Bank of Korea Responds to Legoland Incident with Additional Measures... Expanding Eligible Collateral Securities Scope

Market Stabilization Measures Approved at the Monetary Policy Committee Meeting on the 27th

[Asia Economy Reporter Seo So-jeong] As the liquidity crunch risk grows due to the Legoland asset-backed commercial paper (ABCP) crisis, the government has stepped up liquidity supply, and the Bank of Korea (BOK) will announce additional market stabilization measures on the 27th.

On the same day at 10 a.m., the BOK will hold a Monetary Policy Committee meeting and decide on measures including expanding eligible collateral securities for loans to include public institution bonds and bank bonds as part of market stabilization efforts. Earlier, on the morning of the 25th, the BOK held a Monetary Policy Committee members' consultation meeting to discuss the agenda items such as expanding eligible collateral securities, and the discussed measures are scheduled to be implemented after approval by the Monetary Policy Committee on the 27th.

Currently, banks provide only government bonds, monetary stabilization bonds, and government-guaranteed bonds as collateral when borrowing from the BOK. If the eligible collateral securities are expanded, banks will be able to use already held bank bonds as loan collateral, easing funding pressure. BOK Governor Lee Chang-yong said in a Q&A session after an emergency macroeconomic and financial meeting on the 23rd, "The BOK will discuss including bank bonds and public institution bonds in addition to government bonds as eligible collateral securities at this week's Monetary Policy Committee meeting." The BOK had recognized bank bonds as eligible collateral securities temporarily in March 2020 during the COVID-19 outbreak but ended this temporary measure at the end of March last year.

At the Monetary Policy Committee meeting on the day, attention will also focus on whether the BOK will implement additional measures beyond expanding eligible collateral securities. It is known that the BOK is considering postponing the scheduled increase of the 'Collateral Provision Ratio for Interbank Settlement' (settlement collateral ratio), planned for early next year, and maintaining it at 70%. In April 2020, at the early stage of the COVID-19 crisis, the BOK lowered the settlement collateral ratio from 70% to 50%, but raised it back to 70% in February this year, with plans to increase it to 80% next year.

However, considering the recent liquidity crunch, the Monetary Policy Committee is expected to discuss postponing this schedule. The market expects that if the BOK defers the increase of the settlement collateral ratio, it could help alleviate the liquidity crunch.

However, the reactivation of the Special Purpose Vehicle (SPV) for corporate liquidity support, which purchases corporate bonds and commercial papers (CP), or the special financial stability loans are unlikely to be included in this Monetary Policy Committee discussion. Governor Lee expressed a negative stance at the National Assembly's Planning and Finance Committee audit on the 24th, stating, "We may discuss reactivating financial stability loans or the SPV later, but I think it is not an appropriate policy to do so now." He particularly emphasized, "We cannot use excessive medicine at the beginning," and added, "There is a timing for measures, so we will act when necessary."

The securities industry is demanding the reactivation of the SPV, which supplies liquidity by purchasing corporate bonds and CPs including low credit ratings, as well as the special financial stability loans implemented during the COVID-19 crisis. However, since these measures involve direct intervention by the BOK to increase liquidity, they conflict with the current monetary policy, requiring a cautious approach from the BOK. There are concerns that this could lead to a backlash similar to the severe aftershocks experienced by the UK at the end of last month due to conflicting monetary and fiscal policies.

Market demands to ease the liquidity crunch continue. The previous day, Governor Lee held a dinner meeting with 15 bank CEOs, including Kim Kwang-soo, chairman of the Korea Federation of Banks, where calls for expanded market liquidity supply were raised.

A BOK official said, "Measures such as expanding eligible collateral securities for loans will be finally discussed and approved at the Monetary Policy Committee meeting this morning," adding, "The BOK is also considering various measures to stabilize the market."