Liquidity Ratios & Indicators

Why are liquidity ratios essential?

Liquidity ratios offer a quantifiable measure of a bank's ability to meet its short-term obligations. These ratios provide insights into the bank's financial health and are often closely monitored by regulators, investors, and other stakeholders.

Key Liquidity Ratios

Current Ratio:

This is a basic liquidity metric, calculated as current assets divided by current liabilities. A ratio greater than one indicates that the bank has more assets than short-term liabilities and is, in the short term, financially robust.

Quick Ratio (or Acid Test Ratio):

This is similar to the current ratio but omits inventories from current assets. It's a stricter measure of liquidity, reflecting the assets that can be quickly converted to cash against current liabilities.

Net Stable Funding Ratio (NSFR):

A key Basel III regulatory standard, NSFR ensures that banks have a stable, longer-term funding profile in relation to the composition of their assets and off-balance sheet activities. It should be maintained at over 100%.

Liquidity Coverage Ratio (LCR):

Another Basel III standard, LCR ensures banks have sufficient high-quality liquid assets to withstand a 30-day stressed funding scenario.

How do these ratios guide banks?

Liquidity ratios serve as benchmark indicators for banks. Consistently poor ratios can be an early warning sign of financial distress, prompting corrective action. On the other hand, robust liquidity ratios can bolster stakeholder confidence and open up growth opportunities for banks.

By understanding and actively monitoring these ratios, banks can maintain a balanced financial position, ensuring they remain solvent and can weather potential financial challenges.