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Banking: Checkup of Liquidity and Capital Adequacy Levels
Liquidity Coverage Ratio Above Minimum Requirements
Banking: Checkup of Liquidity and Capital Adequacy Levels
  • By Sean Kim & Yeom Jong-seon
  • March 25, 2020, 14:58
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The authors are analysts of Shinhan Investment Corp. They can be reached at sh.kim@shinhan.com and jongseon@shinhan.com. -- Ed.

 

Liquidity risk regulations more direct and stricter under Basel III vs. Basel II

The collapse of Bear Stearns and Lehman Brothers, caused by excessive exposure to the subprime market, demonstrated the necessity of direct regulation of liquidity risks. The perception of liquidity has changed from the static concept of “stock” to “flow” as the financial crisis showed that it can dry up quickly in a credit crunch. Lack of liquidity in financial markets (bond/stock, etc.) ultimately leads to liquidity issues at financial institutions. Basel III was thus introduced following the financial crisis, with regulations on liquidity coverage ratio (LCR) implemented for direct control over liquidity risks.

LCR above minimum requirements and term-loan rollover ratios remaining stable

Strict regulations on LCR are driving banks to maximize holdings of highly liquid assets for utilization during periods of severe stress. The regulatory requirement for LCR is set at 100% of 30-day net cash outflows in KRW and 80% in foreign currency. Domestic banks currently record local currency LCR of 102-115% and foreign currency LCR of 107-154%, both exceeding minimum requirements. In addition, term-loan rollover ratios appear to be remaining above 100%, albeit at higher foreign currency borrowing costs.

Maintaining sufficient buffer in capital adequacy

Domestic bank holding companies currently record common equity tier-1 (CET1) ratios far above the maximum requirement of 10.5%, which even includes the yet-to-be-fully-implemented countercyclical capital buffer (CCyB). Backed by 200-370bp improvement in BIS ratios vs. levels recorded during the financial crisis, banks are maintaining a sufficient buffer in capital adequacy at present.