Regulators and regulated are running scared after the events of August and September last year. "I'm more confused about valuation [of financial assets] than I have been for some time, said a leading risk manager at a brain-storming session in Geneva last month.
But the shock to the risk-management community is producing some new, or perhaps old, thinking: a financial firm's risk assets can only truly be valued in relation to its liabilities. For example: take an illiquid investment such as a venture-capital stake. If a firm is funding that stake in the money market it runs a liquidity risk and must mark the investment at liquidation value. If it's funding the stake with its own equity, then marking it to market at liquidation value makes economic nonsense: accrual or cost accounting are more appropriate.
Applying that principle to the different parts of a complex investment bank could prove a...
