Macroprudential Policies in Korea

- Toolkits and Experiences

Tae Soo Kang

Bank of Korea

Disclaimer

This presentation represents the views of the author and not

necessarily those of the BOK or BOK policy.

Paris Europlace Financial Forum

New York, April 14, 2014

Contents

Ⅰ. Monitoring and Measuring Macroprudential Conditions

Ⅱ. Macroprudential Toolkits

� LTV, DTI Caps

� FX-related

� Loan to Deposit Cap

Ⅲ. Ongoing Discussions

2/25

I. Monitoring and Measuring Macroprudential Conditions

� 「Financial stability」 : New mandate to the BOK(Bank of Korea Act amendments (Dec. 2011))

� BOK concerns with macroprudential aspects

� A framework for monitoring and measuring macroprudential conditions

3/25

Background

Financial Stability Report

Systemic Risk Assessment Model for Macroprudential Policy (SAMP)

1

2

I- Financial Stability Report

① Analyze and evaluate the potential systemic risk

② Provide early warning of risk

③ Suggest policy alternatives

� Published twice a year, and submitted to the National Assembly

� FSR attempts to …

4/25

1

� Feedback mechanism with domestic and overseas advisor groups

5/25

� Forthcoming FSR (April 2014) identifies five key risks

� To help identify the potential risk factors, BOK conducts Survey of financial

market participants (90 experts) twice a year

① Tapering off of US quantitative easing (77%)

② Slowdowns in growth of China (72%)

③ Household debt problem (70%)

④ Financial instability in emerging market countries (57%)

⑤ Increase in corporate credit risk (41%)

Why

a Model

Needed?

BOK has developed its own systemic risk assessment model

Cannot manage what you cannot measure

InterconnectednessProcyclicality

Sources for Systemic Risk

2

� Examine resilience of financial system (macro stress test)

� Measure individual banks’ contributions to systemic risk (D-SIBs)

I- SAMP

Tail risks unobservable

⇒ For the 2013 FSAP for Korea, SAMP was used to conduct

macro stress test

6/25

Macro

shocks

1st round

loss

2nd round losses due

to default contagion

2nd round losses due

to liquidity contagion

⑤ Multi-period module

• Dynamic update of banks’ B/S

④Funding liquidity contagion module

• Estimation of funding costs and

deleveraging/liquidity withdrawals

• Contagious defaults due to liquidity

withdrawals

① Macro-risk factor module

• Generation of macro-economic

scenarios

③ Default contagion module

• Estimation of 2nd round losses due

to fire sales and credit crunch

• Contagious defaults due to

interbank loan losses

② Bank profit and loss module

• Calculation of bank profits and

losses based on macro scenarios

⑥Systemic riskmeasurement module

• Systemic risk indicators

- Value at Risk

- Expected shortfall

- Probability of systemic crisis

1st & 2nd round

losses

Chart: SAMP Structure

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Ⅱ. Macroprudential Toolkits

1 LTV, DTI Caps

FX-related

Loan to Deposit Cap

2

3

9/25

II- LTV, DTI Caps

Background

� Real estate in total assets : Korea 73.3% (March 2013)

� Housing booms in early and mid 2000s fueled by rapid increases in home mortgage lending by banks

Household Loans

1

Housing Booms and Bank Lending

Housing price

LTV Cap [September 2002]

� LTV has been adjusted a total of 9 times

(6 times for tightening and 3 times for relaxing)

� Limitation : Housing price → Collateral value

→ Affordable additional borrowing

→ Procyclicality amplified

10/25

DTI Cap [August 2005]

11/25

� Curbs possible procyclical behaviour resulting from LTV Cap

� Puts limit on ratio of annual debt repayment amount to debtor’s annual income

� DTI ratio =

������ �������� ������� ���

��������������

������ ������× 100

� DTI has been adjusted a total of 8 times

(6 times for tightening and 2 times for relaxing)

① Procyclical behavior could be reinforced

Unintended Consequence : LTV Cap

� Boom phase: Mortgage collateral → Affordable additional borrowing

→ Countercyclical?

� Downturn phase: LTV moves above threshold (violation of Cap)

→ Pressure on loan recovery → Housing price (fire sales)

→ Procyclicality amplified

Boom

LTV regulation : Procyclicality worsening

12/25

LTV regulation : Countercyclical ?

