Liquidity and funding: LCR, NSFR, deposit insurance and the lender of last resort

Banks fail in two ways. They run out of capital because losses exceed what shareholders put in, or they run out of cash because creditors withdraw faster than assets can be turned into money. The second can happen to a solvent bank within days.

Basel III added two liquidity standards to deal with this risk. Deposit insurance and central bank lending complete the framework by reducing the incentive to run and providing a backstop when markets close.

Why banks are exposed to liquidity risk

A bank’s liabilities are mostly short-term. Current account balances can be withdrawn on demand, and wholesale funding often matures within weeks. Its assets are mostly long-term loans that cannot be sold quickly at full value.

This maturity transformation is the core economic function of banking, as the article on money creation explains. It is also the reason a loss of confidence can turn into a run. Digital banking has shortened the time a run takes, because customers can move balances from a phone at any hour.

The Liquidity Coverage Ratio

The Basel Committee’s LCR standard requires a bank to hold an adequate stock of unencumbered high-quality liquid assets (HQLA) that can be converted into cash to meet its liquidity needs for a 30-calendar-day stress scenario.

The ratio is the stock of HQLA divided by total net cash outflows over the next 30 days. Absent a period of financial stress, it should be no lower than 100%. The standard was phased in from 60% in 2015 to 100% on 1 January 2019.

High-quality liquid assets

HQLA are divided into levels, with limits on the lower-quality levels.

Level	Typical assets	Haircut	Limit
Level 1	Cash, central bank reserves that can be drawn down in stress, qualifying sovereign securities	None	No cap
Level 2A	Certain sovereign, public sector and covered bonds and corporate debt meeting rating and market criteria	15%	Level 2 in total at most 40% of HQLA
Level 2B	Certain lower-rated corporate debt, equities and residential mortgage-backed securities meeting strict criteria	Generally 50%	At most 15% of HQLA, within the 40%

Cash outflows

Outflows are calculated by applying run-off rates to each type of funding. The rates reflect how likely each depositor is to withdraw in stress.

Funding type	Basel minimum run-off rate
Stable retail deposits: fully insured, and in transactional accounts or with established relationships	5%, or 3% where national deposit insurance meets extra criteria
Less stable retail deposits	At least 10%, set by jurisdictions
Operational deposits from clearing, custody or cash management relationships	25%
Unsecured funding from non-financial corporates, sovereigns, central banks and public bodies	40%, or 20% where fully insured
Unsecured funding from other legal entities, including financial institutions	100%

Inflows from performing assets can offset outflows, but only up to an aggregate cap of 75% of total expected outflows. A bank cannot satisfy the LCR purely by expecting its own loans to be repaid.

The standard states that banks are expected to use their HQLA during a period of stress, even if the ratio then falls below 100%. Supervisors assess the situation and respond proportionately.

In EU law

The EU applies the LCR through Article 412 of the Capital Requirements Regulation and a delegated regulation. Article 412 requires institutions to hold liquid assets covering outflows less inflows “under gravely stressed conditions over a period of thirty days”. Under Article 414, an institution that does not or expects not to meet the requirement must notify its supervisor immediately and submit a restoration plan.

The Net Stable Funding Ratio

The LCR deals with a one-month stress. The NSFR deals with the structure of the whole balance sheet over one year. It requires available stable funding (ASF) to be at least 100% of required stable funding (RSF) on an ongoing basis, and it became a minimum standard by 1 January 2018 under the Basel timetable.

Each liability receives an ASF factor reflecting how stable it is. Each asset receives an RSF factor reflecting how much stable funding it needs.

Liability	ASF factor
Regulatory capital and other liabilities with residual maturity of one year or more	100%
Stable retail and small business deposits under one year	95%
Less stable retail and small business deposits under one year	90%
Funding under one year from non-financial corporates and certain other wholesale sources	50%
Other liabilities, including most short-term funding from financial institutions	0%

On the asset side, cash and central bank reserves need no stable funding, while illiquid long-term loans need a high proportion. A bank that funds 25-year mortgages with overnight wholesale borrowing will fail the NSFR even if its LCR looks healthy.

