having eligible collateral in place and the operational ability to use it, which is why contingency plans should cover both.

Sources and further reading

• Basel Committee on Banking Supervision, Basel III: The Liquidity Coverage Ratio and liquidity risk monitoring tools (2013), Basel III: The Net Stable Funding Ratio (2014), and Principles for Sound Liquidity Risk Management and Supervision (2008), on bis.org/bcbs.
• Basel Committee, Monitoring tools for intraday liquidity management (2013), on the same site.
• Federal Reserve Board, Review of the Federal Reserve's Supervision and Regulation of Silicon Valley Bank (April 2023), on federalreserve.gov.

Regulatory details differ by jurisdiction and change over time; check your supervisor's current rules. This article is general information, not financial or legal advice.