Banks Supply 60% of Real Estate Credit... Easing Capital Regulations Needed to Boost Corporate Finance [Financial Innovation: Designing Growth] ①

Banks Supply 58.6% of Real Estate Credit
Corporate Lending Disadvantaged by Capital Requirements
Limits to Easing RWA Regulations... Basel III Compliance Required
Capital Expansion Is an Easier Path for Banks
Securing Capacity for SME Lending

Editor's NoteRecently, financial reform has emerged as a key political agenda in the United States and Europe. The main issues include adjusting regulations that were strengthened after the 2008 global financial crisis, easing bank prudential regulations, and shifting toward a capital market-centered financial structure. These reforms stem from the awareness that finance is not effectively serving as a catalyst for economic growth. In Korea as well, the need to redesign financial policy is increasing. The core is to achieve a balanced redesign among capital and lending, consumer protection and innovation, control and autonomy, and discipline and growth. The next administration must pursue a 'balanced reform' that fosters autonomy and innovation, so that finance can once again function as a catalyst for economic growth by supporting strategic industries and innovation-led growth. In light of the rapidly changing domestic and international environment, Asia Economy has examined the direction and challenges of financial regulation. This series focuses on shifting from 'reform that eliminates regulation' to 'regulation that enables growth.' Beyond simple deregulation, we aim to present policy alternatives for designing a balanced financial ecosystem where autonomy and innovation can coexist.

As of the end of 2024, the size of real estate credit in Korea stood at 1,932.5 trillion won, accounting for 49.7% of total private sector credit. This means that half of the funds supplied by financial institutions are channeled into real estate. Among financial institutions, banks provide 58.6% (1,132.2 trillion won) of real estate credit.

The concentration of credit supply in the real estate market is also negative from a macroeconomic perspective. This is because funds are not being allocated to high-tech industries that drive the Korean economy, resulting in a gradual weakening of growth momentum. Banks alone cannot be blamed. The current policy direction favors the supply of real estate credit. For this reason, voices within the financial industry are growing louder for regulatory easing that would allow for an expansion of corporate finance, as long as bank soundness is not compromised.

Corporate Lending Disadvantaged Under BIS... Capital Requirements for Stocks and SME Loans Should Be Eased

There are calls to ease regulations on risk-weighted assets (RWA) for corporate loans and stocks in order to redirect finance, which is currently concentrated in real estate, into more productive sectors. The assets held by banks have different RWA ratios. In Korea, the average RWA ratio for household loans is 15%, but for corporate loans it is around 45%. As the RWA ratio increases, the capital adequacy ratio decreases, so banks inevitably prefer household loans from a capital soundness perspective. This is why banks have a high proportion of household loans, especially stock-collateralized loans.

A senior official at a major commercial bank said, "Last year, we deliberately reduced corporate loans starting in the fourth quarter to meet the Common Equity Tier 1 (CET1) ratio," adding, "To manage capital soundness, we have no choice but to reduce loans focused on corporate lending, which has a high RWA."

The financial industry is calling for a reduction in risk weights when applying the RWA calculation model. Large commercial banks can choose between the internal model and the standardized model when calculating RWA during the loan screening process. The internal model requires financial institutions to directly estimate expected losses and recovery rates, making it difficult to apply regulatory easing uniformly.

It is known that for the standardized model, the RWA ratio can be adjusted. Since the calculation involves multiplying the predetermined RWA for each asset by the loss compensation value, even a slight reduction in the standard lowers the burden on banks.

There is also a need to ease the rigid method of estimating risk values in the household loan sector. Most banks apply the internal model to both household and corporate loan assessments. Lee Hyoseop, Senior Research Fellow at the Capital Market Research Institute, said, "Rather than directly modifying the standardized model itself, it is possible to consider ways to reduce RWA if certain conditions are met depending on the type of risk-weighted asset," adding, "For example, depending on how the requirements for qualified collateral loans within mortgage loans are interpreted, the RWA can be lowered."

