S. Korea’s Financial Market more Health and Soundness

The volatility of domestic financial market has been unstable since this August due to uneasiness around European sovereign debt crisis and its possible contagion to Italy and heightened uncertainty related to the raising of the US government debt ceiling.

However favorable financial soundness and foreign exchange reserve suggest that such impact on Korea’s economy will be limited. Compared with Asian financial crisis in 1997 and global financial crisis in 2008, our ability to manage risks has been improved than ever usual.

Since the global financial crisis in 2008, Financial Services Commission (FSC) and Financial Supervisory Service (FSS) have made various efforts to enhance the soundness in foreign and bank sector.

The government strengthened regulations of foreign exchange soundness in January, 2010 (1st), and in July, 2010 (2nd). FSC made new standards for FX liquidity risk management and tightened regulations to increase mid- to long- term financing in foreign loan portfolios. In addition, the financial institutions are required to meet minimum holdings of safe FX assets requirement.

The government introduced (’10 Oct) and strengthened (’11 Jul) the regulation of forward exchange position. On July, 2011, the ceiling on the FX forward position by local branches of foreign banks was cut to 200 percent of their capital, while the ceiling for domestic banks to 40 percent.

Also financial regulators have adopted so-called ‘Bank Tax’ in August, 2011. The government began imposing a bank levy of 0.2 percent on short-term non-deposit liabilities with a maturity of less than one year. Borrowing with a maturity of one to three years is facing a 0.2 percent tax rate, while the rate for liabilities that mature in three to five years and more than five years is 0.05 percent and 0.02 percent. A bank levy is regarded as a tool to protect a nation’s financial system from excessive capital flows by imposing taxes on debts held by banks.

In order to restrain foreign loans from growing rapidly, the government banned banks and other financial institutions from investing in foreign-currency denominated bonds (‘Kimchi Bonds’) that are used for conversion into local currency. Kimchi bonds are supposed to help companies finance demand for foreign currency such as in contract settlements, an increasing number of firms haven abusing the bonds and using the proceeds to meet local currency needs, raising concerns over exchange-rate risks. This restriction is to help curb foreign currency loans growth which is not essential and urgent.

In addition the government reformed the regulation on bank’s loan to deposit ratio. The planned changes in the regulation are applied to commercial banks in principle having won-denominated loans in excess of KRW 2.0 trillion. The target for banks’ loan to deposit ratio is to be set at 100 percent with a grace period until June, 2012 whereupon banks will be required to maintain a ratio of under 100 percent from July, 2012.

With these governmental actions, our ability to manage risks and soundness in foreign and bank sector have been improved than just before the global financial crisis in 2008.

In foreign sector, total foreign debt to short-term foreign debt ratio has been significantly decreased from 52 percent in September, 2008 to 38 percent in March, 2011.

(Unit: $100 million)

 

2007.12

2008.09 (A)

2011.03 (B)

Variation (B-A)

          Total foreign debt (a)

3,334

3,651

3,819

168

Short-term foreign debt (b)

1,603

1,896

1,467

429

Short-term foreign debt ratio (b/a)

48.1%

51.9%

38.4%

13.5%

Foreign Exchange Reserve

2,622

2,397

2,986

589

Short-term foreign debt/Foreign Exchange reserve

61.1%

79.1%

49.1%

30.0%

Foreign debt in bank sector

1,929

2,195

1,919

276

Domestic banks

1,090

1,221

1,155

66

Short-term debt

546

655

485

170

(Ratio)

(50.1%)

(53.6%)

(42.0%)

(11.6%)

Local branches of foreign banks

839

974

764

210

Short-term debt

794

939

666

273

(Ratio)

(94.5%)

(96.4%)

(87.2%)

(9.2%)

(Data from FSC)

In bank sector, within the loan to deposit ratio, banks have sustained under 100 percent which is the standard regulation. Moreover, BIS ratio has been significantly improved. Within the foreign currency liquidity ratio, it has been in excess of 85 percent which is the guidance.

 

Before the ’08 crisis (2008.08)

2011.06

Variation

Loan to deposit ratio (except for CD)

124.0%

97.8%

26.2%

BIS ratio

11.36%1)

14.34%2)

+2.98%

Tangible common equity ratio

8.50%1)

11.28%2)

+2.78%

Foreign currency liquidity ratio

102.7%3)

100.3%

2.4%

1)       ’08.6,        2) ’11.3,      3)’07.12

 (Data from FSC)

It is considered that current shaky sentiment of South Korea’s financial market came more from significant downside risks to the economic outlook and sovereign risks of other financial markets such as US and Europe than domestic factors. Moreover, domestic financial market has become more resistant to external shocks in various indicators. It reflects efforts made to enhance soundness of the financial market.

Yong-Heui Lee (leeyongheui@gmail.com)

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Can the ‘bank tax’ be the final answer for preventing banks from failing?

