[Why&Next] "Can't See an Inch Ahead" Shadow Banking Regulations, Confused Banks

Interest Rates Rise and Household Debt Increases Again
Financial Authorities Face Widespread 'Shadow Regulation'
Set Direction with Verbal Warnings, Administrative Orders, and Model Guidelines
Financial Consumers Struggle, Banks Face Management Difficulties as 'Side Effects'

"Because middle-aged customers should feel less unfair." On the 24th of last month, an internet bank changed the design of its 50-year maturity mortgage loan. While the 15-, 25-, and 25-year maturity products apply equally to all ages, the longest maturity product was structured differently. Customers can only choose maturities of '50 years up to age 34,' '45 years for ages 35 to 39,' and '40 years from age 40 onwards.' This was a desperate measure taken after the Financial Services Commission pointed to 50-year maturity mortgage loans as a cause of household loan growth and said it would "consider age restriction measures."

That’s not all. Even the mortgage loan interest rates in the 3% range, which existed as recently as early August, have disappeared. This is because the authorities identified "low-interest non-face-to-face loans" as another main culprit for the increase in household loans. The Financial Supervisory Service conducted an on-site inspection at the end of last month, stating, "We will check whether internet banks are thoroughly reviewing borrowers' income and managing delinquency risks." The frustrating party here is the consumer. Mr. Kim Woosik (33), who tried to get a mortgage loan here, said, "I heard internet banks had the lowest interest rates, so I checked, but the rates had already risen," adding, "I was trying to get a loan with a 40-year maturity after considering various conditions, but that also became impossible."

Financial Services Commission Chairman Kim Ju-hyun is delivering opening remarks at the meeting between the Financial Services Commission Chairman and Financial Association Presidents held on the 22nd at the Press Center in Jung-gu, Seoul. Photo by Yoon Dong-joo doso7@

Not a Law, but More Powerful Than One

Although not laws, the intensity of 'shadow financial regulations' that exert power comparable to laws is increasing. This is why financial sector employees point out that "policy predictability has decreased further under the current government." As loan interest rates rose, household debt began to trend upward, and delinquency rates increased, the soundness of financial companies drew attention, leading to a flood of directives from the authorities. These directives mostly appear as verbal recommendations, guidelines, administrative guidance, or model codes. An executive at a commercial bank said, "I somewhat agree that these are well-intentioned interventions to put out urgent fires, but if administrative actions without legal basis become widespread, side effects also arise."

Back in July last year, no one expected this. At that time, Lee Bokhyun, the newly appointed head of the Financial Supervisory Service, launched a task force saying, "We will improve unreasonable financial supervisory practices (shadow regulations)." The goal was to codify necessary shadow regulations and eliminate those without practical benefits. But so far, the situation has gone in the exact opposite direction. The industry evaluation is that "for over a year, shadow regulations have influenced everything from frequently signaling 'raise interest rates, lower interest rates' and intervening in market prices to replacing CEOs of financial holding companies, thus controlling important management matters of banks."

More Hidden Regulations Than Legal Ones

No one knows exactly how many shadow regulations financial companies currently feel exist. Although the Regulatory Information Portal lists the number of legally codified regulations by the Financial Services Commission, there is a large gap with reality. A financial authority official said, "This number does not match the number of regulations felt in the financial market." However, it can be roughly estimated from past records. In 2014, then Financial Services Commission Chairman Shin Je-yoon conducted a full survey over four months, saying, "We will discover and promote improvements to hidden regulations in the financial field." The survey revealed a total of 3,100 regulations. Hidden regulations (2,000) far outnumbered legal regulations (1,100). According to a Financial Services Commission press release at the time, "Because reforms have focused mainly on legal regulations, many regulations are relatively hidden within policy financial institutions and financial sector associations."

These shadow regulations sometimes hamper financial company management. One key indicator showing a financial company's loss-absorbing capacity in crisis situations is the Common Equity Tier 1 (CET1) ratio. It shows how much common equity capital is secured relative to risk-weighted assets. The regulatory minimum is 8% for the five major banks and 7% for other banks, but the authorities demand higher levels. In March, the Financial Services Commission analyzed that "as of the end of September last year, the domestic banking sector's CET1 ratio was 12.26%, which falls short of major advanced countries such as the European Union (14.74%), the United Kingdom (15.65%), and the United States (12.37%)." A commercial bank official said, "Although there are codified regulations, these are ignored, and the tacit rule between the authorities and banks is that the ratio should never fall into single digits," adding, "This becomes an obstacle when acquiring subsidiaries or needing to retire common shares."

The financial sector worries that if shadow regulations without records or grounds continue, side effects will arise where no one takes responsibility when problems occur. A deputy head of a commercial bank said, "The Financial Supervisory authorities' directives are usually packaged as if banks voluntarily implement them through the Korea Federation of Banks," adding, "If public opinion is favorable and the president praises them, the authorities can say they gave the instructions, but if problems arise, the authorities step back and the banks bear the burden entirely."

Shadow Regulations: 'Should Be Blocked' vs. 'Necessary'

There are voices calling for institutional measures to block shadow regulations. Sung Daegyu, chairman of the Shinhan Life board and a former Financial Services Commission official, wrote in his book titled 'Shadow Financial Regulations' that to reduce model codes, administrative guidance, excessive reporting, subordinate regulations, and personnel interventions, "a 'Financial Regulation Innovation Act' should be enacted to establish the principle of rule-of-law finance." Among these, Sung pointed to model codes as a representative shadow financial regulation. When the authorities want to create a binding norm without it being a law, they use financial-related associations to create model codes. Sung argued that financial companies should not incorporate these model codes into their internal standards, nor should they be penalized for violations. He also opposed administrative guidance on financial product prices such as interest rates and fees.

There is also an opinion that shadow regulations are necessary given the characteristics of the financial industry. The 2011 case of lowering credit card merchant fees for small business owners shows the limited options available to financial authorities. At that time, the National Assembly pressured the authorities, saying, "Why don't you work for the socially vulnerable small business owners?" Without legal authority to lower credit card fees for small merchants, the authorities could only convene card company meetings and make phone calls. Subsequently, fees were lowered several times.

Professor Sung Tae-yoon of Yonsei University's Department of Economics said, "Shadow regulations are necessary for parts where monopoly power is exercised, such as banks operating under licenses," and "For example, it is difficult to rigidly handle DSR (Debt Service Ratio) through law, and much of financial activity is hard to regulate by law, so supervisory authorities inevitably intervene at their discretion."