Bloomberg News

Korea Urges Banks to Boost Liquidity as Europe Debt Storm Brews

September 28, 2011

Sept. 29 (Bloomberg) -- South Korea urged its banks to boost foreign-currency liquidity amid concern they remain vulnerable to the financial storm brewing in Europe, even after more than a decade of reform following an international bailout.

Lenders need to look beyond the U.S. and Europe and diversify their funding into emerging markets such as the Middle East to prepare for a global crisis, Financial Services Commission Chairman Kim Seok Dong told chief executive officers of firms including Kookmin Bank and Woori Bank in Seoul today.

A 9 percent slump in South Korea’s won in the past month and signs of tightening in global credit markets dictates that banks continue shoring up defenses, according to Kim. They have already cut foreign-currency debt to 49 percent of external borrowings from 60 percent when Lehman Brothers Holdings Inc. collapsed in September 2008, finance ministry data show.

“Banks need to secure enough foreign-funding liquidity to avoid a vicious cycle of relying on support from the government or central bank in times of crisis,” Kim said. “We need to be prepared for a situation where external instability lasts for a considerable period,” he said, adding that lenders’ current holdings of easy-to-sell foreign-currency assets are sound.

Regulators are mindful that the International Monetary Fund led a $57 billion bailout during the Asian currency crisis, and that banks’ foreign-currency capital dwindled and the won plunged during the global credit freeze of 2008. Moody’s Investors Service says that while Korean banks are better placed to stave off future turmoil, they remain vulnerable because of their dependence on financing from abroad.

No Overnight Fix

“External shocks such as the euro-zone debt crisis remain major potential sources of risk,” Youngil Choi, a senior analyst at Moody’s in Hong Kong, said by phone yesterday. “Their fundamental weakness in foreign-currency funding, due to a lack of deposit base, can’t be fixed overnight.”

Asian stocks fell today amid concern European policy makers will struggle to stem the region’s debt crisis. The won weakened 0.8 percent against the dollar at 11:33 a.m. in Seoul, and has slumped the most over the past month among 10 Asian currencies tracked by Bloomberg. The Korea Financial Industry Index has retreated 21 percent since July 31 amid a global rout fueled by concern Greece may default on its debt.

“Banks are breakwaters that absorb external shocks on the front lines,” Kim said at today’s meeting. “How well they fulfill their roles can determine the scale of potential difficulties we may face in the future.”

Storm Visible

The FSC chairman this week urged his officials to monitor foreign-currency soundness of financial institutions as “the storm is visible” from Europe, according to an e-mailed statement on Sept. 26. Officials need to be ready to implement contingency plans and revise them if needed, he said.

Korea’s Financial Supervisory Service, a privately funded regulator that works under the FSC, said this week that it may increase the frequency of tests of banks’ ability to meet foreign-currency debt obligations to monthly from quarterly.

The extra testing would be positive for banks after about two-thirds of 18 lenders failed the latest review, Moody’s said on Sept. 26. The FSS on the same day that the stress tests weren’t a matter of passing or failing.

Moody’s sees no immediate reason to change its stable outlook on Korea’s banking sector as for now it’s unlikely that the European debt problem will deteriorate rapidly, Choi said. Korean banks’ capital level, profitability and asset quality have improved from 2008 and 2009 and their capital strength isn’t weaker than peers in Asia, Choi said.

Taken Steps

Authorities have taken steps to curb capital outflows since last year, including reducing banks’ currency-derivative holdings and restricting local companies’ sale of foreign- currency bonds for domestic use.

Short-term debt owed by Korean entities to investors abroad, a risk factor during the global financial crisis, dropped to 38 percent of the country’s foreign borrowings as of June 30 from 52 percent in September 2008, finance ministry data show.

Shortages of foreign cash in Korea during the 2008 credit freeze drove offshore borrowing costs higher, prompting the country to form currency swap accords with the U.S. and Japan, and leading the government to guarantee banks’ debts. During the 1997-98 Asian crisis, South Korea overhauled the banking sector, allowing more than 630 financial firms to fail and selling two of the biggest lenders to overseas investors.

“South Korean banks are much better armed for a crisis than they were three or four years ago,” Haekyu Chang, a Seoul- based banking analyst at Fitch Ratings Ltd., said by phone yesterday. “But no one knows whether preparation is enough before your ship faces a storm. We know the storm is coming but we don’t know how strong it will be.”

--Editors: Russell Ward, Brett Miller

To contact the reporter on this story: Seonjin Cha in Seoul at scha2@bloomberg.net

To contact the editor responsible for this story: Chitra Somayaji at csomayaji@bloomberg.net


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