Korea: Bank Recapitalization Fund

Due to its success in overcoming the market volatility caused by the Asian Financial Crisis of 1997, the Republic of Korea was thought to have been relatively more prepared than its Western counterparts to manage the economic fallout from the Global Financial Crisis (Lee and Rhee 2012). Despite having strengthened its regulatory institutions and policies, however, Korea was greatly impacted by the subprime mortgage downturn in 2007. This was partially due to the fact that during the first half of 2008, overseas lenders collectively withdrew $886 million, and net foreign direct investment turned negative for the first time since 1980 (Fackler 2008). Such a large divestment would later exacerbate Korea’s inability to repay its external debts and, consequently, the relatively stable economy remained vulnerable to exogenous shocks (Harden 2008).

The summer of 2008 brought with it a precipitous decline in confidence as the stock market dropped 38% and the Korean won fell 30% against the dollar. In alarmed response, both banks and major corporations, such as Hyundai and Samsung, began hoarding domestic currency (Harden 2008; Sang-Hun 2008). The failure of Lehman Brothers on September 15 aggravated matters considerably, sending global credit markets into chaos and driving further anxieties over the strength of Korea’s export markets and foreign currency reserves. As the state of the broader economy worsened, individual domestic banks began to experience the effects of the crisis more directly. Woori Bank, one of Korea’s largest lenders, faced a serious liquidity shortage when overseas banks began to refuse to roll over many existing loans and instead insisted that Woori pay its maturing obligations in dollars (Fackler 2008). The government responded by supplying the bank with $280 million in dollar loans.

This lending crisis spread rapidly as investors lost confidence in Korean banks’ abilities to honor their maturing foreign currency loans. Following the collapse of Lehman, capital outflows totaled $42.8 billion between Q4 2008 and Q1 2009 (Kim 2009). Such a large selloff, coupled with the depreciation of the won and rising borrowing costs, caused Moody’s to declare Korea to be “one of the few banking systems in Asia where domestic deposits are insufficient to fund loans” (Sang-Hun 2008). Furthermore, S&P downgraded the Big Four Korean banks—Kookmin Bank, Woori Bank, Shinhan Bank, and Hana Bank—from “stable” to “negative” on October 1. Their ability to raise foreign capital thus continued to decline (Gup 2010).

Having relatively recently opened its market to the international community, Korea did not have access to the same emergency sources of foreign currency reserves as did other countries. It was also more susceptible to market instability due to its transparency and openness to foreign investment (Fackler 2008). In response to the deleterious effects of the Global Financial Crisis, the Korean Financial Services Commission (FSC) sought to calm and protect domestic markets by proposing a comprehensive set of stabilization measures to be enacted throughout 2009. While other interventions, such as the State Guarantee of External Debt of Korean Banks (see Engbith 2020), had been announced previously in October 2008, the government designed a coordinated response to address the ongoing market volatility. Aside from the Bank Recapitalization Fund (the Fund), the new plans provided for the establishment of the Bond Market Stabilization Fund, the Stock Market Stabilization Fund, and the Bank Capital Expansion Fund. The FSC also issued new guidelines for the restructuring of distressed companies and tightened supervision of the financial derivatives market.

On December 18, 2008, the FSC released its agenda and recommendations for the upcoming 2009 fiscal year. Included in those plans was a provision for the creation of the Bank Recapitalization Fund, an intervention designed to assist Korean commercial banks in replenishing capital and lending to the domestic economy by raising capital adequacy ratios by 1.5%. Officially implemented on February 15, 2009, and jointly administered by the FSC and the Bank Recapitalization Fund Oversight Committee, the Fund was founded under the legal authority granted by Article 65, Section 3 (“Emergency Credit to Financial Institutions”), of Chapter IV of the Bank of Korea Act. Importantly, its establishment allowed the government to strengthen the capital base of all banks—even those meeting the Bank for International Settlements (BIS) capital requirements of 9%—to encourage lending to nonfinancial institutions, particularly small and midsize enterprises (SMEs), through the purchase and resale of preferred shares, hybrid securities, or subordinated debt from Korean commercial banks.

The Korean government committed up to a total of KRW 20.0 trillion^FNKRW 1.0 = 0.00097 USD (World Bank). (2% of GDP) for Fund purchases. The Bank of Korea (BOK) first utilized the Korea Development Bank (KDB) 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 at the time, the BOK lent to the KDB (a financial institution) under Article 65, Section 3 (“Emergency Credit to Financial Institutions”), of Chapter IV of the Bank of Korea Act.^FNArticle 80 has since been amended to allow the Bank of Korea to lend to private entities “when severe impediments to obtaining funds from financial institutions occur or when there is a strong likelihood of their occurrence such as periods of severe monetary and credit contraction” (Bank of Korea Act, no. 14242). In addition to acting as a passthrough for the central bank loans, the KDB lent KRW 2.0 trillion to the Fund, bringing the total to KRW 12.0 trillion. The government intended to raise the final KRW 8 trillion by purchasing banks’ subordinated debt 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 trillion to acquire subordinated debt (FSC 2009a). See Figure 1 below:

Figure 1: First Purchase of the Bank Recapitalization FundSource: FSC 2009a, translated from the original Korean.

Participation in the Fund was open to all Korean commercial banks and financial institutions, both regional and national. Preferred shares, hybrid securities, and subordinated debt were eligible for issuance to the Fund by participating banks. In order to reduce stigma, individual caps on usage were imposed based on a bank’s asset holdings rather than credit ratings (Lee and Rhee 2012). 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 (CAR) 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).

To apply for access to the Fund, a bank was required to sign with the Bank Recapitalization Fund Oversight Committee an implementation Memorandum of Understanding (MoU) specifying particular commitments to providing liquidity support to the real economy, SMEs, and corporate restructuring programs. The FSC then continually monitored each institution’s progress with respect to the MoU obligations and adjust any government support accordingly. For instance, a bank that did not demonstrate clear progress toward supporting the real economy could face limited access to the Fund and higher applicable interest rates in subsequent rounds of bond purchases.

Although participating banks were required to support the real economy and commit to corporate restructuring, the FSC was not to intervene in bank management. 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 attached to the capital injection (FSC 2009a).

The Fund was managed by a committee consisting of nine members chosen from the FSC, participating banks, and institutional investors. The chair of the committee was an academic.

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 Fund provided capital in the form of preferred shares, hybrid securities, and subordinated debt. 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 had a maturity of five years or longer (FSC 2009a).

Prior to the first round of bond purchases, the FSC undertook a review of all Korean commercial banks to assess their compliance with the MoU terms. Six banks received “excellent” ratings, while the remaining eight were rated as “satisfactory” (see Figure 2).  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).

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: