Surviving the Squeeze: Liquidity Coverage Ratio for NBFC  liquidity management

– Siddharth Pandey, Assistant Manager | finserv@vinodkothari.com

Background

With the continuous growth and the emergence of large non-banking financial companies (NBFCs) in India, the Reserve Bank of India (RBI) has extended certain bank-level regulations to these institutions with the intention to make them manage their various risks. Among these various risks, liquidity risk is a critical  one, which could lead to the breakdown of a financial institution, and if a contagion builds, it may affect the entire financial system too. No financial institution is entirely immune to it, even a well-performing NBFC with minimal NPAs could face a run on it if it experiences a liquidity crunch. The larger an institution, the greater impact its failure could have on the broader economy.

To address the above concerns, the RBI under the Para 89 read with Annex XXI of the Scale-Based Regulation (SBR) Directions^[1] mandates certain large NBFCs (as discussed below) to maintain a Liquidity Coverage Ratio (LCR).

This article provides a practical guide to the LCR requirements under the SBR Directions, including the regulatory requirements to be followed, and tries to provide insights into its proper implementation by the NBFCs, subject to these norms.

Applicability of the LCR Framework

Before diving into the implementation and challenges of the LCR requirements, let us first understand which NBFCs are actually required to comply with this framework. The RBI mandates that all non-deposit taking NBFCs with asset sizes of ₹5,000 crore or more, as well as all deposit-taking NBFCs regardless of asset size, must maintain a LCR at all times. However, certain categories of NBFCs are exempt from this requirement, including:

• Core Investment Companies (CICs)
• Type I NBFCs (as defined in RBI’s circular dated June 17, 2016^[2])
• Non-Operative Financial Holding Companies (NOFHCs)
• Standalone Primary Dealers

Importantly, even NBFCs subject to LCR must also comply with the RBI’s broader Guidelines on Liquidity Risk Management (under Annexure VI of SBR regulation), which remain applicable irrespective of LCR compliance.

What would be the date of Applicability and continuity of compliance?

Once an NBFC’s asset size crosses ₹5,000 crore, the LCR provisions shall become applicable and remain so unless there is a sustained and substantial reduction in asset size (typically due to long-term strategic decisions). Temporary fluctuations in the asset size do not affect its applicability. However, if the asset size consistently stays below the threshold for a considerable period, the NBFC may seek exemption, subject to RBI’s intimation and approval.

For NBFCs that exceed the ₹5,000 crore threshold after the issuance of these guidelines, there is no fixed timeline for ensuring the LCR compliance. However, they are expected to achieve it as early as operationally feasible on a best-effort basis. Since LCR disclosures are made quarterly, compliance is generally expected by the next quarter following the one in which the threshold was crossed. Now to accurately identify the quarter in which the ₹5,000 crore mark is crossed, it is recommended that the NBFCs approaching this threshold perform quarterly audits.

What is Liquidity Coverage Ratio?

Liquidity Coverage Ratio is a key regulatory requirement aimed to promote the short-term resilience of the liquidity risk profile of the NBFCs. It mandates that applicable NBFCs hold an adequate stock of high-quality liquid assets to meet their net cash outflow requirements over the next 30 calendar days.

This requirement is modeled on the Basel III International Framework for Liquidity Risk Measurement, Standards, and Monitoring^[3], which requires banks to maintain such assets assuming that in times of financial stress, central bank or government interventions typically take about a month to respond during a financial crisis. Therefore, institutions must be self-reliant and capable of surviving a 30-day liquidity shock without external assistance.

Regulatory Ratio Structure

Now that we have understood what the LCR is and why it matters, let us take a closer look at how it is calculated. The regulatory framework provides a clear formula to determine the LCR, which ensures that NBFCs maintain adequate liquidity buffers at all times.

Para 2.1.2 of the Annexure XXI provides a ratio between Stock of High-Quality Liquid assets (HQLA) and Total Net Cash Outflows over the next 30 calendar days to represent LCR.

“2.1.2. Liquidity Coverage Ratio (LCR) is represented by the following ratio:

                                              

This standard aims to ensure that applicable NBFCs have an adequate stock of unencumbered HQLA i.e. assets that are not pledged or otherwise used as collateral and can be quickly converted into cash in private markets with little or no loss in value, to meet its liquidity needs during a 30 day period of significant financial stress.

When the LCR guidelines were initially introduced, the RBI adopted a phase-in approach, allowing applicable NBFCs to gradually comply by progressively increasing their minimum LCR requirements over time. However, as of December 1, 2024, the transition period has concluded, and NBFCs are now required to maintain a minimum LCR of 100% at all times. This means the value of HQLAs shall be always equal or greater than the net cash outflow over 30 days.

Key Components of the LCR and their Calculations

To truly grasp how NBFCs comply with this requirement, it is important to look at the two building blocks of the ratio. So, let us now dive into the key components of the LCR and how each is calculated. The LCR is made up of two key components one is HQLAs (nominator) and other is Net Cash Outflow (denominator). The maintenance of the LCR must be monitored continuously, given that its denominator cash outflows are inherently dynamic and subject to fluctuations and so is the value and liquidity of HQLAs. Hence the proper computation of these two components becomes crucial for understanding LCR.

1.    Total Net Cash Outflow:

In simple terms, total net cash outflows is defined as the total expected cash outflows (i.e. stressed outflow) minus total expected cash inflows (i.e. stressed inflow) for the subsequent 30 calendar days. RBI has specified an exhaustive list of Cash Outflow  and Cash Inflow items under Para 5.1 of Annex XXI, only these specified items can be considered as a cash outflow or cash inflow for computing total net cash outflow.

Further considering the potential fluctuations in the NBFC’s balance sheet due to any financial stress, the RBI has assigned a standard stress percentage that must be applied to the overall cash inflows and cash outflows in order to compute stressed cash flows.

Treatment of Stressed Outflows and Stressed Inflows:

Aspects	Expected Cash Outflows (Stressed Outflows)	Expected Cash Inflows (Stressed Inflows)
Definition	It is the total cash outflows which are expected to be realized within 30 days.	It is the total cash inflow which are  expected to be realized within 30 days.
Stress Factor Applied	Calculated by multiplying the various outflows by 115 percent i.e. various outstanding liabilities and commitments are expected to run off further or be drawn down further by 15 percent	Calculated by multiplying the outstanding contractual receivables by 75 percent i.e. they are expected to under-flow by 25 percent.
Inclusion of Contingent Items	Yes – Includes contingent funding liabilities	No – Contingent and Behavioural inflows are excluded in order to avoid any uncertainty in calculation (e.g. rollover option of commercial papers)
Aggregate Cap	Not capped – full stressed outflows are included	Recognized inflows cannot exceed 75% of total expected cash outflows. This is to ensure a minimum holding of HQLAs at all times i.e. 25% of total expected cash outflows
Regulatory Intent	Ensures NBFCs are prepared for higher-than-expected liquidity demands	To incorporate prudent measures for unexpected fluctuations in cash inflows

 

Hence total net cash outflows over the next 30 days can be written as total expected cash outflows minus Total expected cash inflows OR 75% of total expected cash outflows, whichever is lower.

Total net cash outflows = Total expected cash outflows – Minimum of {Total expected cash inflows OR 75% of total expected cash outflows}

 2.    Stock of HQLA:

The numerator of the LCR is the “stock of HQLA”. HQLAs are those assets which can be easily and immediately converted into cash at little or no loss value. The NBFCs must hold a stock of HQLA to cover the total net cash outflows over a 30-day period under applicable stress scenarios (as discussed above).

 Permissible HQLAs

Have you ever wondered what qualifies as High-Quality Liquid Assets (HQLAs) under the Liquidity Coverage Ratio (LCR) framework? Understanding this is crucial for ensuring liquidity during times of financial stress. Let us take a closer look.

Para 4.1 of LCR framework outlines certain qualitative characteristics that assets must meet to be considered HQLAs. Also, Para 4.3 provides an exhaustive list of eligible assets that fall under this category and assets have been assigned a specific regulatory haircut based on their risk and liquidity profile.

In practice, this means that for an asset to be treated as HQLA, it must appear in the prescribed list, regardless of whether it independently meets the qualitative criteria. Hence, characteristics of an asset alone are not sufficient to be classified as HQLA.

