The government said on the 18th it will not impose penalties tied to the foreign-currency liquidity stress test until the end of June next year so domestic banks can release dollars into the market instead of stockpiling them. The stress test is a system under which banks regularly assess their capacity to respond to dollar funding needs by assuming crisis scenarios. It has been cited as a factor prompting banks to hold more dollars than needed.
The government will also expand the forward FX position (the value of forward foreign-currency assets minus forward foreign-currency liabilities) limits for domestic subsidiaries of foreign banks. As the volume banks can handle in forward FX increases, dollar supply can be expected to rise.
The Ministry of Economy and Finance, the Financial Services Commission, the Bank of Korea, and the Financial Supervisory Service announced a "flexible adjustment plan for foreign-exchange soundness regulations." As the won-dollar exchange rate steadily climbed and topped 1,480 won during trading the previous day, the government decided to ease foreign-currency regulations applied to financial companies, exporting corporations, and foreign companies.
◇ Easing the burden of excessive dollar holdings for banks
The government decided to defer penalties under the banks' foreign-currency liquidity stress test until the end of June next year. Banks that fail the test must submit liquidity strengthening plans to financial authorities. As a result, banks have held more dollars than needed for actual operations. Penalties were to be imposed based on the results of the third-quarter test conducted at the end of September, but the measures were delayed amid the recent high exchange rate.
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The government will also raise the forward FX position limit for domestic subsidiaries of foreign banks from 75% to 200%. With this relaxation, Standard Chartered Bank Korea and Citibank Korea will be able to bring in more dollars from their headquarters. Typically, banks supply foreign-currency funds through a transaction in the FX swap market in which they lend foreign currency and borrow won.
For example, if a domestic Bank A has 10 trillion won in equity capital, the current forward position limit is 75%, or 7.5 trillion won. If this position limit is filled, the bank cannot sell additional dollars in the market even if it wants to. But if the limit is raised to 200%, Bank A can conduct transactions of foreign currency worth 20 trillion won in the market.
◇ Easing foreign-currency loans for exporting corporations and improving convenience for foreign investors in Korea
The government will further ease restrictions on "foreign-currency loans for won-denominated uses" for exporting corporations. This system allows companies to borrow dollars for expenditures to be paid in won, such as labor costs and raw material payments. Previously, it was allowed only for facility funds like factory equipment investment, but going forward foreign-currency loans will be available for routine operating funds as well.
It will also become easier for foreigners to invest in domestic stocks. Until now, foreigners had to open an account at a domestic securities firm to buy Korean stocks. The government will promote the "integrated foreign investor account" so foreigners can trade Korean stocks directly through their home-country securities firms. It is similar to how Koreans buy U.S. or Japanese stocks through domestic securities firms.
Inconveniences faced by foreign corporations listed on overseas exchanges when conducting FX hedging transactions in Korea will also be resolved. FX hedging is an investment technique used to reduce the risk of losses from fluctuations in the value of foreign currency such as the dollar. For example, if 1 dollar is 1,400 won when investing in overseas stocks, one would sign a contract in advance to receive 1,400 won per dollar when selling the stocks later.
Although foreign corporations legally qualify as professional investors, in practice they were classified as retail investors and had to submit documents proving the actual transaction purpose for each FX derivatives transaction. The government plans to recognize foreign corporations listed overseas as professional investors without separate verification so they can conduct FX hedging transactions without complex prior paperwork.
☞ Foreign-currency liquidity stress test
This evaluates whether a financial company can withstand a crisis scenario in which foreign-currency funds rapidly flow out. To pass, it must maintain a state in which foreign-currency inflows exceed outflows at the one-month and three-month points after a crisis occurs. Currently, all commercial banks, 18 securities firms, and 10 insurers are subject to the stress test.
☞ Forward FX position
A forward FX contract is an agreement to buy or sell at a predetermined exchange rate to reduce exchange-rate risk. When exporting corporations sell forward dollars to block future fluctuations in incoming dollar values, domestic and foreign banks take the other side (buying the forward), and the transaction is executed. However, to hedge risks from buying forwards, banks simultaneously sell spot FX. This process leads to short-term dollar borrowing. The forward FX position is the "ratio of forward holdings to equity capital," and the government caps it within a certain limit to curb excessive dollar borrowing and the resulting foreign-currency liquidity instability.