From asset value to recognised capacity
Consider a fictional treasury with unrestricted USD 8 million in cash and unencumbered bonds worth USD 10 million. Its internal policy accepts those bonds but applies a stipulated 20% planning haircut. Assume the policy's conversion allowance is usable within the specified stress horizon, and the treasury faces USD 18 million of net cash needs over that horizon. There are no other funding sources or inflows.
| Resource | Market value, USD m | Recognised amount, USD m |
|---|---|---|
| Available cash | 8 | 8 |
| Eligible bonds | 10 | 8 |
| Total | 18 | 16 |
The bonds contribute million. The recognised buffer is therefore million, leaving a policy shortfall of million.
A simple policy calculation is
where is available cash, contains eligible assets usable within the horizon, is their market value, is the policy haircut, and is the scenario's net funding need on the same currency and timing basis. Here is recognised capacity and is the additional amount needed. This simplified total does not replace a schedule of cash receipts and payment cutoffs.
A larger haircut can reduce capacity even with unchanged asset prices. Raising this example's planning haircut to 30% reduces the bond allowance to USD 7 million, the buffer to USD 15 million and leaves a USD 3 million gap. If the bonds cannot be mobilised in time at all, exclude them from the relevant deadline's calculation rather than merely applying a modest discount.
What makes the stock usable?
An asset belongs in a useful buffer only if the institution has a credible route from holding it to meeting a payment. In practice, this means checking restrictions on use, existing collateral commitments, location and legal entity, currency conversion, market depth and settlement timing. Counting the same bonds both as sale proceeds and as collateral for new borrowing would overstate capacity.
For banks, the Basel Committee's liquidity guidance explicitly connects liquid-asset cushions with stressed needs and operational availability. Regulatory measures such as the liquidity coverage ratio apply their own eligibility and calculation rules. The illustrative buffer above does not calculate that ratio or demonstrate compliance.
Sources
- John C. Hull, Risk Management and Financial Institutions, 4th edition, Wiley, 2015, Chapter 24, Section 24.2, pp. 507–509: funding needs, cash and securities, liquidation and funding access; pp. 514–515: collateral availability and liquidity cushions.
- Basel Committee on Banking Supervision, Principles for Sound Liquidity Risk Management and Supervision, September 2008, Principles 9 and 12; paragraphs 123–127, pp. 29–30: unencumbered assets, stress sizing and monetisation constraints.
- Basel Committee on Banking Supervision, Basel Framework: Liquidity Coverage Ratio, LCR20 and LCR30: the separate calculation and qualifying-asset rules for the regulatory measure.