Reserve Bank of India (RBI) to Review Liquidity Coverage Ratio Framework
Context:
The RBI is poised to reassess the Liquidity Coverage Ratio (LCR) framework to enhance liquidity risk management in banks, prompted by recent occurrences in jurisdictions like Silicon Valley and Signature Bank in the US.
- These incidents showcased the potential for swift fund withdrawals via digital banking channels during periods of stress, prompting the RBI Governor to underscore the necessity of reevaluation.
Relevance:
GS-03 (Indian Economy)
Understanding Liquidity Coverage Ratio (LCR):
- LCR was introduced as part of the Basel III reforms post the 2008 global financial crisis.
- It gauges the proportion of high-quality liquid assets (HQLA) held by financial institutions.
- Under the LCR framework, banks are mandated to maintain a stock of HQLA to cover 30 days’ net outflow during stressed conditions, with a minimum LCR of 100% since January 1, 2019.
- HQLAs encompass assets that can be immediately sold or converted to cash without significant loss of value, including cash, short-term bonds, and excess Statutory Liquidity Ratio (SLR) holdings.
Significance of LCR:
- The LCR serves as a preventive measure, bolstering a bank’s resilience during financial crises.
- Currently, Scheduled Commercial Banks uphold an LCR of 131.4%, substantially surpassing the mandated minimum of 100%.
- However, the LCR’s stringent requirements may lead banks to prioritize cash holdings over issuing loans, potentially impeding economic growth.
Basel Norms:
- These are the international banking regulations which was developed by the Basel Committee on Banking Supervision (BCBS). It primarily focuses and gives guidelines on the risks that the banks and financial institutions undergo by increasing the liquidity of banks and decreasing its leverage.
- Basel is a city in Switzerland.
Basel III Norms:
- The objective of Basel III is to mitigate risks in the financial system by requiring banks to hold greater security in reserve before accumulating funds.
- Basel III norms were scheduled to be enforced in India by March 2019. While certain portions of the agreement have already been enacted in some countries, others are set to commence implementation on January 1, 2023, gradually phased in over five years.
- The Basel III framework comprises three pillars:
- Pillar 1: Minimum capital requirements, necessitating banks to uphold a minimum capital adequacy ratio of 8% along with additional capital buffers like the countercyclical capital buffer and a capital conservation buffer.
- Pillar 2: Supervisory review process, requiring banks to establish a robust process for identifying, assessing, and managing all encountered risks, subject to review by the bank’s supervisor.
- Pillar 3: Market discipline, mandating banks to disclose information pertaining to their capital adequacy and risk management practices to the market. This information aids investors and stakeholders in evaluating the risk associated with investing in the bank.
- The Reserve Bank of India (RBI) extended the Basel III Capital framework to encompass All India Financial Institutions (AIFIs) for all banks in India.
