When your Board still doesn’t understand ILST vs. LCR
Internal Liquidity Stress Testing (ILST) and the Liquidity Coverage Ratio (LCR) are core to a bank’s liquidity risk management practices. They can also be difficult for those outside of Treasury to fully understand, let alone Board members who may come from non-financial industries and only dedicate 2 minutes to your LRM slide.
ILST: The Tailored Safety Plan
Internal Liquidity Stress Testing (ILST) is a ratio of stressed available funding divided by stressed outflows, over different stress scenarios and time horizons. The structure and assumptions driving ILST are internally driven, with general guidelines set out in Reg YY and SR 12-7.
Key Characteristics of ILST:
Customized scenarios and assumptions tailored to your bank’s risk profile (e.g., sudden deposit outflows or market disruptions).
Several time horizons, ranging from a few days to several months. Many banks focus on overnight, 1 week, 30 days, 90 days, and one year
Focus on operational resilience, helping identify vulnerabilities and mitigation strategies.
Think of ILST as a tailored fitness plan for your bank’s liquidity profile and your Director of Liquidity is the personal trainer. It’s customized, adaptable, and built to commensurate with your bank’s size, risk profile, and products/activities.
LCR: The Universal Standard
The Liquidity Coverage Ratio (LCR) on the other hand is a standardized ratio with every bank adhereing to the same assumptions. It ensures banks maintain enough easily sellable assets to survive a 30 day stress scenario, regardless of their individual risk profiles.
Key Characteristics of LCR:
Requires banks to hold high-quality liquid assets (like cash or government bonds).
Focuses on a fixed 30-day stress period.
Standardized by regulators to ensure comparability and compliance.
LCR is like a physical fitness test composed entirely of body weight exercises, it doesn’t matter if your 100 or 300lbs (or 100B or 300B assets) 20 pushups are 20 pushups.
How to Communicate These Concepts Effectively
1. Frame the Concepts in Practical Terms
ILST: “This is our custom outlook for different potential liquidity stress environments unique to our bank.”
LCR: “This is the industry’s minimum standard for short-term liquidity health.”
2. Use Real Examples
Highlight scenarios from your bank: "Our ILST showed we could withstand a 20% drop in deposits over three months without needing external funding."
3. Relate to Strategic Decisions
Link ILST to specific actions like adjusting funding strategies.
Explain how LCR compliance protects the bank’s reputation and regulatory standing.
4. Visualize the Frameworks
Use a diagram showing ILST’s flexible timelines compared to LCR’s fixed 30-day focus.
Common Questions from the Board
Why do we need both ILST and LCR?
ILST is a custom tool for managing our unique risks out to 1 year of stress, while LCR ensures we meet regulatory expectations focused on the first 30 days. Both are regulatory required and capture different sides of the same 'potential stress’ coinHow does ILST inform decision-making?
ILST allows the bank to identify key areas of liquidity risk and assess how those activities or products may behave in several different stressed environments. Treasury and 2LOD can focus on those areas to ensure proper assumptions are applied given the bank’s unique characteristics. THis is most obvious in segmentation, which rarely matches (and arguably should never) LCR segments.What happens if we fail LCR requirements?
If your bank is an LCR bank (>100B in the US) Failure to be over the 100% ratio leads to regulatory scrutiny and possibly reputational damage, and a decrease in depositor and shareholder confidence.
Conclusion
ILST and LCR are complementary tools, two sides of the same coin of ensuring your bank has enough funding sources to cover stressed outflows. They offer the board a quick intuitive snapshot of the bank’s liquidity risk profile. Treasury should ensure its Board understands the key drivers of these ratios and the nuance between the two.