The EU applies the NSFR through CRR Articles 413 and 428b. Article 428b requires a ratio “of at least 100 %” and adds that institutions should keep the currency profile of their funding generally consistent with that of their assets.

What the ratios mean for a new bank

1. Deposit mix is a design decision. Insured retail deposits in transactional accounts carry the lowest run-off and the highest ASF. Rate-sensitive deposits gathered through comparison platforms behave less predictably and may be treated as less stable.
2. Deposits from fintech partners and financial institutions are expensive in liquidity terms. Under the LCR, unsecured funding from financial institutions carries a 100% run-off unless it qualifies as operational.
3. Concentration matters beyond the ratios. Supervisors also look at reliance on a few large depositors or a single distribution channel.
4. Holding HQLA has a cost. Liquid assets earn less than loans, so liquidity requirements reduce margins in the business plan.
5. Currency mismatches need their own plan. A bank that lends in one currency and takes deposits in another must manage liquidity in each.

Supervisors also expect an internal liquidity adequacy assessment, a contingency funding plan with tested actions, and daily monitoring of intraday liquidity for banks that participate in payment systems.

Deposit insurance

Deposit insurance reduces the incentive to run by assuring smaller depositors that they will be repaid even if the bank fails. It is funded by contributions from member banks.

Jurisdiction	Coverage per depositor per bank	Source
European Union	EUR 100,000 on aggregate deposits, with higher temporary protection that Member States must set for certain deposits, such as those from private residential property transactions	Directive 2014/49/EU
United Kingdom	£120,000 since 1 December 2025	FSCS

The EU directive requires schemes to make the repayable amount available within seven working days, after a transitional period that ran until 31 December 2023. International good practice is set out in the IADI Core Principles for Effective Deposit Insurance Systems, most recently revised in September 2025, which the IMF and World Bank use in financial sector assessments.

A new bank must join the scheme of its home jurisdiction before taking covered deposits. It must also be able to produce accurate depositor data quickly, so that the scheme can pay out within the legal deadline. This capability is part of the operational build that supervisors review.

The LCR links back to deposit insurance. A deposit counts as stable only if it is fully insured by an effective scheme and meets the relationship or transactional account criteria. The Basel standard notes that the presence of deposit insurance alone is not sufficient.

The lender of last resort

Central banks provide liquidity to banks against collateral. This is the oldest part of the safety net, and its design differs by jurisdiction.

In the euro area, banks access regular monetary policy operations through the Eurosystem. Beyond these, the ECB describes emergency liquidity assistance (ELA) as central bank money provided by national central banks “to solvent financial institutions that are facing temporary liquidity problems, outside of normal Eurosystem monetary policy operations”.

The ECB Governing Council can object where ELA would interfere with the objectives and tasks of the Eurosystem. The current ELA agreement dates from September 2024.

In the United Kingdom, the Bank of England’s toolkit includes a Short-Term Repo facility, an Indexed Long-Term Repo, a contingent term repo facility activated in market-wide stress, and the Discount Window Facility. The Discount Window is a bilateral, on-demand facility for firms that anticipate or experience an unexpected liquidity need.

What central bank access requires

1. Eligibility. Usually a licensed bank under robust prudential supervision, with a central bank account.
2. Collateral. Central banks lend only against eligible collateral, with haircuts. Loans must be pre-positioned and legally ready before they are needed.
3. Operational readiness. Settlement connections, legal documentation and testing should be in place in normal times.
4. Solvency. Emergency lending is designed for solvent institutions. It does not replace capital.

Questions supervisors ask about liquidity

1. Which depositors will fund the bank in its first three years, and how quickly could they leave?
2. What share of deposits is insured, transactional and relationship-based?
3. How much HQLA will be held, in which currencies, and where?
4. What does the contingency funding plan do on day one, day five and day thirty of a stress?
5. Which central bank facilities can the bank use, and is collateral ready for them?

The next article turns from balance sheet rules to the people who run the bank: governance and fit and proper requirements.