Lee further stated, "For household loans, the internal model is uniformly applied to mortgages and individual business owners, but for self-employed and small business owners, the standardized model could be applied, or the risk value could be calculated more reasonably," adding, "Small business owners have a high default rate, which results in a high RWA, but if regulations are eased, it would both achieve the goal of supplying funds to ordinary people and reduce the capital soundness burden on banks."

Authorities Must Comply with Basel III... Considering RWA Easing Using Public Funds

Although the Financial Services Commission is actively pursuing regulatory easing, there are limitations. This is because Korea follows the Basel III regulations introduced by the Basel Committee on Banking Supervision (BCBS) under the Bank for International Settlements (BIS).

Basel III is a set of regulations established after the 2008 global financial crisis to enhance the soundness of financial institutions. Banks worldwide are required to maintain a CET1 ratio of 4.5%, a Tier 1 capital ratio of 6%, and a BIS ratio of at least 8%. However, the Financial Services Commission has strengthened the standards, recommending that financial companies under financial holding companies maintain a consolidated CET1 ratio of 12-13% or higher since January 2023.

While the Financial Services Commission is showing a willingness to ease regulations, it maintains that it cannot deviate from global regulatory standards. An official from the financial authorities emphasized, "The authorities cannot unilaterally ease regulations beyond the scope of Basel III," adding, "Although each country has discretion to ease regulations, violating Basel III would result in penalties for all Korean financial institutions."

Financial Services Commission Chairman Kim Byunghwan also commented at a monthly press briefing on May 7, "We cannot violate international rules such as RWA and capital regulations. We are in discussions with banks to find ways to help within that framework."

The measure currently under consideration by the Financial Services Commission is the so-called 'Equity Investment Guideline.' Currently, when domestic banks invest in corporate equity, an RWA of 400% is applied. If public institutions such as the Korea Credit Guarantee Fund or the Korea Technology Finance Corporation provide guarantees, the RWA ratio can be lowered. However, banks must inquire with the Financial Supervisory Service each time to confirm government guarantees and whether the RWA can be reduced.

An official from the Financial Services Commission said, "When inquiries are made about stock holdings, interpretations can differ depending on the person in charge, and it has taken a long time to make equity investment decisions," adding, "We are preparing guidelines to enable banks to make investment decisions quickly without the burden of capital regulations." The aim is to ease RWA regulations within the scope of Basel III.

The Situation in Europe, Where Banks Dominate Finance, Is Similar... Attention on Former ECB President Draghi's Financial Reform Proposal

Mario Draghi, former President of the European Central Bank (ECB), presented some interesting points in his report "The Future of European Competitiveness" released on September 9, 2024. He points out that structural transformation, beyond regulatory easing, is needed so that finance can play a role in supplying funds to high-growth sectors. In the report, Draghi argued, "We must assess whether current prudential regulations, including the implementation of Basel III, are appropriate for the competitiveness of banks."

However, experts unanimously agree that a reevaluation of Basel III regulations is realistically difficult. This is because they are already internationally agreed-upon basic prudential regulations for banks. Unlike Europe, Korea has already implemented Basel III, which is also cited as a limitation to regulatory easing. In other words, the level of RWA regulatory easing currently being considered by the Financial Services Commission is likely to fall short of expectations. Accordingly, there are opinions that, rather than easing RWA regulations, capital expansion by banks would be more appropriate to create more capacity for SME lending.

Kim Youngdo, Research Fellow at the Korea Institute of Finance, explained, "It is true that under the current prudential regulatory structure, if loan assets (exposures) increase, risk-weighted assets increase proportionally, but risk-weighted assets do not increase more than the increase in exposures," adding, "This is because, thanks to appropriate risk management so far, banks using internal models have been able to reduce risk-weighted assets." Kim further emphasized, "From a prudential regulatory perspective, the current social demand for banks to expand SME lending can be addressed more effectively through capital expansion."