Many people agree that the global financial crisis was caused by growth competition among banks, which led them to invest risky derivative products to make more profits. In line with this view, many governments, such as the U.S., the U.K., Germany, France and Sweden, as well as the International Monetary Fund (IMF) are trying to introduce the ‘bank-tax’ to global finance system expecting to collect bail-out money for the means controlling and regulating financial institutions, especially the huge banks.  In G-20 Finance Ministers meeting, which was held on 23rd of April in Washington D.C, adapting the ‘bank tax’ to financial companies was discussed as the main agenda and the IMF submitted reports about what kind of method of levying banks would be most appropriate and acceptable world wide.

Four mainly considered ways of taxing banks

Currently, four main methods of charging tax to banks are considered and researched by the IMF. The four techniques are:

  • Balance Sheet Tax;
  • Excess Profits Tax;
  • Financial Trading Tax; and
  • Insurance Levy.

Let’s look through briefly about those methods.

The first method is ‘Balance Sheet Tax’. It is that a government charges a fixed ratio of taxes in terms of its level of assets or liabilities of each financial institution. The U.S. government and many other countries are positively considering using this method since it is considered as effective way of keeping under control of increasing banks’ assets and liabilities. The purpose of charging taxes for assets is a kind of burden of risks, particularly big banks because if they fail, the consequences will be substantial. Also the reason for taxing liabilities, mainly on non-deposit except long-term stable fund: is to restrain the unreasonable attempts to fund capital from borrowings.

The second one is ‘Excess Profits Tax’, which was proposed by Strauss-Kahn, the managing director of IMF. It is considered as the most efficient way of recollecting the bailout money, because it does not affect the bank’s operational strategy and prohibits moral hazard. However, it is realistically hard to measure the excess profit of banks, also there is a likelihood of negative effects to bank’s efforts of making profits.

The third one is ‘Financial Trading Tax’; also known as ‘Tobin tax’, which is mostly favored by some European countries. It charges for foreign currency trading or a certain financial transactions to prevent the flowing of short-term investment. However, it is an unrealistic way since it is difficult to monitor and charge everyday financial transactions. Also there is a possibility of distorting the flow of funds to escape the fees because of these reasons, the IMF and the U.S. and Canadian governments have negative attitudes toward this method.

The last one is ‘Insurance Levy’. It charges banks a compulsory amount of insurance fee, which is similar to the current deposit-protection rule. But this method is not welcomed by the IMF and to many governments because of the chance of incurring unfair competitive gains and the moral hazard of investing in higher-risk products to cover the insurance tax.

Prospects for bank tax

It is expected that the ‘Balance Sheet Tax’ will be the main plan chosen by the IMF and many other governments. However, there is a big difference in the view of the bank tax not only between developed countries and developing countries, but also the interests of each country. Especially, the Canadian government who is the host of June G-20 meeting, has strong objection to bank levy since they didn’t go through a serious financial crisis. Hence, it is likely to take more time to make globally accepted agreement.

Possible side-effects of introducing bank tax

The profits of banks are expected to be affected banks directly. Morgan Stanley expects that introducing bank tax will affect the EPS by decreasing it 3 to 6 % during 2010 – 12 to the U.S. and European banks. Also, there is a likelihood of reducing loans to public because of decreasing risky assets investment. This might have negative effect on the improvement of banks’ corporate governance and the economic recovery process.  On the other hand, banks can invest to more risky assets to recover their profit reduction and to pay for the taxes. Moreover, banks can transfer the service cost to customers to share the burden of taxes with customers.

Alternative approach in changing the internal problem of banks

 

Banks are not just a company, which operates for making profits. They are the substantial components of one country’s economic system. So they need to be safely operated with social responsibility. However, managers and directors have been trying to pursue a short-term achievement for their remunerations, such as unimaginably high salaries or stock options etc. For these reasons, banks lacked in long-term strategic planning, which leads them to poor risk management. Also, the managers and directors’ social responsibility and ethical behavior needs to be refined. Therefore, a long-term strategic management planning and directors/managers who have socially responsible minds will be required.

Can the ‘Bank tax’ be the final answer for preventing banks from failing?

The purpose of trying to introduce the ‘bank tax’ is to be prepared for any future financial crises. Many governments and the IMF recognize the current crisis is caused by the huge banks’ aggressive investment to risky assets and derivatives also funding capital by increasing liabilities. So they charge tax on banks’ level of assets or liabilities on their balance sheets to achieve a control of banks and to restrain their operational strategies. Also, for enhancing the stability of banks’ activities, it is considered necessary to improve banks’ internal management system by restructuring corporate governance, long-term strategic operation plan, and the directors/managers’ socially responsible minds. However, it is still a controversial issue because each country’s benefit will be affected differently by adopting the ‘bank tax’. Therefore, global consensus, which should be a generally accepted agreement, must be reached during the upcoming G-20 meetings and as the host of 2010 G-20 meeting, Korea is required to wisely negotiate different opinions between developed and developing countries.

So do you still think that the ‘bank-tax’ can be the final answer for preventing banks from failing?

How do you think about this issue?