Despite the passage of the impeachment bill, the exchange rate of the won against the U.S. dollar has exceeded 1,450 won, raising concerns about the soundness indicators of banks, such as the capital adequacy ratio of the Bank for International Settlements (BIS) and the liquidity coverage ratio (LCR). While there is an opinion that domestic banks have sufficient management capacity, it appears that authorities are also considering easing LCR regulations in anticipation of a potential acceleration of dollar outflows in the long term.
According to the minutes of the 22nd Monetary Policy Committee meeting of the Bank of Korea on the 19th, concerns related to this issue appear to have been exchanged among the committee members. One committee member noted, "As the won-dollar exchange rate remains at a high level, even if various regulatory ratios decline, the foreign currency LCR ratio or BIS capital ratio of financial institutions will remain sound, so its impact on financial stability will be limited."
However, they emphasized, "Financial institutions may change their funding and operational behaviors, such as selling risk-weighted assets and reducing loans, in order to maintain BIS capital ratios at their current levels due to rising exchange rates, and this could impact the economy, so continuous monitoring of this situation should be carried out."
Typically, when the won-dollar level rises, the BIS capital adequacy ratio, which is a key asset soundness indicator for banks, and the foreign currency LCR, which is a liquidity indicator, deteriorate. The BIS capital adequacy ratio is calculated by dividing the bank's equity by risk-weighted assets (RWA). An increase in the exchange rate raises the exposure of foreign currency assets, leading to an increase in the risk-weighted assets, which decreases the BIS capital adequacy ratio.
The foreign currency LCR ratio refers to the proportion of high liquid assets such as dollars and U.S. government bonds that banks must hold in anticipation of net foreign currency outflows over the next 30 days. When the exchange rate rises, the LCR decreases due to increased collateral requirements for derivative trades and a reduction in foreign currency deposits. Following the state of emergency, the exchange rate jumped by 36 won in two weeks, with the weekly closing price on the 17th recorded at 1,438.9 won, leading to concerns among commercial banks over the high exchange rate.
Concerns about the deterioration of soundness indicators due to high exchange rates have persisted even before the state of emergency. Last month, Jin Ok-dong, the chairman of Shinhan Financial Group, said, "If the won-dollar exchange rate remains at the 1,400 won level at the end of the year, it will put pressure on financial institutions' BIS ratios, and if the exchange rate ends at 1,400 won, it will be extremely difficult to meet the BIS ratios," adding, "In that case, each financial institution will have to reduce their assets."
As the situation stands, there are calls to postpone the normalization of the LCR, scheduled for next month, until the won-dollar exchange rate stabilizes. The Financial Services Commission lowered the LCR from 100% to 85% in response to the COVID-19 pandemic and then gradually regulated it to 97.5% from July this year. Authorities have decided to revert the bank's LCR regulations back to 100% starting January 1 of next year.
The current foreign currency LCR standard, which indicates the ratio of foreign currency high liquid assets to foreign currency net cash outflows over 30 days, is 80%. If the LCR ratio is 80%, it implies that if the expected net foreign currency outflow is assumed to be $1 billion, more than $800 million must be held. If the government relaxes this ratio, the pressure on banks to secure dollars may decrease, facilitating the supply of dollars.
Authorities currently believe that banks have sufficient LCR management capacity. As of the end of September, the average foreign currency liquidity coverage ratio (LCR) of the four major commercial banks (KB Kookmin, Shinhan, Hana, and Woori Bank) was 157.3%, exceeding the regulatory level.
However, within the financial sector, there are still concerns about the potential acceleration of dollar outflows, stating that "it is uncertain when a crisis might occur."
A financial sector official said, "Banks are monitoring the potential for losses due to exchange rate movements by managing foreign currency assets and liabilities at a balanced level," but added, "While banks' LCRs are currently high and do not hinder risk management, there is a need to establish conservative plans considering the upward trend of exchange rates and capital outflows."