February 13, 2018

IMF issued staff report and selected issues report in the context of the 2017 Article IV consultation with Korea. Directors highlighted that the financial system is sound and macro-prudential policies are effectively addressing financial stability challenges, including from high household debt. They encouraged the authorities to remain vigilant to emerging risks, especially from non-bank financial institutions. Directors considered that the regulatory burden for firms should be eased, especially in the service sector.

The staff report highlighted that the regulatory reforms are strengthening the resilience of the financial system. Capital ratios of banks are well above the regulatory minimum, at 14.8% in 2016. A Basel III capital surcharge on five domestic systemically important banks and a countercyclical capital buffer (CCyB) were put in place in 2016 and will be phased-in gradually. The surcharge will rise to 1% in 2019. The CCyB has not been activated yet. Its maximum size is of 2.5% of risk-weighted assets; however, it is likely to remain low, owing to the slowdown in credit growth. Banking system liquidity is improving, with the loan-to-deposit ratio at 119%. Bank asset quality is good, with a non-performing loan (NPL) ratio of 1.25%. Indicators of financial soundness for non-bank financial institutions (NBFIs) are also strong, although their NPL ratios tend to be higher than those of banks, reflecting the generally lower quality of borrowers. Part of the increase in capital ratios in 2016 was due to lower risk-weights. The supervisory authorities are tightening and harmonizing regulation across different types of financial institutions, which should help contain further migration of credit risk from banks to NBFIs. Rising interest rates could pose a risk to asset quality. Low interest rates have contributed to low NPLs by making repayment easier; however, asset quality could deteriorate with a large hike in interest rates. Stress tests of interest rate increases are essential to assess asset quality and credit risk.

The staff report reveals that the supervisory authorities conduct a range of bottom-up and top-down stress tests for banks at an annual or quarterly frequency. Top-down stress testing, involving common macroeconomic risk scenarios for the financial system, will be extended to NBFIs next year. Bottom-up stress tests are already being applied to individual NBFIs and generally show a high level of resilience. Measures targeting external financing risks of banks have been adjusted as the macro-prudential policy framework was overhauled. In January 2017, substantial reforms of the macro-prudential policy framework targeting external risks were implemented. They included a new currency-differentiated liquidity coverage ratio (FX-LCR) and the abolishing of five existing measures that overlapped with the FX-LCR. A standard Basel III net stable funding ratio (NSFR) is being implemented; making it currency differentiated was considered unnecessary, given that currency mismatch risks are low.

The selected issues report discusses topics related to enhancing the monetary policy framework in Korea; strategy for Korea's fiscal policy in a low-growth environment; Korea's integration into global value chains and external balance; macro-prudential policy and high-household debt; labor market duality in Korea; new minimum wage policy in Korea; and recent trends in financial performance and investment of largest companies in Korea.

 

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Keywords: Asia Pacific, Korea, Banking, NBFI, Basel III, NPL, Macro-Prudential Policy, Stress Testing, IMF

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