Korea Tells Banks to Hold Liquid Dollar Assets on Outflow Risks

  • Government also eases cap on banks’ currency forward positions
  • Rule changes reflect increased risks of capital outflows

South Korea will require banks to hold an adequate amount of liquid foreign-currency assets as a buffer against capital outflows during external shocks.

Starting in 2017, local banks will be required to hold at least 60 percent of the expected amount of foreign-currency outflows during a one-month crisis as highly liquid assets, according to a joint statement Thursday from the Finance Ministry, financial regulators and the Bank of Korea. The so-called foreign-currency liquidity coverage ratio has so far been a recommendation, not a regulation, to banks in South Korea.

The government also loosened restrictions on currency forward positions to 40 percent of their capital for local banks from 30 percent, and for foreign banks’ branches to 200 percent from 150 percent. A higher cap means banks have more leeway in using derivatives to borrow dollars, which can help in times of financial market volatility. The new limits will be applied starting next month.

The rule changes come amid uncertainty in global financial markets with a possible rate increase looming from the Federal Reserve and Britain’s potential exit from the European Union raising risks of capital outflows from Korea, according to the statement. Other unnecessary foreign-currency liquidity regulations will be eliminated with adoption of the liquidity coverage ratio, the statement showed.

Adjusting Regulations

Korea’s capital-flow control measures were introduced in 2010 when the country was worried about too much inflow strengthening the won and a rise in short-term external debt. With Korea no longer facing huge inflow pressure, policy makers have been voicing the need to adjust regulations to reflect changes in economic situations.

The foreign-currency liquidity coverage ratio won’t be applied to foreign banks’ branches within Korea as their headquarters will be subject to regulations of their relevant countries. Different ratios will be applied to policy banks like the Korea Development Bank.

Overseas investors bought 3 trillion won ($2.5 billion) more of Korean stocks than they sold this year through May, while cutting holdings of local debt by 2.6 trillion won, data from the financial regulator show. The won’s movement has been volatile this year as expectations of a Fed interest rate increase have changed. It appreciated 1.6 percent against the dollar in June, having weakened about 4 percent in the previous two months.

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