Liquidity Risk Metrics and Contingency Funding
The LCR compares eligible high-quality liquid assets with net cash outflows over a 30-day stress period. A contingency funding plan adds the triggers, people and executable funding actions needed when liquidity deteriorates.
The method at a glance
Illustrative comparison · million · bars start at zero
- Initial HQLA120
- Initial net outflows100
- Second HQLA110
- Second net outflows125
Original scenario with already-adjusted inputs. LCR moves from 120% to 88%; the second cash gap is 15 million.
| Concept | How it works | Watch for |
|---|---|---|
| LCR | Eligible HQLA / stressed 30-day net cash outflows; apply the prescribed adjustments. | Dividing unadjusted assets by ordinary expected outflows. |
| Haircuts | Borrowing capacity = collateral value × (1 - haircut), before other constraints. | Assuming a higher haircut leaves funding unchanged. |
| Contingency funding | Specify triggers, authority, collateral and execution time. | Listing a funding source without testing availability under stress. |
01LCR
How it works: Eligible HQLA / stressed 30-day net cash outflows; apply the prescribed adjustments.
Watch for: Dividing unadjusted assets by ordinary expected outflows.
02Haircuts
How it works: Borrowing capacity = collateral value × (1 - haircut), before other constraints.
Watch for: Assuming a higher haircut leaves funding unchanged.
03Contingency funding
How it works: Specify triggers, authority, collateral and execution time.
Watch for: Listing a funding source without testing availability under stress.
Original worked example
A buffer falls as outflows rise
Eligible HQLA is 120 million and calculated stressed net outflows are 100 million. In a second scenario HQLA falls to 110 million and net outflows rise to 125 million. Treat inputs as already adjusted.
- 1
Initial illustrative LCR = 120/100 = 120%.
- 2
Second scenario LCR = 110/125 = 88%.
- 3
Cash needed to match the second denominator is 125 - 110 = 15 million.
The second scenario has a 15 million gap to a 100% ratio. Identify feasible funding actions; the ratio alone does not specify the remedy.
Illustrative assumptions and calculations for learning. Not observed market data or an official exam item.
Apply the method and check its limits
Before you start: Eligible liquid assets, net stressed outflows and collateral valuation.
Apply the LCR denominator consistently
LCR = eligible HQLA / 30-day net cash outflows
Use inputs after the relevant eligibility rules, haircuts, caps and prescribed stress assumptions. In the basic framework, recognized inflows are generally capped at 75% of outflows. With outflows 100 and eligible inflows 90, the capped inflow is 75 and net outflows are 25, not 10. The chart’s outflows are already net, so do not deduct inflows from them again.
Turn the ratio into a funding action
Cash raised against collateral = market value × (1 - haircut)
Ten million of collateral raises 9 million at a 10% haircut and 7.5 million at 25%. If a lender requires the original financing to remain supported, the shortfall is 1.5 million. A contingency plan specifies a trigger, available assets, settlement deadline and decision owner. Avoid counting an already pledged asset as a fresh funding source.
Haircuts can create a cash demand without a price move
If collateral worth 10 million supports borrowing at a 10% haircut, capacity is 9 million. At a 25% haircut it is 7.5 million even if the collateral price is unchanged. The borrower must repay 1.5 million or supply eligible collateral. This mechanism can amplify funding stress across otherwise hedged positions.
Work through the topic
Calculate a simplified LCR with its inflow cap, quantify haircut-driven funding needs, and turn a cash shortfall into a contingency plan with realistic capacity and timing.
Apply the inflow cap before calculating the ratio
The LCR numerator is an eligible stock of high-quality liquid assets after applicable adjustments. The denominator is total net cash outflows under the specified 30-day stress. In the standard calculation, recognized inflows are capped at 75% of outflows, subject to the applicable framework and exceptions. This prevents the basic metric from assuming that every outgoing payment can be funded entirely by incoming cash.
For an original simplified case, assume eligible adjusted HQLA of 18 million, stressed outflows of 60 million and otherwise eligible inflows of 50 million, with the standard cap applicable. The cap is 0.75 × 60 = 45 million. Recognized inflows are min(50, 45) = 45 million, so net outflows are 15 million and LCR is 18/15 = 120%.
