Evaluation of Capital Regulation of the Securities Companies in Korea and its Implications[17-03]
Yong Rin Park, Seokhoon Lee
The date
15 February 2017
Securities and Banking Industries, Financial Groups
This report aims to discuss the current status and significance of capital regulation for securities companies in Korea and to evaluate current capital regulation, Net Capital Ratio and leverage regulation, from the standpoint of the effectiveness of the regulations in light of their regulatory purpose.
Existing capital regulations are classified into risk based and non-risk based capital regulations. Under the risk based capital regulation, as is represented by Basel capital regulation regime, sufficient capital is required in accordance with the riskiness of assets. Non-risk based capital regulation is related to the size of assets and/ or exposure, and its representative example is leverage ratio regulation.
Current capital regulation for securities companies in Korea, introduced in 2016, inherited the same components, i.e., net capital and risk weights, as the previous capital regulation, but adopted different formula for prompt corrective action. This makes exact comparison of both capital regulation possible. From the perspective of preventing default of financial institution it is theoretically shown that previous regulation provides lower probability of default, but current regulation is more robust to parameter uncertainty about risk weights.
Also, it is empirically shown that both the current and the previous capital regulations have explanatory power for measuring the financial soundness of the securities companies in Korea, but that the previous regulation is somewhat superior to the current regulation in terms of the significance, and the consistence of the regression coefficients, and R2.
The leverage ratio regulation of domestic securities industry is different from Basel Ⅲ leverage ratio regime, and it is insufficient in terms of international coherence. For instance, it does not include some exposures included in Basel III regulatory formula such as items in the off-balance sheet. The domestic securities industry leverage ratio regulation seems to be higher than the 'backstop' level that complements the net capital ratio regulation, which is a risk-based capital regulation.
Capital regulation for securities companies boils down to the question of which type of capital regulation should be adopted and how stringent the regulation should be. These choices ultimately depend on regulatory philosophy about the expected role of securities companies, and involve research into the level of existing customer and creditor protection, and the cost-benefit analysis of capital regulation of securities business.