[Song Seungseop's Financial Light] How Much Cash Should You Keep? ... 'LCR' to Prevent Liquidity Crisis

Finance is difficult. It is filled with confusing terms and complex backstories intertwined. Sometimes, you need to learn dozens of concepts just to understand a single word. Nevertheless, finance is important. To understand the philosophy of fund management and consistently follow the flow of money, a foundation of financial knowledge is essential. Therefore, Asia Economy selects one financial term each week and explains it in very simple language. Even those who know nothing about finance can immediately understand these 'light' stories, lighting a bright 'fire' of financial understanding.

[Asia Economy Reporter Song Seungseop] There is a joke that during winter, you should carry at least 1000 won in cash in your wallet. When you want to eat street food like Bungeoppang or fish cake, you need cash to buy it anytime. Similarly, banks must always hold a minimum amount of cash. For what reasons and how much cash must they hold?

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The Liquidity Coverage Ratio (LCR) is an indicator that shows how much cash assets are held compared to the expected expenditures over the next month. For example, if a person expects to buy 1000 won worth of Bungeoppang in a month and currently holds two 1000 won bills, the LCR would be 200%.

From a bank's perspective, it is specifically calculated as ‘high-quality liquid assets’ divided by ‘net cash outflows’ over the next month. Net cash outflows are the amount of cash expected to be spent in 30 days minus the cash expected to come in. If a bank plans to spend 2 million won and expects 1 million won to come in, the net cash outflow is 1 million won. High-quality liquid assets refer to the total amount of assets that can be easily converted into cash and have high liquidity. These include physical cash held, deposits, government bonds, and so on.

Therefore, a bank with a high LCR can be considered relatively safe. Even if an emergency occurs where a large amount of money suddenly flows out, the bank can withstand it on its own without support from financial authorities. However, if the LCR is excessively high, the bank must hold too much cash, which can worsen its business performance.

The LCR Created by the 2008 Global Financial Crisis

Financial Supervisory Service Building

The origin of the LCR dates back to the 2008 global financial crisis. At that time, large banks gathered excessive funds and recklessly sold loan products, resulting in a severe shortage of assets that could be used like cash. Just as people buy Bungeoppang in winter, banks also need to pay out cash at times, but they ultimately failed to do so properly. To resolve the situation, central banks worldwide had to provide massive funds to financial companies.

In response, the Basel Committee on Banking Supervision, an organization that sets standards for stable international finance, proposed new principles. These were the ‘Principles for Sound Liquidity Risk Management and Supervision,’ from which the concept of LCR emerged. Countries gradually adopted the LCR, and banks had to reduce spending or hold more cash to maintain an appropriate LCR.

In Korea, since 2015, the Financial Services Commission has regulated the LCR under Articles 26 and 63 of the Banking Act. For foreign currency, the LCR must be maintained at 80%, and the combined LCR for both Korean won and foreign currency must be maintained at 100%.

However, currently, due to COVID-19, LCR regulations have been somewhat relaxed. Since last year, the foreign currency LCR was lowered by 10 percentage points to 70%, and the Korean won LCR was lowered by 20 percentage points to 80%. The temporary regulatory easing was originally scheduled to end last September, but as the COVID-19 situation lasted longer than expected, it was extended by six months and will continue until next month.

This content was produced with the assistance of AI translation services.