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In a capitalist economy, a private firm seeking finance must negotiate with prospective investors in the open market, which establishes standards about the terms on which debt and equity investment will be forthcoming. In addition to these market-financing standards, the capital structure of some financial firms—particularly broker-dealers, federally insured depository institutions, and insurance companies—must satisfy other requirements imposed by federal or state regulators to promote liquidity and solvency. Regulators take a heightened interest in these firms because they serve a public function in providing credit and other financial services. To grasp what regulatory capital rules try to accomplish, the reader must make a conceptual shift to see these financial firms as highly leveraged borrowers, contending with the demands of their own creditors. From this perspective, the financial stability of these firms becomes a matter of public concern. The first section explains regulatory capital as a corporate finance issue about how capital structure can protect creditors—especially unsecured ones – from unexpected financial losses. The rest of the chapter examines the major features of the regulatory capital regimes that apply to financial intermediaries. The second section starts with depository institutions, i.e., banks. These standards have become the locus of policy debates about risk-based capital. The third section discusses the regulatory capital rules that apply to broker-dealers registered with the U.S. Securities and Exchange Commission (“SEC”).1 Broker-dealers have long been subject to net capital rules that promote the firm’s liquidity in order to promote orderly self-liquidation. More recently, large broker-dealers have been allowed to adopt a risk-based method—akin to that used in bank capital—for meeting their net capital requirements. The fourth section considers insurance companies, which adhere to risk-based capital standards imposed by state law. The fifth section warns that large, complex financial organizations may find themselves inadvertently subject to bank-style capital rules if deemed “systemically important” by the newly created Financial Stability Oversight Council (“FSOC”).



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Edward Elgar


Law | Securities Law


in Research Handbook on Securities Regulation in the United States, Markham, Jerry; Gjyshi, Rigers, ed.

Scholars and students of financial law, banking and regulatory law will find this book a useful resource, as will attorneys, compliance professionals, risk-mitigation professionals and corporate leaders.

The Rise of Risk-based Regulatory Capital: Liquidity and Solvency Standards for Financial Intermediaries