Korea: Bank Recapitalization Fund

On December 18, 2008, the Financial Services Commission announced a package of short-term stabilization measures to be implemented throughout 2009. Among other interventions intended to boost liquidity within the Korean economy, the FSC plans provided support for the domestic financial markets through the establishment of the Bond Market Stabilization Fund and the Stock Market Stabilization Fund, bolstered the soundness of capital reserves through the Bank Capital Expansion Fund, and increased consumer confidence with a series of amendments to existing debt repayment laws. Furthermore, the FSC laid out plans to oversee the restructuring of distressed companies and tighten supervision of the financial derivatives market.

Article 65, Section 3 (“Emergency Credit to Financial Institutions”), of Chapter IV of the Bank of Korea Act stipulates the following:

The Bank of Korea may, in any of the following subparagraphs, extend credits to any financial institution secured on assets whose properness has been temporarily granted with the consent of not less than four members:

1. Where it extends credits temporarily to any financial institution in a vital emergency in which the stabilization of currency and banking business are directly threatened.

The diverse composition of the committee was intended to reflect different interests in a balanced way and to ensure transparency in the management of the Fund (FSC 2009a). The committee decided on applicable interest rates and other conditions of the program. It was also responsible for reviewing mandatory reports submitted by the banks regarding their usage of the injected capital.

The Bank of Korea utilized the Korea Development Bank as a conduit to channel KRW 10.0 trillion in loans to the Fund. This was due to the fact that Article 80 of the Bank of Korea Act limited loans to profit-making enterprises (i.e., nonfinancial institutions like the Fund) only when “there [was] a severe deflation of monetary credit.” Because that was not the case, the BOK lent to the KDB (a financial institution) under Article 65 of the Bank of Korea Act.

The KDB lent an additional KRW 2.0 trillion, bringing the total to KRW 12.0 trillion.

The government intended to raise the final KRW 8.0 trillion by purchasing banks’ subordinated and hybrid securities through the Fund and selling them to institutional investors in the form of securitized bonds.

Of the KRW 20.0 trillion allocated, the Fund used KRW 10.0 trillion for the purchase of preferred shares (KRW 2.0 trillion) and hybrid securities (KRW 8.0 trillion); it utilized the other KRW 10.0 trillion to acquire subordinated debt (FSC 2009a).

The FSC decided what capital to inject after a review of each bank. While preferred shares and hybrid securities were considered Tier 1, subordinated debt was categorized as Tier 2. Hybrid securities were to have a maturity of 30 years or longer, with a call option after five years from issuance; it was also subordinated to the Tier 2 capital. Subordinated debt was to have a maturity of five years or longer (FSC 2009a).

On March 31, 2009, the Fund purchased from eight Korean banks and financial institutions  KRW 3.5 trillion in hybrid securities with maturities of 30 years and KRW 500 billion in subordinated debt with maturities of five years and nine months. This was the sole round of purchases conducted by the Fund. The table in Figure 3 details the issuances by bank.

In designing the program, the Korean government aimed to increase BIS ratios among Korean banks by 1.5%. However, it was not a requirement for participation that banks’ capital adequacy ratios fall below a certain threshold; on the contrary, the Fund allowed the government to inject capital into banks with ratios above the BIS requirement of 9%, which had previously not been legally feasible. It was thus hoped that providing stronger capital bases for commercial banks would encourage increased lending to the real economy.

Banks could voluntarily access the Fund when in need of capital.

Banks were assigned, according to the size of their assets, to Group I, II, III, or IV. Within the limits imposed for each group (as shown in Figure 5 below), the capital injection amount for each bank was limited to a 1.5% increase in its capital adequacy ratio and varied according to its lending to small and medium-size businesses. The Fund determined the CAR limits based on a desire to avoid any imbalance in or concentration of capital support for selected banks (FSC 2009a).

Source: FSC 2009a

Initial interest rates for participation were dictated by the scoring grid described in Figure 2 above. Upon applying for access to the program, each bank was required to sign with the Korean government an MoU stating its continued commitment to assisting the real economy. The FSC then conducted monthly progress assessments and adjusted accordingly the terms of Fund utilization, interest rates, and other usage restrictions. These reviews took place throughout November and December 2008 (FSC 2009a).

FSC’s review of the commercial banks’ compliance with the MoU terms resulted in six banks receiving “excellent” ratings, while the remaining eight received “satisfactory” ratings. An interest rate of 6.59% was imposed on nationwide banks with an “excellent” rating issuing hybrid securities, while those deemed to be “satisfactory” incurred an additional 30 basis points (6.89%). Similarly, nationwide banks with ratings of “excellent” issuing subordinated debt were charged an interest rate of 6.49%, while “satisfactory” banks were charged at a rate of 6.59%. To account for the discrepancy between regional and nationwide banks’ credit ratings, regional banks were charged an additional 30 basis points on top of their larger counterparts’ rates (FSC 2009b).

This stipulation was intended to encourage banks to continue to lend and to take on restructuring themselves. Specific usage of capital injected was tailored to each bank, and the banks submitted a monthly report on compliance with specific conditions agreed upon in their individual MoUs (FSC 2009a).

According to the Fund’s internal operating rules, its activities were to be terminated upon full repayment.

On December 9, 2011, the Bank Recapitalization Fund Oversight Committee approved the implementation of an additional early repayment scheme whereby issuers were able to buy back their hybrid securities before maturity. This arrangement allowed four banks,^FKookmin (KRW 600 billion), Hana (KRW 300 billion), Woori Bank (KRW 200 billion), and NH Bank (KRW 400 billion). whose earnings had increased over the course of 2011, to purchase a total of KRW 1.5 trillion in hybrid securities (FSC 2011). The outstanding amount to be recovered was thus lowered to KRW 1.2 trillion, or 29% of the Fund’s total utilization.

The remaining KRW 1.2 trillion in hybrid securities was repaid in full by August 2016, at which point the Bank Recapitalization Fund ceased operations.