Downturn

Housing Price Cycle and the Role of LTV Cap

② Caused Funding Liquidity Risk

13/25

Unintended Consequence : DTI Cap

� Average maturity of mortgage loans : 5.4 years (2004) → 11.3 years (2013)

� Banks’ funding maturity has not changed greatly(Composition of banks’ funding (2013) : Deposit 67%, Wholesale funding 17%, Borrowing 16%)

Mortgage loan maturities

DTI ratio =

������� ����� ����

+ ��������

����� �����DTI ratio =

������� ����� ����

+ ��������

����� �����

� DTI caps designed in favor of

longer maturity

Pre- and Post-crisis Capital flows

14/25

II- FX-related Toolkits

Background

2

Capital Flow Volatility

� Capital flows to Korea : Volatile and procyclical

� About one half of total bank inflows during two-year period prior to Lehman Crisis flowed out within five months after it

‘06.1 ~

‘08.8

‘08.9 ~

‘09.3

Equity -683.8 -65.7

Bond 516.4 -108.5

Bank borrowing 1,084.9 -571.5

(Short-term) (998.5) (-573.8)

(100 million dollars)

Capital inflows to Korea, and GDP Growth

Background

Notes: Currency mismatches = foreign liabilities – foreign assets

Maturity mismatches = short-term foreign liabilities – short-term foreign assets

� A sharp increase in mismatch of short-term external debt through foreign

bank branches drives systemic risk

Domestic Banks Foreign Bank Branches

Currency and Maturity Mismatches

15/25

FXMarket

Pull factors

MajorShip builders

Push factorsForeign investorsForeign financial

institutions

(1) Leverage caps on banks’ FXDerivatives positions

(2) Macroprudential Stability Levy on bank’s non-core FX liabilities

� Volatility and mismatches in FX market can be understood in terms of both pull and push factors

� Pull factor Swollen hedging demand from major ship-builders amid

strong market expectations of currency appreciation

� Push factor Capital inflows resumed from second half of 2009 on back

of ample global liquidity

16/25

S-T External

Debt

(1) Leverage caps [October 2010]

� Aimed at curbing banks’ short-term external debt

Selling FX Forward

Buying $ for hedging

S-T $ Borrowing

Ship

Builders

Domestic

Banks

Foreign

Branches

Foreign

Bank

Branches

Overseas

Banks

� Caps on banks’ FX derivatives positions : 150 % of equity capital for

foreign bank branches, 30 % for domestic banks

17/25

� Aimed at curbing excessive increase in bank’s non-core liabilities

� Lower levies applied to longer-maturity liabilities

Macroprudential Stability Levy

(2) Macroprudential Stability Levy [August 2011]

Bank borrowing and Business cycle

18/25

� Leverage caps have contributed to reductions in currency and maturity mismatches

Maturity Composition of External Debt

(Foreign bank branches)

Note : 1) Black and green vertical lines refer to the dates of the introduction of the Leverage Caps and the

Macroprudential Stability Levy, respectively.

(Domestic banks)

Effects of Leverage Caps

0

20

40

60

80

100

2009Q1 2010Q1 2011Q1 2012Q1 2013Q1

Short term Long term(%)

0

20

40

60

80

100

2009Q1 2010Q1 2011Q1 2012Q1 2013Q1

Short term Long term(%)

19/25

� MSL has reduced arbitrage margin and raised FX funding costs

� Total levy collected estimated to be as large as 12 % of net profits for foreign bank branches (domestic banks : less than 1 %)

Note : 1) Interest differential (3M)-Swap rate (3M)

Arbitrage Transaction Incentives1)

(Foreign bank branches)Ratios of Levy to Net Profits

(As of end-2012)

Note : 1) Estimated ratios

Effects of MSL

0.7

12.4

0

2

4

6

8

10

12

14

Domestic banks Foreign bank branches

(%)

20/25

II- Loan-to-Deposit Cap [December 2009]

Background

3

Textbook CaseReality

(Boom period)

Funding

Lending

Lending opportunity

S-T Funding through

wholesale finance

Lending expansion based on

wholesale funding

� Procyclicality

� Interconnectedness

21/25

Loan-to-deposit ratio = KRW-denominated Loans

KRW-denominated Deposits�

≤ ���%

⇒ With LTD ratio limited to within 100%, banks are forced to reduce

reliance on wholesale funding

Wholesale funding

22/25

Loan-to-Deposit ratio

Effects of LTD Cap

� Reducing procylicality of bank lending behavior and

interconnectedness among financial institutions

23/25

III. Ongoing Discussions

24/25

� The institutional framework for macroprudential policy

� US type (FSOC) vs. UK type (BOE)

� The recent recommendation by the IMF is noteworthy, that the

establishment of a financial stability committee is necessary and that

central bank should play a key role on it

� Macroprudential vs. Capital Flow Management

� Potential conflicts with the Capital Liberalisation

25/25