BOK Expands 'Loan Collateral' to Include Loan Receivables for Banks: "Lessons from SVB, Preparing for Liquidity Risks"

Expansion from Existing Marketable Securities to Loan Receivables
Emergency Lending Now Possible with Loan Receivables as Collateral
Broader Funding Options for Financial Institutions
"Expected to Contribute to Financial System Stability"

The Bank of Korea has added loan receivables to the list of eligible collateral for loans to financial institutions aimed at supporting liquidity. In the wake of the bank run at Silicon Valley Bank (SVB) in the United States, the need to prepare for liquidity risks has grown, prompting the central bank to expand the collateral scope to include loan receivables, which make up the largest portion of bank assets.

Exterior view of the Bank of Korea.

On the 14th, the Bank of Korea announced that the Monetary Policy Board had approved the "Regulation on Emergency Lending to Financial Institutions Using Loan Receivables as Collateral."

This measure allows financial institutions, including banks, to obtain standing loans (liquidity adjustment loans) using loan receivables as collateral, in addition to existing marketable securities such as bank bonds, high-quality corporate bonds, and government bonds. Bong Gwansu, Director of the Credit Policy Division at the Bank of Korea's Monetary Policy Department, explained, "The Bank of Korea is able to lend to financial institutions, but under the principle that a central bank should not incur losses, it must always secure high-quality collateral." He added, "This decision increases the potential use of high-quality loan receivables."

This move is a response to the increased possibility of liquidity risks, such as bank runs, as the digital transformation of finance accelerates. In fact, in 2023, 85% of deposits were withdrawn from SVB in the United States within two days due to the spread of anxiety via social media, and SVB's UK subsidiary saw 30% of its deposits leave in a single day, making liquidity risks a reality.

Director Bong stated, "Since then, the need to strengthen the liquidity backstop role of the central bank's lending system has increased," and added, "To prepare for the possibility of large-scale deposit withdrawals due to changes in the financial environment, it has become important to pre-secure and utilize loan receivables, which account for the largest share of financial institutions' assets." As of the end of June this year, loan receivables accounted for 69.8% of total bank assets.

Under this decision, if a financial institution experiences a deterioration in liquidity due to funding imbalances or a temporary shortage of settlement funds due to system failures, and thus requires additional liquidity support, the Monetary Policy Board may approve emergency loans secured by loan receivables. The scope of eligible loan receivables is limited to corporate real estate-backed loans (excluding mortgage loans for residential properties) and credit loans where the borrower's credit rating is sound (BBB- or higher, or an expected default probability of 1.0% or less). To prevent interconnected risk, loan receivables to related parties such as affiliates and major shareholders are excluded, and only senior loans are recognized in consideration of credit risk.

Director Bong emphasized, "Primarily, liquidity will be supplied using marketable securities as collateral, but in emergencies, the Monetary Policy Board may decide to provide liquidity support using loan receivables as collateral. The introduction of this system does not mean that banks are unable to cope with liquidity crises with marketable securities alone. The goal is to strengthen the multilayered safety net."

Kim Beomseo, Team Leader of the Collateralized Lending Planning Team in the Monetary Policy Department, said, "With this measure, financial institutions will be able to secure liquidity in times of temporary cash shortages without having to sell off marketable securities, which is expected to help prevent instability in the financial markets. Financial institutions now have an expanded means of emergency funding, and this will also help improve their liquidity ratios compared to loans collateralized by marketable securities."

The Bank of Korea plans to implement the new system starting in January next year, after completing preparatory steps such as IT system testing with financial institutions by the end of this year.