Korea Development Institute (KDI) said on the 17th that the current standards for assessing the financial soundness of securities firms cannot properly gauge risk. It said there is a need to bring back the "strict standard" that was applied before 2016.
Accordingly, when ChosunBiz analyzed the financial soundness of the top 10 securities firms under the strict standard on the 19th, NH Investment & Securities and Meritz Securities did not meet the criteria.
The current standard for assessing the financial soundness of securities firms is the net capital ratio (NCR). This method uses the figure obtained by dividing "net operating capital minus risk amount" by "required maintenance equity capital (the minimum capital that must be maintained under law to engage in certain business)." If this figure is below 100%, it is deemed risky.
KDI's analysis is that this standard has problems. The larger the securities firm, the more risk can be concealed. That is because even if two securities firms have a fivefold difference in net operating capital, the same amount is applied for required maintenance equity capital.
For example, suppose Company A has 100 billion won in net operating capital and 50 billion won in risk amount, and Company B has 500 billion won in net operating capital and 450 billion won in risk amount, and both companies have 10 billion won in required maintenance equity capital. Under the current method, both companies' NCR would be calculated at 500%.
However, looking at the scale of risky assets relative to actual capital capacity, Company A is at 200% and Company B is at 111%, meaning Company B's risk is nearly twice as high. An accounting expert said, "There is clearly an 'optical illusion' that dilutes risk related to the financial soundness of large securities firms."
This current standard was revised after 2016. The strict standard that was applied before then calculated by dividing net operating capital by risky assets. If this ratio falls below 150%, it is deemed to fail the criteria.
When ChosunBiz analyzed the financial soundness of the top 10 securities firms with equity capital of at least 3 trillion won as of the end of June under the strict standard, NH Investment & Securities (146.97%) and Meritz Securities (139.05%) did not meet the criteria. But under the current standard, both NH Investment & Securities (1,726.05%) and Meritz Securities (1,146.27%) meet the criteria.
This difference also showed in the March 2020 "equity-linked securities (ELS) margin call incident," which inflicted losses in the 1 trillion won range on the domestic securities industry. At the time, the current NCRs of large securities firms all exceeded the standard, so no risk signal was detected. Even in that case, applying the strict standard shows two firms fell short and the remaining one barely cleared the bar.
Accordingly, the Financial Supervisory Service is reportedly reviewing measures to improve the overall method of calculating the current NCR. KDI said, "It is time to push for systematic improvements to prudential regulations so that the expanded functions of securities firms do not lead to an excessive increase in systemwide risk."
Meanwhile, an NH Investment & Securities official said, "As of the end of Oct., our financial soundness ratio under the strict standard exceeds 153.95%." However, the latest disclosed financial data related to soundness are as of June.