Stemming the flow

Few banks hold capital against their liquidity risk exposures, arguing that liquidity risk makes no material contribution to potential unexpected loss. Bob Allen of the Australian Prudential Regulation Authority disagrees, and proposes a possible approach to quantifying liquidity risk economic capital

The predominant view among both banks and prudential regulators internationally appears to be that banks do not need to hold capital - either regulatory or economic - against their liquidity risk exposures. There are very few dissenters. Pillar II of the new Basel II regulatory bank capital framework1 does say that "banks should evaluate the adequacy of capital given their own liquidity profile and the liquidity of the markets in which they operate", but that is all. No guidance is provided on