The purpose of prudential liquidity regulations is to ensure that institutions are liquid at all times. Quantitative provisions for liquidity were introduced into European law for the first time by the Capital Requirements Regulation (CRR, Regulation (EU) No 575/2013), in keeping with the Basel liquidity framework. The two Basel minimum standards (LCR, NSFR) and the additional monitoring metrics (AMM) are implemented by means of appropriate implementing technical standards and in the context of CRR II.
Liquidity coverage ratio (LCR)
The LCR defines the minimum stock of high-quality liquid assets (HQLA) credit institutions need to hold as liquidity reserves in order to cover their net cash outflows under a severe 30-day stress scenario. Commission Delegated Regulation (EU) 2015/61 with regard to liquidity coverage requirement for credit institutions, as amended by Commission Delegated Regulation (EU) 2018/1620, sets out the underlying stress scenario and, derived from that scenario, the assets to be held and the cash flows to be taken into account.
Net stable funding ratio (NSFR)
The NSFR is a minimum standard for reducing funding risk over a longer horizon. It aims to ensure that institutions have a sustainable funding structure by limiting maturity transformation between asset-side business and funding, thereby mitigating the risk of future funding problems. To this end, the sum of liabilities weighted by their degree of long-term reliability (available stable funding) must at least be equal to the sum of assets and off-balance-sheet exposures weighted by factors that reflect their liquidity characteristics and residual maturities over a medium-term horizon (required stable funding). Regulation (EU) 2019/876, also known as CRR II, has transposed the NSFR rules published by the Basel Committee in October 2014 into EU law and established the NSFR as a minimum standard. One feature specific to the EU has been added to uphold the principle of proportionality: small and non-complex institutions may alternatively apply a simplified NSFR.
Additional monitoring metrics (AMM) for liquidity reporting
Institutions’ liquidity status is too complex to be suitably captured by just two metrics. Therefore, the two minimum standards have been augmented by monitoring metrics which permit supervisors to appropriately analyse an institution’s liquidity and funding risk.
The EBA guidelines on LCR disclosure were published on 8 March 2017 and have been applicable since 31 December 2017. They supplement the existing European disclosure requirements and complete the disclosure format harmonised across Europe. LCR disclosure comprises qualitative and quantitative information on liquidity risk management and on components and fulfilment of the LCR. CRR II enshrines the disclosure of liquidity ratios, including the disclosure of the newly introduced NSFR, in Part Eight of the Regulation; the guidelines are fleshed out in an Implementing Regulation.
Credit institutions need to have intraday liquidity at all times in order for payment and settlement systems to function smoothly. That is why intraday liquidity management is a key principle of sound liquidity risk management. The “Monitoring tools for intraday liquidity management” proposed by the Basel Committee comprise specific metrics for monitoring intraday liquidity for the purposes of institutions’ internal liquidity management as well as banking supervision and payments oversight. In the EU, the management of intraday liquidity risk is assessed as part of SREP.