Liquidity and funding standards applicable in the European Union and in the Grand Duchy of Luxembourg
Two liquidity standards have been adopted in the European Union to ensure that financial institutions are stable and are completed by a set of monitoring tools. These funding and liquidity standards are designed to achieve two separate but complementary objectives:
- The first standard is the liquidity coverage ratio (LCR). It promotes the short-term resilience of a bank’s liquidity risk profile by ensuring that it has sufficient high-quality liquid assets (HQLA) to survive a significant stress scenario lasting for 30 days. Financial institutions are required to hold at all times liquid assets, the total value of which equals, or is greater than, the net liquidity outflows which might be experienced under stressed conditions over a short period of time (30 days). Net cash outflows are to be computed on the basis of a number of assumptions concerning run-off and draw-down rates. The LCR improves the banking sector’s ability to absorb shocks arising from financial and/or economic stresses, thus reducing the risk of spillover. This requirement is applicable since 2015.
- The second standard is the Net Stable Funding Requirement (NSFR). It promotes a sustainable maturity structure of assets and liabilities to ensure the resilience of financial institutions over a longer time horizon of one year. Financial institutions are required on an ongoing basis to raise stable funding (equity and liability financing expected to remain stable over a one-year time horizon) at least equal to their stable assets or illiquid assets which cannot be easily turned into cash over the following 12 months. The NSFR supplements the LCR by creating an additional incentive for banks to fund their activities with more stable sources of funding and entered into force on 28 June 2021.
- In addition to the LCR and NSFR standards, a set of liquidity risk monitoring tools exist to measure other dimensions of a bank’s liquidity and funding risk profile. These tools are used for the ongoing monitoring of the liquidity risk exposures of financial institutions. The most relevant of these monitoring tools is the Maturity Ladder (table C66.00) that provides a comprehensive overview of the balance sheet items and of some selected off balance sheet items per residual maturity.
Legal acts defining liquidity and funding risk requirements
The European liquidity standards are defined by the following legal acts:
- Part 6 of Regulation (EU) No 575/2013 of 26 June 2013 on prudential requirements for credit institutions and investment firms (Capital Requirements Regulation, CRR). Following its amendment by Regulation (EU) 2019/876, the NSFR became applicable as from the 28 June 2021 for all credit institutions;
- Commission Delegated Regulation (EU) 2015/61 of 10 October 2014 to supplement Regulation (EU) No 575/2013 with regard to liquidity coverage requirement for Credit Institutions (LCR DA), as amended;
- Commission Implementing Regulation (EU) 2021/451 of 17 December 2020 laying down implementing technical standards for the application of Regulation (EU) No 575/2013 of the European Parliament and of the Council with regard to supervisory reporting of institutions and repealing Implementing Regulation (EU) No 680/2014 (ITS as regards templates and instructions), as amended;
In addition, when required by European regulations or to ensure a comprehensive liquidity risk framework, the CSSF adopted local regulations, circular or circular letters to banks which are listed hereunder:
- Circulars CSSF 07/301 and CSSF 12/552 which lay down the main guiding principles for sound, overall risk management, including liquidity risk;
- Circular CSSF 09/403 which sets out the qualitative requirements with regard to a sound liquidity risk management;
- Regulation CSSF N° 15-02, article 16, which specifies the regulatory qualitative expectations on the liquidity risk management framework;
- Circular letter on Declaration of liquidity related products and services referred to in Article 23(2) of the LCR DA, dated 22 November 2016;
- Circular letter on Declaration and reporting of derivatives outflows referred to in Article 30 of the LCR DA, dated 9 February 2018.