Latest Publictions

2016 Apr/19
The Net Capital Rule for US Broker-Dealers: The Path-Dependent Regulatory Framework Survey Papers 16-05 PDF

This monograph introduces the historical changes and the legal and institutional framework to enhance the understanding of the US NCR. Capital requirement regulation can be classified into two types: Basel-based and NCR-based. Basel-based approach is  going-concern in that it restricts the broker-dealers’ risky investments to prevent the bankruptcy preemptively. On the other hand, NCR-based one is gone-concern, where smooth liquidation process and the consumer protection are foremost important.
Regarding the US NCR, there are three methods: the basic method, the alternative method, and the alternative net capital. The basic method requires that a broker-dealer maintain net capital equal to 6.67% of its aggregate indebtedness. This is equivalent to a 15 to 1 leverage regulation. The uniform net capital rule was introduced in 1975, and the laternative method was optional for broker-dealers that computes aggregate debit items owed by customers.
The traditional purpose of the US NCR has been to ensure sufficient liquidity to protect customer assets and other brokers. Since the 1990s, due to a series of events such as bankruptcy of Drexel Burnham Lambert Group, large broker-dealers has been blamed for the systemic risk. In 2004, SEC introduced the CSE Rule allowing broker-dealers to compute the required capital by using VaR model. After the financial crisis, the CSE Rule was criticized for increasing the amount of debt that the large investment banks could take on their books. Subsequently, it was abolished, but large broker-dealers still use the alternative net capital method now.
Thousands of Focus reports were examined, and it was found that large and medium broker-dealers are likely to choose the alternative methods, while small ones choose the basic method. In particular, broker-dealers using the alternative method enjoys higher than average leverage ratio. On the other hand, small broker-dealers using the basic method are constrained regarding the leverage.
Regulatory capital is the path-dependent, is the result of gradual improvement efforts. Therefore, a review of the system in terms of the consumer protection and the risk-return profiles of the securities industry should be conducted prior to any revision in regulatroy framework. In addition, investigating capital requirement regulation requires the full understanding of entry regulations, regulatory leverage, and financial holding companies. A detailed stuy for their relationships is necessary based on the domestic market data for the constructive discussion. In particular, it is imperative to look into the risks that the Korean securities firms impose on the market and other firms’ bankruptcy probability in terms of systemic risks is  imperative.
improvement efforts. Therefore, a review of the system in terms of protection and the risk of customer accounts prior to domestic financial institutions to improve the environment, should be followed. In addition, capital requirements and entry regulations, regulatory leverage, financial holding company, it is necessary to clearly identify the relationship as regulated. Finally, this analysis is required for the national securities based on the data in order to cope with this discussion. In particular, the risks and the impact these have on the bankruptcy of individual securities and markets, such as the existence of systemic risk is imperative.