Ignoring the cap would give a denominator of 10 million and an apparent ratio of 180%. The arithmetic would be correct for the wrong denominator. Asset eligibility, composition limits and flow assumptions must also be established before using the supplied values. A simplified ratio above 100% does not prove compliance with every applicable requirement or adequate liquidity at every payment deadline.
| Step | Calculation | Result |
|---|---|---|
| Inflow cap | 75% × 60 | 45 |
| Recognized inflows | min(50, 45) | 45 |
| Net cash outflows | 60 - 45 | 15 |
| LCR | 18 / 15 | 120% |
Original simplified LCR, millions, with standard inflow cap
- Inflow cap
- Calculation: 75% × 60
- Result: 45
- Recognized inflows
- Calculation: min(50, 45)
- Result: 45
- Net cash outflows
- Calculation: 60 - 45
- Result: 15
- LCR
- Calculation: 18 / 15
- Result: 120%
Quantify the funding effect of a haircut change
A collateral haircut reduces the amount of funding available against an asset’s market value under a specified transaction. If collateral worth 10 million supports borrowing at a 10% haircut, the simple funding amount is 9 million. Raising the haircut to 25% reduces the amount to 7.5 million, leaving a 1.5 million funding gap if the borrower must maintain the original 9 million financing.
If the collateral’s market value also falls to 8 million, funding at the 25% haircut becomes 6 million. The gap relative to the original 9 million is then 3 million. Separate the price change from the haircut change so that the explanation remains traceable. Their combined effect is multiplicative through market value × (1 - haircut), not a sum of percentage labels.
A collateral call is a cash or asset transfer requirement; it is not automatically a new economic loss of the same amount. The underlying market move may already have been recognized in value. Track valuation effects, funding needs and realized transaction costs separately. Also check whether the pledged asset remains available for any other liquidity action.
Size contingency actions using usable proceeds and deadlines
Suppose the 3 million gap must be closed by noon tomorrow. An asset sale expected to produce 4 million in two days does not meet the deadline without interim funding. A committed facility of 2 million may help, but its undrawn amount, eligibility conditions, currency and operational access must be checked. An uncommitted line should not be treated as certain under the very stress that may cause it to disappear.
Construct a sequence with amounts available by the deadline. In an original plan, an accessible 2 million facility plus 1.2 million of same-day sale proceeds covers the gap with 0.2 million remaining, before any unmodeled costs. If the sale produces only 0.8 million, the plan falls short by 0.2 million. This sensitivity identifies which action needs a backup and which assumption should trigger escalation.
Test execution as well as the spreadsheet. Confirm authorized signers, settlement instructions, collateral movement and communication routes. Assign an owner to the activation decision and record the point at which waiting reduces feasible options. After an exercise, compare planned proceeds and timing with observed results, then update capacities rather than carrying forward an untested headline limit.
Does 120% LCR mean 20% of assets can be freely spent?
No. The ratio compares a defined adjusted asset stock with defined stressed net outflows. It is not a percentage of total assets available for any purpose. Encumbrance, currency, entity and operational access still matter.
Why distinguish a haircut from a price decline?
A price decline changes collateral market value; a haircut changes the proportion recognized for funding. Both can reduce proceeds, and their effects compound. Separate them to explain the shortfall and identify an appropriate response.
Try a changed assumption
HQLA is 30 and gross outflows are 100; eligible inflows are 90 before the 75% cap. What is the simplified LCR?
Show answer and reasoning
Recognized inflows are 75, net outflows are 25 and LCR is 30/25 = 120%. Ignoring the cap would overstate it as 300%.
Original learning check. No email or account needed.
Does an LCR below 100% always mean immediate failure?
No. The Basel standard contemplates use of the buffer in stress. Supervisory treatment and local rules matter. Diagnose cash needs, stress conditions and available actions rather than treating one ratio as a default prediction.
Sources and scope
Links checked 2026-10-10. GARP establishes exam scope; the technical references support the methods identified below. These are selected study notes and original examples, not complete curriculum coverage or official exam questions.
- GARP FRM study materials and 2026 learning objectives
Exam-domain scope and the official route to the annual learning objectives. This page does not certify coverage of every reading.
- Basel Committee: Liquidity Coverage Ratio
High-quality liquid assets and net cash outflows over a 30-day stress period.
- Basel Committee: stress testing principles (2018)
Stress-testing objectives, governance, methodology and use in risk management.
Prepared by MiloPrep editorial team. MiloPrep is independent of GARP. References do not imply endorsement or independent review of these notes.