Critics say that as comprehensive financial investment companies (investment banks) rode the government's push to expand the supply of venture capital and focused only on growing in size, the share of short-term funding at major securities firms has reached a danger level. In particular, as funding structures shorten, warnings are growing that if asset deterioration overlaps, the overall soundness of the securities industry could rapidly worsen.
Behind the rapid growth of investment banks, risk factors are also mounting, and the financial authorities, which have emphasized expanding the supply of venture capital, have now called for risk management.
◇ Authorities note need to manage investment bank liquidity
On the 21st, the Financial Supervisory Service convened executives in charge of operations and audits from seven investment banks for a roundtable. The move is seen as a response after credit rating agencies recently noted that investment banks' asset soundness burdens are growing.
Since improvements to the investment bank system were announced 10 years ago to foster "mega-investment banks (IB)," domestic investment banks' capital and profits have grown to about half the size of commercial banks. In particular, after the financial authorities expanded the pool of commercial paper issuers last year and launched the integrated managed account (IMA), large securities firms' asset size and leverage rose sharply.
The volume of commercial paper, which exceeded 15 trillion won at the end of 2020, topped 54 trillion won as of the end of March this year, rising about 3.5 times in five years, and IMAs are nearing 3 trillion won as of the end of March.
As the footprint grew quickly, latent risks also expanded. In particular, short-term borrowing relative to equity capital at investment banks jumped sharply. According to Korea Ratings, the ratio of short-term borrowing to equity capital at domestic investment banks surged from 37% in 2015 to 135% last year. This stems from the expansion in commercial paper operations, and compared with major overseas IBs whose borrowing structures are longer term, it shows how reliant domestic securities firms are on short-term funding.
By firm, Meritz Securities, which previously operated a merchant banking business, has reduced its short-term borrowing burden, but most other investment banks rose sharply. In particular, Korea Investment & Securities Co. and KB Securities, which actively use commercial paper, exceed 200%.
Korea Ratings said, "Investment banks have gained growth opportunities through the corporate finance market with commercial paper, but their exposure to short-term money market volatility has also increased," adding, "Obligations to supply venture capital and the policy of expanding long-term asset investments can add risk to investment banks' liquidity structures."
◇ "Concentration in direct investment" is also a weak point
Another vulnerability is that domestic investment banks are overly concentrated in direct investments in risky assets.
In global financial markets, IBs typically provide a range of financial services, including not only direct investment but also investment and financial advisory, funding, asset management, and trading. But domestic investment banks are focusing on businesses that earn revenue by managing funds raised through commercial paper and IMAs.
Experts say that although various techniques are deployed in the management process, if an investment loss occurs, the investment bank must shoulder it in full, so both commercial paper and IMAs should in substance be viewed as direct investments.
A maturity mismatch between funding and investment is also a structural risk. Commercial paper typically raises funds on a short-term basis of less than one year, but the funds raised are invested in medium- to long-term assets. As the maturity mismatch between assets and liabilities deepens, the burden of liquidity management on investment banks inevitably grows.
It appears that Seo Jae-wan, assistant governor of the Financial Supervisory Service, urged stronger liquidity management at investment banks during the roundtable in recognition of this situation. Seo said, "Check the liquidity of assets managed with commercial paper so you have the capacity to respond even under stress, such as heightened market volatility, and for IMAs, closely review liquidity at the asset selection stage so that investors can withdraw funds before maturity without disruption."
◇ "Need to improve the NCR system that cannot detect risk"
The Korea Development Institute (KDI), the government's economic policy think tank, advised that preemptive measures are needed to prevent risks arising from investment banks' expansion of short-term funding from spilling over into systemic risk.
In a report released last year, KDI noted, "As assets and leverage are rapidly expanding at large securities firms, short-term funding is increasing, but the current NCR (Net Capital Ratio) system, the soundness regulation for securities firms, does not sufficiently reflect the risks accompanying growth in size, raising concerns about a regulatory gap from the perspective of financial system stability."
KDI added, "For large securities firms, it is desirable to switch the current NCR system to the traditional NCR method of 'net operating capital ÷ risk amount,' while maintaining the current NCR of '(net operating capital − total risk amount) ÷ required maintained equity capital' for small and midsize securities firms as a differentiated approach."