What is the liquidity coverage ratio (LCR)?

The liquidity coverage ratio (LCR) is fundamentally a regulatory requirement established under Basel III guidelines. It mandates that banks maintain a sufficient amount of liquid assets to cover their total net cash outflows over a 30-day stress scenario. This means that financial institutions must ensure they have enough high-quality liquid assets (HQLA) that can be easily converted into cash to meet short-term obligations in times of financial stress.

This requirement is crucial in enhancing the resilience of banks and the banking system as a whole, reducing the risk of bank runs and ensuring that institutions can survive a financial crisis without requiring emergency assistance. The LCR is a critical measure in risk management, aiming to protect the stability of the financial system by promoting the adequacy of liquid resources available to banks.

In contrast, the other options do not accurately represent the concept of the LCR. Guidelines for equity investment pertain to strategies for managing stock investments, measuring credit risk involves evaluating the likelihood of borrower default, and diversification strategies relate to reducing risk across a portfolio by investing in various asset classes. None of these concepts directly involve the specific liquidity requirements encapsulated by the liquidity coverage ratio.