Monetary Policy Workshop on Strengthening Macroprudential FrameworkMacroprudential Framework held by IMF Regional Office for Asia and Pacific(March 22~23, 2012, Tokyo)

MacroprudentialMacroprudential Policy Policy Framework:Framework:

The Case of KoreaThe Case of Korea

Tae Tae SooSoo Kang Kang Bank of KoreaBank of Korea

DISCLAIMER: This presentation represents the views of the author and not necessarily those of the BOK or BOK policy. The views expressed herein should be attributed to the author and not to the BOK, its management or its Monetary Policy Committee.

DISCLAIMERDISCLAIMER

The views expressed in this presentationThe views expressed in this presentation

DISCLAIMERDISCLAIMER

The views expressed in this presentation The views expressed in this presentation represent those of the presenter and do not represent those of the presenter and do not necessarily represent those of the Bank ofnecessarily represent those of the Bank ofnecessarily represent those of the Bank of necessarily represent those of the Bank of Korea. Korea.

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OutlineOutlineOutlineOutlineI.I. Potential Systemic Risks Unique to Korea Potential Systemic Risks Unique to Korea

II.II. MacroprudentialMacroprudential Measures DeployedMeasures Deployed1)1) M iM i d d thd d th1)1) Main Main rreasons we advanced these measureseasons we advanced these measures

2)2) Impacts of these measures Impacts of these measures

III.III. Possible Obstacles to ImplementationPossible Obstacles to Implementation-- Asymmetric impacts in addressingAsymmetric impacts in addressing procyclicalityprocyclicalityAsymmetric impacts in addressing Asymmetric impacts in addressing procyclicalityprocyclicality

I.I. Potential Systemic Risks Unique to KoreaPotential Systemic Risks Unique to Koreay qy q

C it l Fl V l tilitC it l Fl V l tilit1 Capital Flow Volatility Capital Flow Volatility

2 Household DebtHousehold Debt

Both factors affect systemic risk in terms of procyclicality. Implies Korean economy exposed more to systemic

risk in the time-varying dimension, than in the cross-sectional dimension. (B. Aydin, M. Kim and H. Moon: “Financial Linkages across Korean Banks”

1/14

( y gIMF ,WP/11/201, 2011)

In particular, strong procyclicality of capital flowsp , g p y y pamplifying business cycle fluctuation is a systemic risk factor common to emerging Asian countries

Capital Inflows to Asia & GDP Growth Capital Inflows to Korea & GDP Growth

35.0

40.0

12.0

14.0

Capital inflows/GDP(LHS)

(%) (%)

5.0

10.0

2 0

3.0

4.0

10 0

15.0

20.0

25.0

30.0

6.0

8.0

10.0 GDP growth (RHS)

10 0

-5.0

0.0

-2.0

-1.0

0.0

1.0

2.0

GDP Growth (RHS)

-5.0

0.0

5.0

10.0

0.0

2.0

4.0

01 02 03 04 05 06 07 08 09 10 11-20.0

-15.0

-10.0

-6.0

-5.0

-4.0

-3.0

00 01 02 03 04 05 06 07 08 09 10 11

Net Capital Flow/GDP (LHS)

Source: BOK staff calculation

(conjecture) Emerging Asian Economies may have high reliance for credit supply on capital inflows in the form of externalfor credit supply on capital inflows in the form of external liabilities, rather than on funding by domestic bank deposits.

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1 High Capital Flow VolatilityHigh Capital Flow Volatility1 High Capital Flow Volatility High Capital Flow Volatility

Capital Flows Financial Market Volatilities (std. dev*)250

Short-term debt(billion dollars)

221.9 0 35140

A B150

200

Short term debtBondEquity

.9

101.60.25

0.30

0.35

100

120

140 Won/Dollar FX rate (LHS)KOSPI (LHS)Treasury Bond Yield (3Y, RHS)

C

0

50

100

97 11~98 3 98 4~08 8 08 9~08 12 09 1~11 6 11 7~11 12 0.10

0.15

0.20

40

60

80

A B-100

-50

97.11~98.3 98.4~08.8 08.9~08.12 09.1~11.6 11.7~11.12-21.4

-69.6

-12.6

0.00

0.05

0

20

97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12C

(Asian Crisis)B

(Lehman Crisis) * 3-month moving averages

Source: BOK staff calculation

(EU Debt Crisis)

3/14

2 Rapid Increase in Household DebtRapid Increase in Household Debt2 Rapid Increase in Household DebtRapid Increase in Household Debt

High Level Household leverage at historic peak

Floating Rates Almost 90% of mortgage loansg g g

Household Debt-to-Disposable Income Mortgage Loans, by Interest Rate Type1)

155%Fixed Rate

10.1%

129%

Floating Rate 89.9%

2005 2006 2007 2008 2009 2010

Source : Bank of Korea

Sources : Bank of Korea, 9 major domestic banksNote: 1) As of end-2011 4/14

II.II. MacroprudentialMacroprudential Measures DeployedMeasures Deployedpp p yp y

