4. It is proposed that the building-block approach should apply in the following manner. The minimum standard would be expressed in terms of an "x plus y" formula, in which "x", denoting specific risk, would apply to the reporting institution's gross equity positions (i.e. the sum of all long equity positions and of all short equity positions) and "y", or general market risk, would apply to the difference between the sum of the longs and the sum of the shorts (i.e. the overall net position in an equity market).

5. If, in the future, wider convergence with securities regulators can be achieved, it is proposed that individual national authorities should have discretion to continue to apply a comprehensive approach, i.e. one that combines specific and general market risks in a single risk charge. To use such an approach, the individual regulator would be required to demonstrate to the satisfaction of his fellow regulators that such an approach would produce, in all circumstances, capital charges equal to or greater than those produced by the minimum "building-block" approach. This demonstration could be made by showing that the authority's rule, by its very nature, required capital charges equal to or greater than the building-block methodology.

6. In setting appropriate charges for the x plus y formula, the Committee proposes that the charge for y (general market risk) should be 8% of the net open position. This number was reached on the basis of analysis in collaboration with securities regulators of the price volatility of the principal equity indices in the major markets.

7. The criteria for determining the x factor for specific risk need to reflect the diversification of the portfolio and the extent to which it contains liquid and marketable stocks. It is important to ensure that a relatively high "x" factor applies unless the portfolio is both liquid and well-diversified. It is proposed that an appropriate x factor in the absence of any such assurances should be 8%.

8. Although the Committee accepts that a lower x factor should apply for major institutions whose portfolios are liquid and diversified, it has proved extremely difficult to define liquidity and diversification in a sufficiently tight manner to be used for establishing a common minimum standard. Criteria for liquidity could include turnover, the number of market-makers or belonging to a major index. Diversification could be established by portfolio methodology or by some simple rule requiring concentrations above a certain threshold to carry a higher charge or requiring a minimum number of evenly spread holdings. However, national market characteristics are crucial. Comment is invited on adequate common criteria for liquidity and diversification.

9. In the light of these difficulties, all members of the Basle Committee are content to allow national regulators discretion to determine their own criteria for liquid and diversified portfolios so long as x is not set lower than 4Z and on the understanding that a minimum of 82 would apply to portfolios of stocks that fail to meet the liquidity and diversification test, Annex 7 illustrates the capital required for a range of hypothetical portfolios which qualify for 4% (i.e. a 4 plus 8 formula).