The Bank of Korea expects that the surge in the won-dollar exchange rate to 1,450 won will not negatively impact the financial soundness of financial institutions. However, they noted that if short-term capital demand coincides with a rapid rise in exchange rates, some institutions could face challenges in liquidity management, requiring caution.
In a Financial Stability Report published on the 24th, the Bank of Korea assessed that the impact of the exchange rate increase on profits and losses would be limited, as domestic banks maintain a near-equilibrium between foreign currency assets and liabilities.
It indicated that there is little concern over an increase in the won-converted value of risk-weighted assets (RWA). This is because the share of foreign currency assets in domestic banks' RWA in the third quarter of this year is 22.6%, lower than 26.2% at the end of the third quarter of 2022, a previous period of rising exchange rates. RWA is calculated by assigning weights according to the risk level of money lent or invested by banks.
The decline in the liquidity coverage ratio (LCR), the minimum required holding ratio of easily cashable assets such as government bonds, is also expected to be minimal. The Bank of Korea explained that while there is downward pressure due to margin deposits related to foreign exchange derivatives, banks are conservatively managing their foreign currency liquidity, thereby maintaining the LCR.
The K-ICS solvency ratio, a capital adequacy indicator for insurance companies, is also unlikely to be affected by exchange rates. This is because most foreign currency assets held by insurance companies are hedged. Although a rise in hedging expenses may necessitate additional won funds or trigger margin calls, it is manageable given the scale of won-denominated bonds held by the insurers.
The negative impact on the net capital ratio (NCR), a capital adequacy indicator for securities companies, is also limited. The Bank of Korea noted that although the total risk amount, including foreign exchange risk amount, might increase due to the rise in the exchange rate, the securities firms' foreign currency 'net worth' position helps raise the net capital for business operations. Moreover, the effect of expanding foreign exchange risk amount and foreign currency asset-related credit risk amount resulting from exchange rate increases is not significantly reflected in the total risk amount.
The Bank of Korea stated, 'Overall, the negative impact of exchange rate hikes on the financial soundness of financial institutions is expected to be generally minor. However, there is a possibility of some financial institutions facing challenges in liquidity management if short-term capital demand coincides with a sharp exchange rate increase, thus caution is advised.'