1 Responses to Capital Flow Volatility Responses to Capital Flow Volatility

Capital Inflows Capital Outflows

International Cooperation

Ai d t t bili i h t t it l fl d t bli hi Aimed at stabilizing short-term capital flows and establishing backstop (safeguard) against sudden capital outflows

5/14

1) Main reasons we advanced these measures In open emerging markets, non-core liabilities take form of short-term

FX liabilities, increasing vulnerability to outbreak of crisis High capital flow volatility also causes interest and FX rate deviation

1) Main reasons we advanced these measures

High capital flow volatility also causes interest and FX rate deviation from economic fundamentals, thereby weakening monetary policy transmission channel

Non-core Liabilities of Korean Banks

Net FX Liabilities

(billion dollars) (%p)

Foreign Portfolio Investment and Term Spread

(trillion won) (billion dollars)

1 0

2.0

3.0

7.0

12.0Bond InvestmentEquity InvestmentTerm Spread

(billion dollars) (%p)

A B

400

500

600 FX borrowingDebt SecuritiesOthers

(trillion won)

A 150

200

250

short-term liabiliieslong-term liabiliies

(billion dollars)

A B

-1.0

0.0

1.0

-3.0

2.0

A B

100

200

300

A: Lehman CrisisB: EU Debt Crisis

B

50

100

150

Source: Shin & Shin (2010), updated by BOK staff

-2.0 -8.008.1 08.7 09.1 09.7 10.1 10.7 11.1 11.7 12.1

0

100

05 06 07 08 09 10 11

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005 06 07 08 09 10 11

2) Impacts of these measures (in response to capital inflows)

Effective so far Short-term External Debt Decreased Arbitrage Incentive Reduced Arbitrage Incentive Reduced Terms of Foreigners’ Bond Investment Lengthened

Foreign Bank Branches’Changes in External Debt before Foreigners’ BondForeign Bank Branches Arbitrage Incentive

Changes in External Debt, before and after ceilings

Foreigners Bond Investment, before and after

taxation

1.5 Arbitrage incentivesLevy rate(short-term)Moving Avg. of net arbitrage incentive

(%)

67 1100

150

200 (billion dollars)

7

9 short-term bond investment

long-term bond investment

(billion dollars)

Implementation(Jan. 11)

0.5

1.0

g g g

Arbitrage incentive Arbitrage incentive

60.4

171.8 67.1

-156.6 -100

-50

0

50

100

short-term external debtlong-term external debt

1

3

5

0.0 Jan-11 Apr-11 Jul-11 Oct-11

before levy Arbitrage incentiveafter levy

-200

-150

Before Ceiling(Apr. 09~Dec. 10)

After Ceiling (Jan. 11~Nov.11)

-3

-1

09.1Q 3Q 10.1Q 3Q 11.1Q 3Q

Announcement(Oct. 10)

Source: Bank of Korea 7/14

2 Responses to Household DebtResponses to Household DebtCaveat: more work needed to establish how much of changes in house price and loan growth attributable to macroprudential policy

Housing indicators (Seoul area) before and after loan regulation tightening1)

tightening

Mortgage loans2) House prices3) Housing transactions4)

1) Comparison between six-month periods before and after strengthening of loan regulations 2) In trillions of won 3) Apartment basis 4) In units of 10,000 * Source: Bank of Korea 8/14

III.III. Possible Obstacles Possible Obstacles to to ImplementationImplementation

Asymmetric impacts in addressing procyclicalityCountercyclical Buffers/ Dynamic Provisioning

pp

1 Countercyclical Buffers/ Dynamic ProvisioningCeilings on LTD/DTIAdjustments of Risk Weights on Specific Exposures

1

2

3 j g p p

More effective BoomMore effective during Boom

Boom DownturnLess effective during Bust

Countercyclical policy Credit cycle before MAPPActual credit cycle after MAPP

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1 Countercyclical Buffer (CCB)Countercyclical Buffer (CCB)

Boom: E+w A?D bt b t ff ti i dit t l

1 Countercyclical Buffer (CCB)Countercyclical Buffer (CCB)K: capital ratioE: equity

• Doubts about effectiveness in credit control • Despite regulators’ deployment of CCB,

banks still have incentive to increase more profitable loans.

w: risk weightA: asset value

• Impacts may be offset by time lag, or less effective in periods of rapid credit expansion, since banks given transition period up to 12 months to meet CCB targets.

?

Boom DownturnB

Bust: E+ w A?• Doubts about effectiveness in mitigating

deleveraging (slowing decrease in A) Boom

• Under uncertainties about duration of financial crisis, banks likely to opt to maintain their capital buffer targets set during boom, out of concerns that declines in their capital ratios

?