That said, this does not imply that the characteristic-based assessment under Para 4.1 is irrelevant. For instance, if an asset listed under Para 4.3 fails to satisfy the qualitative criteria  whether due to entity-specific challenges or broader macroeconomic factors- it would still not qualify as HQLA for the NBFC in question.

Ineligibility and Replacement of Assets
Para 4.6 states that if an asset ceases to be eligible, the NBFC, within a period of 30 calendar days, will have to replace the asset entirely to maintain the required LCR, unless it has sufficient HQLAs after removing such asset from HQLA.

Let us examine some commonly debated assets and assess whether they qualify as HQLAs under the LCR framework:

1. Fixed Deposits:

On a literal reading of the list of permitted HQLAs, term deposits are not explicitly included. Additionally, the footnote to the term “Cash” clarifies that “Cash” refers exclusively to cash on hand and demand deposits with Scheduled Commercial Banks.

Accordingly, fixed deposits, despite possessing most characteristics of HQLAs, are not considered HQLAs, even if they do not have any specific withdrawal lock-in period. However, if a term deposit is repayable within 30 days, it can be taken as an inflow within a 30 days period.

• Mutual Funds:

While Mutual Funds may exhibit some of these characteristics — particularly in terms of liquidity and valuation transparency — it is important to note that the Mutual Fund Investments are not included in this exclusive list of specified HQLA under the Directions. Accordingly, in our view, the said investment would not qualify as HQLA under the current provisions of the LCR as per the RBI’s SBR Directions. And unlike fixed deposits it cannot even be considered as an inflow.

Haircuts

To ensure that only reliable and true assessment of  liquid assets are considered for meeting the Liquidity Coverage Ratio (LCR), the RBI prescribes haircuts—percentage deductions from the market value of eligible assets. These adjustments account for the possibility of a decline in asset value if sold quickly under stressed conditions. The formula for the same may be written as:

Stock of HQLA = Current market value of Asset – (% haircut * Current market value of Asset)

The figure below outlines the different HQLAs based on their minimum haircut requirements.

Illustrations

Let us walk through a practical illustration using the specific cash outflow and inflow items listed. This will help demonstrate how total Net Cash Outflow is calculated as per RBI’s liquidity framework.

 Cash Inflows (due in next 30 days)

Inflow Item	Assumed Value (₹ crore)
a. Maturing secured lending transactions backed by HQLA[4]	20
b. Margin Lending backed by all other collateral	10
c. Other inflows by counterparty	30
d. Net derivative cash inflows	5
e. Other contractual cash inflows	5
Total Cash Inflows	₹70 crore

 

Cash Outflows (due in next 30 days)

Outflow Item	Assumed Value (₹ crore)
a. Unsecured wholesale funding	65
b. Secured funding	20
c. Additional item:
(i) Undrawn committed credit/liquidity facilities	10
d. Other contingent funding liabilities	5
Total Cash Outflows	₹100 crore

 Stepwise Calculations:

Step 1: Apply Stress Factors

Category	Multiple by stress factor	Value (₹ crore)
Stressed Outflows	₹100 crore × 115%	₹115 crore
Stressed Inflows	₹70 crore × 75%	₹52.5 crore

Step 2: Cap on Recognized Inflows

• 75% of Stressed Outflows = ₹115 crore × 75% = ₹86.25 crore
• Stressed Inflows = ₹52.5 crore (less than ₹86.25 crore). So, ₹52.5 crore is recognized as inflow.

Step 3: Compute Total Net Cash Outflow

Total Net Cash Outflow= ₹115 crore−₹52.5 crore = ₹62.5 crore. This is the minimum liquidity buffer the NBFC must maintain in the form of High Quality Liquid Assets (HQLAs).

