The appropriate supervisory and regulatory response to these risks would, therefore, be to insist on full disclosure and transparency of off-balance sheet commitments / exposures and supervisory insistence on an appropriate mix of “stored” and “purchased” liquidity and appropriate capital charge for liquidity risk; the higher the “purchased liquidity” component, the higher the capital charge and the higher the “stored liquidity” component, the lower the capital charge.
Thus, banking supervisors and regulators need to be more hands-on and pro-active in focusing supervisory attention on this critical risk category than has been the case so far. (In fact, in India the Committee on Financial Sector Assessment almost presciently focused on this critical risk in the month of May itself, much before the liquidity and credit crunch of August 2007).