A local level set algorithm for simulating interfacial flows described by the two-dimensional incompressible Navier–Stokes equations is presented. The governing equations are solved using a finite-difference discretization on a Cartesian grid and a second-order approximate projection method. The level set transport and reinitialization equations are solved in a narrow band around the interface using an adaptive refined grid, which is reconstructed every time step and refined using a simple uniform cell-splitting operation within the band. Instabilities at the border of the narrow band are avoided by smoothing the level set function in the outer part of the band. The influence of different PDE-based reinitialization strategies on the accuracy of the results is investigated. The ability of the proposed method to accurately compute interfacial flows is discussed using different tests, namely the advection of a circle of fluid in two different time-reversed vortex flows, the advection of Zalesak's rotating disk, the propagation of small-amplitude gravity and capillary waves at the interface between two superposed viscous fluids in deep water, and a classical test of Rayleigh–Taylor instability with and without surface tension effects. The interface location error and area loss for some of the results obtained are compared with those of a recent particle level set method. Copyright © 2005 John Wiley & Sons, Ltd.