Liquidity Coverage Ratio (LCR)
A First-Ever: LCR Applies to Assets No Longer on Bank Balance Sheets
Last updated: August 7, 2018
The Liquidity Coverage Ratio (LCR) Rule under Basel III: The LCR is one of two new liquidity ratios required under Basel III. The Basel III reforms are a direct response to the financial crisis and focus on global regulatory standards on bank capital adequacy and liquidity; these new standards were developed by the Basel Committee on Banking Supervision (BCBS) and endorsed by the G20 leaders. The LCR, in particular, is an effort to reinforce the liquidity risk profiles of banking institutions as it promotes the short-term resilience of a bank’s liquidity risk profile by requiring banks to maintain an adequate supply of unencumbered ‘high quality liquid assets’ (HQLAs) that can be converted into cash easily and immediately to meet its liquidity needs for a 30-day stress period. In the U.S., the LCR requirement was phased in starting in January 2015 and took full effect in January 2017.
CMBS Doesn’t Make the Cut: HQLA assets are divided into three levels: 1, 2A, and 2B, with increasing market- value haircuts applied to the HQLA assets based on the level. While IG-rated corporate debt securities are deemed to be Level 2B (25% to 50% haircuts), triple-A rated CMBS do not qualify as HQLAs.
Reaching Beyond the Current Balance Sheet: The LCR applies to CMBS – including those transactions that have been sold and that are no longer consolidated on the balance sheet of any bank – and to construction loans, as well as any credit facility with a revolving line.
Impact of the Rule: While it is difficult to quantify, the LCR most likely has had some impact on the attractiveness of certain CRE-products (e.g., CMBS, CRE CLOs, and construction loans) to banks and other investors. It also plays a role in the redistribution of capital availability to multifamily projects versus non-multifamily projects, given the preferred status of GSE-related securities under the LCR HQLA regime. Market participants across CRE-related sectors and more broadly agree that the LCR has been highly influential in determining relative liquidity levels, raising the attractiveness of those asset classes that are included as HQLAs versus those, like CMBS, that are not HQLA-eligible.