This annex briefly examines the differences between the requirements which are needed for securities firms with the requirements which have traditionally been applied to banks.

Securities Regulators

Securities firms generally take positions as short-term traders and have to be able to meet losses as they occur. This leads to an emphasis on

1. marking securities and commodities positions to market to reflect current value, thus including any losses incurred even though no transaction recognising that loss has taken place, and

2. position risk requirements which provide a margin of safety against potential losses which can be incurred as a result of market fluctuations.

The capital of securities firms must be adequate to deal with specific risks encountered (ie, position, settlement, and other basic risks). Securities firms holding large positions are more vulnerable to sudden market movements than diversified banks because a large portion of their net worth can be lost quickly. This has led securities regulators to place considerable emphasis on liquidity and to treat illiquid assets conservatively.

Because of the fluctuations in the risk-based requirements, the securities regulators in some countries have adopted a more flexible approach to allowable capital than is the case for the harking supervisors. For example. some countries securities regulators allow short-term subordinated loans or bank guarantees to serve as a substitute for capital.

Banking Regulators

The banking regulators take a much longer-term view of their firms. The assumption is that banks hold the majority of their assets to maturity and. therefore, that credit risk is the important and predominant risk. This also means that those assets do not have to be marked to market. Banking regulators, who are interested in whether a firm can meet claims as the fall due on a long-term basis, look at the maturity mismatch of a bank's book and perhaps require a proportion of a bank's assets be in liquid form.

With respect to securities positions bank regulators generally focus on the credit risk in the relevant securities. In addition, some bank regulators impose limitations on securities positions in relation to owner's equity. Bank regulators currently are exploring a risk-based capital approach for banks' securities positions.