Here is anotherillustration to demonstrate how to calculate HQLA as per the RBI guidelines. Assume an NBFC holds the following assets on the first day of the stress period:

Asset Type	Amount (₹ crore)	Haircut %	Eligible HQLA Value (Post Haircut)
1. Cash (on hand and demand deposits)	50	0%	50.00
2. Government Securities (Sovereign bonds)	20	0%	20.00
3. Foreign Sovereign Bonds (0% risk weight, meets all criteria)	20	0%	20.00
4. AAA-rated Corporate Bonds (not issued by FI/NBFC)	80	15%	68.00 (₹80 – 15%)
5. Corporate Bonds rated AA- (not issued by FI/NBFC)	40	15%	34.00 (₹40 – 15%)
6. A-rated Commercial Paper (not issued by FI/NBFC)	10	50%	05.00 (₹10 – 50%)
7. Equity Shares (in Nifty/Sensex, not issued by FI/NBFC)	10	50%	05.00 (₹10 – 50%)
8. Sovereign Bonds with BBB+ rating (20–50% risk weight)	60	50%	30.00 (₹60 – 50%)
TOTAL HQLA			232.00

The total High-Quality Liquid Assets amount to 371.2% of the total net cash outflows calculated above. Consequently, the Liquidity Coverage Ratio stands at 371.2%, significantly exceeding the regulatory minimum requirement of 100%.

Permitted breaches of LCR in times of stress

The framework also recognizes that financial stress events may necessitate the use of HQLAs. Accordingly Para 3.5 of Annex XXI provides certain predefined scenarios that may qualify as such stress scenarios, during which an NBFC is permitted to draw down its stock of HQLA even if doing so causes the LCR to temporarily fall below the minimum mandated requirement of 100 percent.

However, in such situations, NBFCs are required to immediately inform the Reserve Bank of India, specifically the Department of Regulation and the Department of Supervision, with the following details:

• The reasons for the drawdown of HQLA,
• The nature of the stress event, and
• The corrective measures being taken to restore compliance with the LCR requirement

LCR Disclosures

As per Paragraph 6 of the LCR guidelines, applicable NBFCs are required to make quarterly disclosures regarding their Liquidity Coverage Ratio. These disclosures must be included in two places:

• Notes to Accounts in the annual financial statements, and
• On the official website of the NBFC.

The disclosure must follow the format prescribed in Appendix XXI-A of the RBI guidelines. Importantly, the quantitative data disclosed should be presented as a simple average of daily observations over the previous quarter, i.e., calculated based on daily data collected over a 90 day period. This approach provides a more stable view of the NBFC’s liquidity position across the quarter, rather than a point in time snapshot.

In addition to these quantitative disclosures, NBFCs are also required to include a qualitative explanation in the Notes to Accounts. This narrative disclosure is intended to provide context and enhance the understanding of the LCR figures. It should address the following key areas:

• primary drivers influencing the NBFC’s LCR results and how the components contributing to the LCR have evolved over time,
• intra-period and historical changes in liquidity position,
• breakdown of the HQLA composition,
• concentration of funding sources, which may indicate reliance on particular counterparty or instrument,
• exposure to derivatives and potential collateral requirements,
• currency mismatches within the LCR that could pose liquidity risks, and
• other significant inflows or outflows not captured in the standard LCR template but considered material to the NBFC’s overall liquidity profile.

Conclusion

The Liquidity Coverage Ratio under the SBR Directions marks a pivotal step in strengthening the liquidity risk management practices of large NBFCs in India. By mandating the maintenance of a 100% LCR, the RBI has ensured that applicable NBFCs remain resilient during periods of financial stress, capable of meeting their short-term obligations without external support. The framework not only enhances market discipline but also brings NBFCs closer in line with global prudential standards. While compliance with the LCR norms may present operational and strategic challenges—particularly in, liquidity forecasting, and portfolio adjustments—it ultimately contributes to a more stable and robust non-banking financial sector. As NBFCs continue to evolve in size and significance, adherence to such regulatory safeguards will be essential in building long-term investor confidence and systemic stability.

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^[1] Master Direction- RBI (Non-Banking Financial Company – Scale Based Regulation) Directions, 2023

^[2] As per Press Release dated June 17, 2016

^[3] Basel III: The Liquidity Coverage Ratio and liquidity risk monitoring tools

^[4] At the option of the NBFC these items may be considered as part of the HQLA computation, in which case the total cash inflows will be ₹50 crores instead of ₹70 crores..