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Strengthening Foreign Exchange Soundness
Korea’s financial regulatory institutions issued a plan to strengthen foreign exchange soundness and improve supervision of financial companies
Strengthening Foreign Exchange Soundness
  • By matthew
  • December 15, 2009, 00:00
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WHILE it is said that the foreign exchange soundness of domestic financial companies has recovered to the level it was before the financial crisis, the Financial Services Commission (FSC) and the Financial Supervisory Service (FSS) issued a plan to strengthen foreign exchange soundness and improve supervision of financial companies on November 19, in order to address the need to consistently reinforce the foreign exchange soundness and systems of financial firms in order to prevent further crises, as the vulnerability of financial companies in terms of foreign exchange has been identified during the overcoming of the crisis. The government said that this was to strengthen standards in order to manage the foreign exchange liquidity of banks and limit the forward exchange trade to under a certain rate.

Based on the plan, the FSC will limit the forward exchange rate in contracts between banks and exporting companies to up to 125% of the cash transaction in order to prevent an excessive foreign exchange hedge. This means that if an export price is 100 million dollars, banks can buy forward exchanges from the exporter up to 0.125 billion dollars. This will be applied to Korean branches of foreign banks, too, and is an indirect regulation as it limits trade with exporters rather than a direct one such as regulations on liquidity ratios.

The regulation on the forward exchange trade of banks is aimed at strengthening foreign exchange soundness. According to the FSC, exporters entered into contracts on forward exchanges whose amounts were higher than the export prices. Exporters also increased short-term foreign loans by excessively selling forward exchanges for speculative reasons. Therefore, banks borrowed more foreign currency than necessary without managing the credit risks and this distorted the foreign currency market. This excessive forward exchange trade by exporters is believed to be the primary cause of problems with foreign exchange liquidity at the time of global financial crisis. However, the government did not rule out ways to exceed the 125% ceiling of forward exchange trade rates based on the exporters’ credit rating. The Bank Risk Management Committee will evaluate the credit rating of exporters and enable companies to buy forward exchange up to 140% of an actual trade.

At the same time, banks shall invest at least 2% of total foreign currency assets in riskless assets such as government and public bonds above Grade A. This was aimed to help financial companies cope with foreign currency liquidity in the future as it was mostly governmental support which enabled companies to solve liquidity shortages during the last crisis. However, banks such as Korea Development Bank and Export Import Bank of Korea, owned mostly by the government, will be exempt from having to have riskless assets and implementation will be delayed until the second half of 2010.

In addition, reporting related to foreign exchange soundness will be strengthened, and will be applied to foreign banks in Korea, again. Foreign currency assets, foreign currency liquidity ratios, and the status of foreign currency debt maturity shall be reported every month, while the status of supply and operation of foreign currency funds will be reported every quarter.

While these regulations aim to strengthen foreign currency soundness, there are concerns that there may be side effects, such as worsening corporate capital problems and discouraging exports. These concerns particularly highlight ongoing concerns for exporters, such as a double dip or the high prices of raw materials. The plan is expected to be implemented from 2010, with revisions to relevant Acts completed this year. The FSC confined the subject of implementation to only banks, excluding other financial areas for the time being, saying that the regulations would extend based on the performances of banks.