1. Total Foreign Debt
Recent debts have largely been incurred as a result of bridge-financing (based on anticipated future returns) such as currency forwards. This type of financing has different characteristics to that of liabilities incurred to finance current account deficits which were prevalent prior to the Asian Financial Crisis.
As of the end of June 2008, it is estimated that $151.8 billion out of a total of $419.8 billion of foreign debt by BOK will be not be subject to any repayment burdens, and thus reduce the actual foreign debt amount to $268 billion.
The exclusion of debts which are not subject to any repayment burdens will result in an actual net foreign asset amounting to $154.5 billion.
The current external debt ratio as of the end of June 2008 stands at 86.1%. However, the figure falls to 54.4% when foreign bank branches are excluded, significantly reducing external debt risks.
2. External Debt by Sector
A. Government Sector
The bulk of the government sector debt ($51.8 billion out of $63.1 billion) consists of KRW-denominated government bonds and currency stabilization bonds purchased by foreigners, for which the Korean government and the BOK has ample repayment capacity.
The remainder consists of $3.3 billion in foreign currency-denominated FX equilibrium bonds, $3.4 billion in public loans, etc. (i.e. long-term external debts that pose little risk).
B. Banking Sector
Foreign debts without any repayment burdens incurred from shipbuilders' currency hedging, etc. account for 44.6%, or approx. $93.8 billion, of the external banking sector debt.
Foreign debts incurred by domestic branches of foreign banks from their headquarters abroad are very low-risk compared with those of Korean banks.
* Foreign bank branches hold 43.1% of total external banking sector debts, and 57.7% of short-term debts.
We are applying stringent criteria for FX liquidity to domestic banks than observed in other countries; hence, our current FX liquidity level remains stable.
* Developed nations such as the US, UK, Japan, and Germany do not regulate FX liquidity. It is only applied in some countries, including China and Mexico.
The inconsistent ratios between assets and debts maturing within 7 days, 1 month, and 3 months are within stable ranges.
C. Other Sectors (non-banking FIs, non-financial corporations)
The bulk of external debt within non-banking financial institutions' ($20 bn out of $28 bn) originates from finance companies. Finance companies have stable financing abilities and operational structures.
A high proportion of debts are long-term, while assets are mainly short-term such as credit card receivables.
* This is in contrast with the practice of borrowing short-term and lending long- term by Korean merchant banks prior to the Asian Financial Crisis.
Finance companies employ currency swaps in managing KRW assets: as long as they have enough KRW, they can secure foreign currency to repay external debts upon maturity.
Of the $118.2 bn external debt held by non-financial corporations, $50.9 bn are advance receipts for shipbuilding orders and $7.1 bn are loans from parent companies based overseas. In other words, almost half (49.1%) of the external debt within the non-financial sector are not subject to any repayment burdens.
Ⅱ. Analysis of Foreign Reserves
1. Definition of "Usable Foreign Reserves" and the Current Composition of Foreign Reserves
Usable foreign reserves: similar to the concept of foreign reserves.*
* External assets readily available to the monetary authority to offset current account imbalances, to intervene in the FX market, etc. (IMF definition)
Foreign reserve figures released at the beginning of each month refer to usable foreign reserves.
- The foreign reserve figures included in statistics since August 1999, has been clarified to refer to reserves of foreign assets immediately convertible to cash (usable foreign reserves), in line with the IMF definition.
e.g.) The amount of $2 bn from the Foreign Currency Equilibrium Fund invested to Merrill Lynch through the KIC is excluded from the foreign reserves.
※ Statistics prior to August 1999 featured (official) foreign reserves and usable foreign reserves separately.
(Foreign reserves = usable foreign reserves 1)+ deposits in foreign branches of Korean banks + currency swap agreements with the Bank of Thailand)
The current composition of foreign reserves
Korea's foreign reserves currently consist of safe assets including deposits, government bonds, government agency bonds, international organization bonds, etc.
* A is the officially required minimum rating for foreign reserve assets, but their actual ratings are AA or above.
All of the $239.7 bn in foreign reserves as of the end of September 2008 are immediately convertible to cash.
Ⅲ. The Liquidity of Foreign Currency of Korean Banks
Korean banks have been encountered some difficulties securing overseas funding as a result of disruptions in the global credit markets following the collapse of Lehman Brothers. Offers of more than one-month loans have been disappearing in foreign currency markets, and overnight Call rates have sharply increased following the dollar shortage.
Excessive demand for dollar funding has lowered the swap point and swap basis in the USD/KRW swap market where banks can procure USD.
Despite these difficulties, Korean banks have been faring relatively well as they hold surplus funds remaining from the first half of the year. They have also been able to secure a certain level of funding based on strong credit relationships with foreign lending institutions.
As of September 30, the foreign currency liquidity ratio of domestic banks was above the recommended level of 85%. The 1-month and 7-day gap ratios were also above the recommended -10% and 0%, respectively.
The monitoring of major economic indices has been increased since concerns over the
U.S. subprime market were first raised last year. We have also been tracking the foreign currency liquidity of domestic financial institutions and encouraging them to manage their foreign currency liquidity risk and exposure to mortgage-related products to ensure that they remain financially sound.
As a result, the ratio of foreign currency in Korean banks remains above the levels which supervisory regulations recommend. Moreover, the delinquency rate on bank loans is very low and stable. Even BIS and IMF consider the banks as credible recourse debtors.
