BACKGROUND
The net capital ratio (NCR) has been serving as a key index to assess financial soundness of securities firms since it was first introduced in April 1997. The NCR has been widely used as standards for financial authorities to take prompt corrective actions, grant membership of KRX, or evaluate primary dealers.
However, it has been pointed out that the current NCR rules no longer reflect changes in securities market and business model. The current NCR rules, mainly focused on regulating brokerage business in domestic market, restrict security firms from engaging in investment banking business or expanding into overseas markets. With the current method of computing NCR, it is difficult to exactly evaluate securities firms’ financial soundness or loss absorbing capacity.
Against this backdrop, the FS C plans to overhaul net capital ratio (NCR) rules for securities companies, as part of its effort s to revitalize the country’s capital markets.
KEY CONTENTS
1. Modification to the NCR formula
Currently, the NCR is calculated as a percentage of net operating capital to gross risks.
Net Capital Ratio (%) = (net operating capital/gross risks) × 100
Under the current formula, however, securities firms are forced to hold unnecessarily excessive capital. Securities companies are needed to secure an additional amount of net operating capital, bigger than the increased amount of risks, to maintain the same level of NCR. The current NCR makes investors difficult to figure out amounts of net equity capital of securities firms, leading the m to the misperception that higher NCR means the better financial soundness.
The FSC plans to modify the NCR formula as follows:
(net operating capital – gross risks) / sum of equity capital required to maintain each business unit’s license
Thresholds for corrective actions will be adjusted to corresponding to the modification to the NCR formula.
Securities companies will be allowed to choose which formula they would use until the end of 2015. The new NCR formula will be fully introduced starting from 2016.
2. Consolidated computations of NCR
Since net capital ratio of a brokerage company is computed on an individual basis, equity investment in its subsidiaries are all subtracted from net operating capital, which fails to properly reflect subsidiaries’ risks in the parent company’s NCR.
It also restricts securities firm s from expanding into overseas market and pursuing M&A since equity investment into such activities are subtracted from net operating capital.
The FSC will introduce consolidated computations of NCR for all securities firms with subsidiaries under the K-IFRS starting from 2016. Prior to the full implementation in 2016,7 the consolidated NCR rule will be first applied to large securities companies8 in 2015 as a pilot operation.
3. Adjustment of items subtracted from net operating capital
Securities firms’ loans to companies are currently subtracted from net operating capital, which drives NCR down. That has been constraining securities firms’ investment banking (IB) business. In order to address such problems, securities firms’ corporate loans will be reflected into credit risks, instead of being subtracted from net operating capital.
SCHEDULE
Considering the impact of new NCR rules on the industry, modification to the NCR formula and consolidated computations will be implemented after the FSC gathers opinions from the industry through public hearings and then revise relevant regulations.
Adjustment of items subtracted from net operating capital will be implemented as soon as relevant regulations are revised (presumably in the third quarter of 2014).
* Please refer to the attached PDF for details.