Countercyclical policy Credit cyclemight be interpreted as aggravated financial soundness

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2 Ceilings on DTI/LTVCeilings on DTI/LTV2 Ceilings on DTI/LTVCeilings on DTI/LTV

BOOM BUST

?

Effective in limitingexcessive credit provision by banks during economic

May be less effective in improving liquidity conditions or supply of credit Despite eased LTV/DTI limits, banks

upturns likely to focus on cash hoarding rather than lending

4,000

5,000

6,000

Tightening of LTV

Introduction of DTI (Aug. 05)

Tightening of DTI (Feb. 07)

Tightening of DTI (Sep. 09)

(billion won )

Loosening of DTI (Nov 08)

Loosening of DTI (Aug. 10)

Mortgage Loan Fluctuations1)

1,000

2,000

3,000

4,000 g g(Oct. 03)

(Nov. 08)

0

1,000

Jan-03 Jul-03 Jan-04 Jul-04 Jan-05 Jul-05 Jan-06 Jul-06 Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10

Source: Bank of Korea 11/14

Empirical Test on Determinants of Loan SizeEmpirical Test on Determinants of Loan Size

Dependent Variable: Household Loans (with income information)2006

(Tighter DTI)2007

(Tighter DTI)2008

(Eased DTI)2009

(Tighter DTI)2010

(Eased DTI)2011

(Tighter DTI)

Financial VariablesLog (collateral value) 0.705*** 0.622*** 0.653*** 0.782*** 0.687*** 0.621***Income of Borrower 0.009*** 0.022*** -0.003*** 0.010*** 0.014*** 0.011***co e o o o e 0.009 0.022 0.003 0.010 0.014 0.011Interest Rate (CD yield)1) -0.072*** -0.029*** -0.095*** -0.136*** -0.043*** 0.072***High Credit2) dummy 0.082*** 0.038*** -0.059*** 0.089*** 0.046*** 0.048***Gangnam3) dummy 0.045*** 0.075*** 0.171*** 0.003*** 0.088*** 0.111***

Non-financial VariablesInterest Only Payment4) dummy -0.164*** -0.043*** 0.059*** 0.118*** 0.101*** 0.006***Group Loan dummy 0 019*** 0 017*** 0 035*** 0 089*** 0 083*** 0 007***Group Loan dummy -0.019 0.017 0.035 0.089 0.083 -0.007Business Owner5) dummy 0.023*** 0.024*** 0.026*** 0.042*** 0.034*** 0.029***Maturity 0.025*** 0.021*** 0.015*** 0.015*** 0.020*** 0.023***

Regulatory VariablesLTV dummy -0.093*** -0.046*** 0.004*** -0.102*** -0.031*** -0.116***DTI dummy -0.051*** -0.096*** -0.066*** -0.046*** -0.008*** -0.019***

CConstant 2.431*** 2.858*** 3.110*** 1.230*** 1.963*** 2.583***Adj. R2 : 0.364Obs. : 48,016

Adj. R2 : 0.308Obs. : 35,530

Adj. R2 : 0.295Obs. : 55,698

Adj. R2 : 0.332Obs. : 71,545

Adj. R2 : 0.292Obs. : 72,481

Adj. R2 : 0.282Obs. : 40,985

Analysis shows LTV/DTI to have asymmetric policy impacts: regulation tightening more effective than regulation easing

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3 Adjustment of Risk Weights on Specific Exposures (ARW)Adjustment of Risk Weights on Specific Exposures (ARW)3 Adjustment of Risk Weights on Specific Exposures (ARW)Adjustment of Risk Weights on Specific Exposures (ARW)

<Operating Mechanism of ARW>

Increase in credit risk in a particular asset, AiIncrease in credit risk in a particular asset, Ai

Operating Mechanism of ARW

Upward adjustment of risk weights for loans to the asset (wi)Upward adjustment of risk weights for loans to the asset (wi)

Increase in capital requirements (K)Increase in capital requirements (K)

Incentive to reduce exposure to the asset (Ai)Incentive to reduce exposure to the asset (Ai)

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<Banks’ Responses in Unintended Direction>p: Regulator’s action and intended

direction of banks’ response: Banks’ responses in reality

Excessive concentration on a particular asset, AiExcessive concentration on a particular asset, Ai

: Banks responses in reality

Upward adjustment of risk weights for loans to the asset (wi), and resultant tightened capital requirement (K) Upward adjustment of risk weights for loans to the asset (wi), and resultant tightened capital requirement (K) g p q ( )g p q ( )

Banks’ ReponsesR it li i (E )

Banks’ ReponsesR it li i (E )1 Recapitalizing (E )Reducing other assets(Aj ) with lower risk weights and returnsRecapitalizing (E )Reducing other assets(Aj ) with lower risk weights and returns

According to UK FSA (2009),

1

2

According to UK FSA (2009), ARW (wi) E 50%, exposure to other assets 25%

exposure to targeted asset 25% 14/14