[Exclusive] Foreign Exchange Market Shaken by Gye-eom Wave... "Considering Expansion of Forward Exchange Positions"

Announcement of 'Foreign Exchange Supply Improvement Measures' in December
Review of Deregulation on Forward Exchange and LCR
First Institutional Improvement Since COVID-19

The government is considering expanding banks' forward foreign exchange positions for the first time in 4 years and 9 months. This is to cope with the rising instability in the foreign exchange market amid the martial law and impeachment political situation. The Ministry of Economy and Finance and the Bank of Korea will announce these measures as part of a liquidity easing policy under the 'Foreign Exchange Supply and Demand Improvement Plan' later this month.

Yonhap News

Easing Foreign Currency Liquidity Regulations

According to multiple officials from fiscal and monetary authorities on the 10th, the government is reviewing the expansion of banks' forward foreign exchange positions to improve banks' foreign currency procurement conditions. The forward foreign exchange position is the value obtained by subtracting forward foreign currency liabilities from forward foreign currency assets. The government regulates the limit on forward foreign exchange positions, and expanding this limit results in an increase in foreign currency funds.

Typically, banks use forward foreign exchange in the foreign exchange swap market for hedging, fundraising, and liquidity management. They lend and borrow foreign currency and Korean won as needed. However, under the current Foreign Exchange Transactions Regulations, domestic banks can only hold forward foreign exchange positions up to 50% of their capital, and foreign bank branches in Korea up to 250%. This means that even if they want to procure more foreign currency, it is impossible once the limit is reached.

As a result, situations have occurred in the foreign exchange market where banks had sufficient capacity but foreign currency procurement was blocked. A Ministry of Economy and Finance official said, "While foreign currency outflows are freely allowed, foreign currency inflows are tightly controlled," adding, "Because the balance is off, authorities have been considering loosening restrictions on foreign currency inflows as well." He further explained, "(Expanding forward foreign exchange positions) is intended to rationalize foreign exchange policy."

This measure is the first since March 2020, about 4 years and 9 months ago. On March 17 of that year, as the won-dollar exchange rate surged to its highest level in 10 years and the foreign exchange market was volatile, the government increased the limits for domestic banks from 40% to 50% and for foreign bank branches from 200% to 250% the next day. At that time, the daily trading volume in the domestic swap market was about $12 billion, and the government analyzed that the deregulation led to an additional inflow of foreign currency funds amounting to $5 billion to $10 billion.

The current discussions also emerged amid a soaring exchange rate. Since President Yoon Suk-yeol declared martial law on the 3rd, the exchange rate has been rising daily. On the 9th, the won-dollar exchange rate rose 17.8 won from the previous day to 1,437 won. On a weekly basis, this is the highest level in 2 years and 1 month since October 24, 2022. There are even forecasts that it could rise to the 1,500 won level if foreign capital continues to flee. The government believes that increasing forward foreign exchange positions could influence exchange rate stability, as the capital market and foreign exchange market are connected.

In particular, the government expects to prevent a dollar shortage crisis in advance. Currently, foreign exchange supply and demand is stable, so there is no significant problem, but if any disruption occurs, a severe shock is inevitable. Another Ministry of Economy and Finance official said, "If foreign currency funds cannot be procured, companies will worry about survival and financial institutions about bankruptcy," adding, "Given the high economic uncertainty, this is like building a breakwater to allow the private sector to borrow foreign currency funds proactively."

The side effects of expanding the limit are expected to be limited. Expanding forward foreign exchange positions increases foreign currency borrowing and worsens soundness indicators. A financial authority official asserted, "Since the soundness of the foreign exchange market is sufficiently secured, the risks from deregulation will be limited." A foreign exchange authority official also evaluated that negative effects are unlikely, saying, "Currently, external credibility and the soundness of financial institutions are sufficient, and overseas net financial assets are ample."

All-Out Efforts to Ease Market Instability

Other measures for foreign exchange supply and demand are also being discussed. Easing the foreign currency Liquidity Coverage Ratio (LCR) regulation is also under consideration. Currently, banks are required to hold liquidity equivalent to 80% of foreign currency liabilities maturing within 30 days. Because of this, some banks with sufficient soundness cannot efficiently utilize the foreign currency funds market, according to financial sector claims.

During inter-agency consultations, calls to ease the Financial Supervisory Service's stress tests were also raised. This is regarded as part of a comprehensive plan to respond to the recently heightened market instability and enhance the stability of the foreign exchange market. The market expects that this regulatory easing measure will have a positive impact on securing liquidity in the domestic foreign exchange market.

A Bank of Korea official said, "We are currently listing various measures," adding, "We are distinguishing between those that can be implemented immediately and those that require a time lag, designing them in a way that is practically helpful."

Meanwhile, fiscal and monetary authorities are making all-out efforts to secure overall market stability. Kim Byung-hwan, Chairman of the Financial Services Commission, emphasized, "We are monitoring the financial market situation 24 hours a day and will ensure that market stabilization measures prepared for each sector, such as the 10 trillion won Securities Market Stabilization Fund (Securities Stabilization Fund), the 40 trillion won Bond Market Stabilization Fund (Bond Stabilization Fund), corporate bond and commercial paper (CP) purchase programs, and foreign currency liquidity supply by Korea Securities Finance Corporation, are implemented timely."

A Financial Services Commission official explained, "The Bond Stabilization Fund alone is currently operated at about 20 trillion won, and including corporate bond purchase programs operated by KDB Industrial Bank and IBK Industrial Bank, the total is about 40 trillion won." He added, "We purchased bonds and received repayments last week as well, and will continue to buy bonds in November, trading CP and corporate bonds according to market conditions," but also noted, "Currently, the corporate bond market is not in a highly unstable situation." Regarding the Securities Stabilization Fund, he said, "We can only say that it is prepared to be activated immediately whenever momentum arises."

The Ministry of Economy and Finance, led by Deputy Prime Minister and Minister of Economy and Finance Choi Sang-mok, is focusing on calming anxiety. After the declaration of martial law, Deputy Prime Minister Choi sent urgent letters to finance ministers of various countries, heads of major international organizations, and global credit rating agencies. He then met with the International Monetary Fund (IMF) and continued meetings with foreign media, foreign investors, and ambassadors of major countries. The Ministry of Economy and Finance stated that this is an effort to convey that there are no problems with the Korean economy.