In the case of Korean branches of foreign banks’, they have a minimum possibility of collecting their loans and funds at the same time due to arbitrage opportunities. The branches borrow foreign currency at a low rate from their headquarters and transact F/X SWAP with Korean banks (Sell&Buy). With the Korean Won bought in the transaction, they invest in safe assets, such as Korean government bonds. Even if they do collect their funds, the impact on the F/X spot market appears to be limited.
Recently, Korean banks have encountered some difficulties securing overseas funding as a result of disruptions in the global credit markets following the collapse of Lehman
Brother in September. However, most of the difficulties stem from domestic banks’ in order to deal with the maturing debt without using their foreign currency assets so as not to disrupt foreign currency credit flows to the market.
On October 6, the government began to inject US$5 billion in fresh foreign currency credit to local banks through the Export-Import Bank of Korea. Given government support and the foreign currency liquidity ratio of domestic banks, the global credit crunch is likely to have limited impact on domestic financial institutions and the real economy. Overseas borrowing conditions are also expected to improve as the U.S. House of Representatives passed the bailout package on October 3.
Ⅳ. Status and Evaluation of the Financial Soundness of Domestic Banks
Concerns were recently raised over a possible deterioration of banking soundness as lending growth slowed along with the economic slowdown. However, the financial position of the banks' such as profitability, asset soundness and capital adequacy are in good shape.
Korea also has an excellent record in the first half in terms of net income (6.7 trillion won), ROA (0.9%) and ROE (12.5%) compared to other major advanced nations.
The deliquency rate (1.0% at the end of August 2008) and the NPL ratio (0.7% at the end of June 2008) also remained relatively low.
With regards to adequacy, the BIS ratio (11.55% of BaselⅠ, 11.36% of BaselⅡ) is similar to that of advanced countries* as of the end of June 2008.
There is a possibility that the stable position of banks may decline as a result of a prolonged economic slowdown. However, this is not likely to occur abruptly like the US subprime crisis. The loss absorption capacity** is also in good shape thanks to the strengthened supervision policy*.
Tightened policy measures are in place as a response to unstable factors in each sector that raises concerns for default risks such as the SME loan.
Looking at the recent trends in lending, bank lending growth has slowed in the third quarter owing to the effects of economic slowdown and strengthened risk management.
The delinquency rate has increased slightly but is not historically high and the coverage ratio is acceptable.
However, the delinquency rate (0.5%) of mortgage loans of which consists of household lending (about 60%), is very low and the LTV(47%) is also fine.
For future preparation, policy efforts have been made to preemptively respond to possible default risks by monitoring each bank, thereby continuously enhancing the effectiveness of supervision.
For SME lending, greater liquidity support has been extended for cash-strapped SMEs.
For household lending, the government will encourage long-term loans and provide credit recovery support in order to reduce the burden of debt payment for borrowers in the lowest income brackets according to schedule.
For PF lending, preemptive measures were prepared as a response to an abrupt recession in the real estate sector owing to measures dealing with unsold new housings (6.11,8.21) up-until now and strengthened risk management*.
The deposit-loan ratio (including CD) of domestic banks crrently stands at 105.4% as of July 2008 (The figure goes up to 86.8% if bank bonds are included).
It is reasonable to include CD because the nature of CD is very similar to deposits.
① Eighty two percent of CDs were sold over the counter as of the end of July 2008 to date.
② CD has a higher roll over rate than time deposits (In case of a bank, CD has 43.7% while time deposits have about 39% as of June 2008).
※ The issued amount has also increased for bank bonds as well (a 20% rise in the first half of 2008).
The deposit-loan ratio has somewhat increased due to a rise in lending but it is no cause for concern given the local-currency based liquidity ratio (106% at the end of July 2008).
On the other hand, lending growth has recently slowed because of the effects of the economic slowdown and higher interest rates. Thus, the deposit-loan ratio is expected to improve accordingly.
Ⅴ. Responsive Measures to the Potential Unstable Factors in the Financial Markets
With respect to PF lending, the government will manage risks preemptively through measures such as Risk Management Standards for PF (September 30th), strengthen the effectivness of supervision based on the results of a study conducted on 899 construction businesses funded by PF (which is to be completed in October) and to encourage restructuring of savings banks with possible default risks in a manner to minimize any impact on the markets such as M&As.
SME lending trends and the stability of each bank will be closely monitored. Preemptive measures will be mapped out to include ways to help financially distressed SMEs affected by the credit crunch as it was announced by the government (Oct.1) in order to prevent possible spread of a default crisis.
In terms of household lending, the government will closely monitor any additional burdens of debt repayments due to the hike in interest rates and changing trends in the real estate market. It will also provide people in the lowest income bracket who are vulnerable to external shocks with greater support such as a credit recovery support program.
In terms of the real economy such as the construction sector, the government plans to make various efforts. First, it will pursue support led initiatives by financial companies such as work-out programs and agreements to construction companies. Second, it will make institutional improvements that hamper financing through fixed assets such as unsold new housing. Third, it plans to support small (SME) companies suffering from losses related to currency option contracts - known as "knock-in knock- out (KIKO)" options through Korea Credit Guarantee Fund (KODIT) and Kibo Technology Fund(KIBO).
* Please refer to the attached PDF below.