As the aftereffects of the 'state of emergency' in the foreign exchange market grow, the government is considering measures such as 'expanding the forward exchange position limits' and 'easing liquidity coverage ratio (LCR) regulations for banks.' The aim is to ensure smooth dollar supply in the market by significantly loosening short-term foreign debt liquidity regulations, which have been in place to maintain foreign exchange soundness.
According to the Bank of Korea and the Ministry of Strategy and Finance on the 12th, the foreign exchange authorities plan to announce a 'structural improvement plan for foreign exchange supply and demand to promote foreign currency inflow' as early as this month.
This measure comes in response to the surge in political uncertainty following the Dec. 3 state of emergency, which led to a large-scale withdrawal of foreign investment funds and a spike in the won-dollar exchange rate. Recently, the won-dollar exchange rate has jumped to around 1,440 won per dollar during the day's trading.
The government is reviewing measures such as ▲ expanding the forward exchange position limits ▲ easing bank LCR regulations. The forward exchange position limit refers to the cap on the amount of forward exchange that banks and others can hold relative to their capital. Increasing the limit on the amount banks can transact (foreign currency asset-liability) in the foreign exchange futures market could expand banks' ability to supply foreign currency funds, potentially resulting in increased dollar supply.
Currently, this limit is restricted to 50% of their capital for domestic banks and 250% for local branches of foreign banks. These limits have remained unchanged since their introduction in October 2010. Although there have been instances where the limits were tightened to 30% and 150%, respectively, they have never been relaxed beyond the current 50% and 250%.
Another measure, the LCR, refers to the high-liquidity assets such as dollars and U.S. Government Bonds that banks must set aside to prepare for net foreign currency outflows over the next 30 days. If the LCR is 80%, banks must hold at least $800 million if the anticipated net foreign currency outflow over 30 days is assumed to be $1 billion. If the government relaxes this ratio, the pressure to secure dollars may decrease, leading to a smoother dollar supply.
The current foreign currency LCR regulation for banks is 80%. During the early days of the COVID-19 pandemic, when the foreign currency liquidity situation for banks worsened, it was lowered to 70% in March 2020. The government is also implementing integrated (Korean won + foreign currency) LCR regulations, which are set to be normalized to 100% as of Jan. 1 next year. The potential halt of this normalization schedule is also being discussed.
These systems have been established over the past decade to strengthen South Korea's 'foreign exchange soundness.' In particular, the forward exchange position system was introduced during the 2008 global financial crisis when short-term foreign debt surged, causing instability in the foreign exchange market, as a measure to curb excessive capital inflows. While initially introduced to prepare for a long-term decline in the won-dollar exchange rate, thereby strengthening the Korean won, it is now being utilized in the opposite direction. The decision appears to be based on an assessment that even short-term foreign debt should be encouraged to enter the market to improve supply and demand conditions.
The foreign exchange authorities explain that these measures are not solely because of the state of emergency. Due to the lingering trauma from the International Monetary Fund (IMF) foreign exchange crisis, South Korea's foreign exchange supply and demand policy has consistently been 'difficult to bring in, relatively easy to let go.' However, it is now believed there is a sufficient foundation to shift this structure.
A Bank of Korea official noted, 'We have been considering easing measures to improve the asymmetric foreign exchange supply and demand policy for 2-3 years,' adding, 'This regulatory easing is not something that emerged suddenly, but rather a more accelerated implementation of policies that should have already been pursued (in light of the current situation).'
Regarding concerns about the potential deterioration of foreign exchange soundness due to regulatory easing, it was explained that 'when evaluating the soundness of the foreign exchange institutional sector, not only the size of short-term foreign debt but also various standards are considered.' They further noted, 'if regulatory easing leads global credit rating agencies or the IMF to assess that Korea's potential foreign exchange sector soundness has weakened, that would be more harmful than beneficial, so this is being fully considered.'
Depending on the situation, unprecedentedly bold measures for regulatory easing, which have not been seen in the past, might be implemented. On the 10th, Vice Prime Minister and Minister of Strategy and Finance Choi Sang-mok stated, 'Regarding excessive market volatility, we will respond 'actively' enough to reverse market sentiment.' As a result, there are speculations in the market that even the abolition of the forward exchange position system might be considered.
If regulatory easing is implemented, it could play a 'psychological relief' role by signaling that the foreign exchange authorities are committed to stabilizing foreign exchange supply and demand. However, given the significance and the particularity of the political situation caused by the state of emergency, there are concerns that such measures can only be temporary solutions. A foreign exchange authority official stated, 'We will present measures after discussions with relevant institutions between this month and early next year.'