Ring-fencing our banks

Subject: Economy

Section: Monetary Policy

Context: Banking crisis in US

Details:

While dealing with increased financial distress, banks look to the central bank or the government to come to their rescue. Liquidity Coverage Ratio is the financial shield that protects a bank from an impending bankruptcy
A major fault line that the financial crisis of 2008 exposed in banking sectors worldwide was the improper monitoring of the liquidity risk. A steep fall in the US housing market led to extreme financial stress in the US between mid-2007 and early 2009. Numerous banks worldwide recorded huge losses and relied on central banks to avoid bankruptcy.
Liquidity Coverage Ratio was thus devised to control and monitor the liquidity of financial firms from 2009. Comprehensive measures were undertaken to respond to the global financial crisis, called the “Basel III post-crisis reforms”.

Liquidity Coverage Ratio: what is it?

When the financial crisis hit, many banks worldwide faced a liquidity shock. They didn’t have enough assets that could be converted into cash to avoid defaulting. Liquidity Cover Ratio (LCR) requires a bank to maintain a certain stock of High-Quality Liquid Assets (HQLA) to help it weather a stressful period, like the financial crisis of 2008.
It helps the bank stay afloat during a financial crisis, at least until the government or the central bank can come to its rescue.
In India, the Reserve Bank of India (RBI) implemented LCR on 1st January 2015, after the Indian framework for LCR requirements was issued on 9th June 2014.
The LCR is designed to ensure that banks hold a sufficient reserve of high-quality liquid assets (HQLA) to allow them to survive a period of significant liquidity stress lasting 30 calendar days.