Seoul downpour

As the clouds darken over the global economy, South Korea’s financial regulators are bracing for a storm. James King reports.

On June 23, Kim So-young, the vice-chairman of South Korea’s top financial regulator, the Financial Services Commission (FSC), announced that the Korea Deposit Insurance Corporation (KDIC) will be given new powers to pre-emptively intervene to save struggling financial companies from default. The move marks a notable expansion of the KDIC’s mandate, which has traditionally had limited precautionary powers, and underscores the its concerns as global economic conditions deteriorate.

The country’s export-driven economy and its status as a bellwether for global trade leave it highly exposed to downside external risks. Today, these difficulties include probable US and eurozone recessions, rolling Covid-19-linked shutdowns in China, and conflict in Europe. Internal problems are also mounting, as the collapsing value of the won, low domestic investment levels and high household debt, among other issues, threaten the country’s medium-term economic prospects.

“The South Korean economy faces a number of downside risks that are both domestic and external in nature,” says Min Joo Kang, ING’s senior economist for South Korea and Japan.

Fleet of foot

As a result, South Korean regulators are moving quickly to buttress the financial system against any potential turmoil. Additional powers for the KDIC, which holds both a deposit insurance scheme and financial system stability function, are a case in point. The KDIC played an outsized role in reviving the country’s financial sector through capital injections during the Asian financial crisis of 1997 and the global financial crisis of 2008/09. The key difference today, however, is that the bulk of system risk lies with non-bank financial institutions (NBFIs).

During a June FSC Financial Risk Taskforce meeting, Mr Kim highlighted the “excessive leverage of specialised credit finance companies”, and their reliance on bond issuance for funding as a key source of liquidity risk in the financial system. In observing these risks, the vice-chairman also called for a wider “regulatory overhaul” of the financial industry and for regulatory authorities to consider ways of expanding support for the sector during times of crisis.

“I think the moves described in Mr So-young’s announcement are prudent — the government is trying to prevent a worst-case scenario by readying the KDIC to confront illiquidity, in addition to insolvency,” says Adam Kulam, senior research associate at the Yale School of Management, who spoke with The Banker in a personal capacity.

“In my [view], this announcement strengthens the KDIC’s role in maintaining the financial safety net in Korea, ahead of potential illiquidity in funding markets for non-banks.”

Liquidity risks

South Korea’s experience with financial crises has typically involved large capital outflows, contributing to liquidity strains across the country’s financial system. Consequently, the country’s regulatory authorities are now particularly vigilant when it comes to managing liquidity risks.

With some economists forecasting a recession for the country’s economy in 2023, there are good reasons for regulators to be concerned. The Korean won fell to a 13-year low in June, while exports grew at their slowest pace in 19 months in the same month.

“If the economic slowdown translates to sluggish corporate bond markets, then these credit finance companies — whom I’m guessing are already sub-investment grade — will have to compensate buyers with even higher yields, further compromising their own capital positions and raising the risk of their own default,” says Mr Kulam.

“I view the FSC’s measure [to give the KDIC additional powers] as an attempt to expand the financial safety net to include vulnerable NBFIs; the government is preparing to lower the NBFIs’ default risk in the event of a widespread credit crunch.”

Yet, as Mr Kulam makes clear, the KDIC’s additional powers are far from settled. In particular, no details have been released concerning the specific range of recipients, the quality of capital or the size and terms of funding, among other particulars. Nevertheless, the FSC is not alone in voicing its concerns over the threats facing the economy. On July 4, the country’s finance minister, Choo Kyung-ho, and the governor of the Bank of Korea, Rhee Chang-yong, met to discuss the “complex” set of economic risks stacking up against the country. The two leaders vowed to act pre-emptively to tackle any emerging economic threats.

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