The State Guarantee of External Debt of Korean Banks

Purpose

To guarantee the foreign currency debt issued (including extensions of maturity) by domestic banks between the period of October 20, 2008, and June 30, 2009, in order to relieve liquidity strains stemming from those banks’ difficulties in repaying their foreign currency loans.

Key Terms

Announcement Date

October 19, 2008
Operational Date

October 20, 2008
Date of First Guaranteed Debt Issuance

April 6, 2009
Issuance Window Expiration Date

Originally June 30, 2009; Extended to December 31, 2009
Program Size

$100 billion
Usage

$1.3 billion by Hana Bank in total
Outcomes

No defaults
Notable Features

Limited to debt issued in foreign currencies to ensure continued access to external funding

Following the Lehman Brothers bankruptcy of September 15, 2008, a number of foreign governments enacted stabilization measures in order to bolster their currencies and inject much-needed liquidity into domestic markets. As part of its effort, the Korean Ministry of Strategy and Finance announced a series of government interventions that included a three-year guarantee of foreign debt issued (including extensions of maturity) by domestic banks between October 20, 2008, and June 30, 2009. This opt-in program was introduced as a preemptive step in ensuring that Korean financial institutions would retain competitive access to external funding in the wake of the global credit crunch. Though the guarantee cap was set at $100 billion, maximum utilization totaled only $1.3 billion issued by a single participant (Hana Bank). On June 30, 2012, the guarantee scheme was terminated with the repayment of all obligations by Hana Bank.

The collapse of Lehman Brothers in September of 2008 prompted many governments of developed economies to coordinate stabilization efforts in order to calm domestic and global markets. Among those, the Republic of Korea enacted on October 20, 2008, a series of measures that its Ministry of Strategy and Finance recommended would both aid in boosting the won against the dollar and help to relieve liquidity pressures stemming from the foreign currency loans coming to maturity in the midst of the worldwide credit crunch. This package included a $100 billion, three-year government guarantee of foreign debt issued (including extensions of maturity) by domestic banks between October 20, 2008, and June 30, 2009. The opt-in program would allow participants access to guarantee coverage for up to 100% of principal and interest, including default interest and related expenses.

Eligible domestic banks needed to apply to the Ministry of Strategy and Finance to obtain foreign debt guarantees. Individual guarantee limits were set based on the Korean Financial Services Commission’s assessment of each eligible bank’s foreign debt maturing by June 30, 2009.

Only Hana Bank, one of Korea’s four largest banks, applied to participate in the program, issuing a total of $1.3 billion in guaranteed bonds in April and June of 2009. The State Guarantee program was terminated with the repayment of all commitments by Hana Bank on June 30, 2012.

Key Design Decisions

Legal Authority 2

The Korea Development Bank and Korea Eximbank were charged with the responsibility of financing guarantees before the Ministry received formal approval from the National Assembly (Ministry of Strategy and Finance 2008). After gaining authorization, the Ministry would assume responsibility for all guarantees, including those previously offered by KDB or Eximbank (Ministry of Strategy and Finance 2008).

Program Size 1

Eligible Institutions 1

According to Article 2 “Definitions” of The Guidelines, the term “Domestic Bank” refers to any one of the following: (i) Kookmin Bank, Shinhan Bank, Woori Bank, Hana Bank, Korea Exchange Bank, Citibank Korea, Standard Chartered First Bank Korea, Pusan Bank, Daegu Bank, Kwang Ju Bank, Kyongnam Bank, Jeonbuk Bank, and Jeju Bank, each established under the Banking Act; (ii) the Korea Development Bank established under the Korea Development Bank Act; (iii) Industrial Bank of Korea established under the Industrial Bank of Korea Act; (iv) the Export-Import Bank of Korea established under the Export-Import Bank of Korea Act; (v) National Agricultural Cooperative Federation established under the Agricultural Cooperatives Act; and (vi) National Federation of Fisheries Cooperatives established under the Fisheries Cooperatives Act. “Domestic Bank” includes foreign branches of a Domestic Bank” (2008).

Eligible Debt - Type 1

“Non-resident” as defined in Article 3, Paragraph 1, Subparagraph 13 of the “Foreign Exchange Transaction Act” (2008), excludes branches of foreign banks located in Korea by definition since the Act defines them as “residents.” However, Article 2, Paragraph 2 of The Guidelines (October 31, 2008) included them as “non-residents” (Ministry of Strategy and Finance 2008)

The “non-resident” definition part of Article 2, Paragraph 2 was deleted when the “Operational Guideline” was partially revised, as the purpose of the guarantee was thus changed from “State Guarantee of the Foreign Currency Debt of Domestic Banks owed to Non-Residents” to “State Guarantee of the Foreign Currency Debt.” This has the effect of extending eligibility to include foreign currency debt owed to “residents” as well as “non-residents.”

Eligible Debt - Maturities 1

Eligible Debt - Currencies 1

Participation Limits for Individual Firms 1

Fees 1

This standard fee, based off a 360-day calendar year, was imposed regardless of the individual bank’s credit rating. However, the Ministry of Strategy and Finance retained the right to set different guarantee fee rates “depending on market conditions, the financial condition of the Obligor, performance of covenants by an Obligor [. . .] and other relevant factors” (Ministry of Strategy and Finance 2009a).

Other Conditions 1

Process for Exercising Guarantee 1

The Korean government would fulfill its guarantee obligations if the “Obligor [failed] to satisfy its payments on the due date as required under the Guaranteed Debt” (Ministry of Strategy and Finance 2009a). The Korean government would also honor the guarantee payments in the case that the debt under contract was to be “accelerated as a result of the Obligor’s failure to comply with covenants under the Guaranteed Debt” (Ministry of Strategy and Finance 2009a).

Program Issuance Window 1

This intervention was employed as a temporary measure meant to calm domestic markets and preempt any assumptions that Korean banks were not as stable or competitive as their international counterparts (Ministry of Strategy and Finance 2008). It was also intended to boost the won and relieve liquidity pressures stemming from maturing foreign loans by shoring up confidence in domestic banks’ ability to lend (Ministry of Strategy and Finance 2008). Managing Director of the IMF Dominique Strauss-Kahn initially hailed the intervention as one that would “bring Korea's policies closer in line with advanced countries, including some in the region, and help ease pressures in the local dollar funding market” (IMF 2008). Given the limited utilization of the guarantee program, few have evaluated its domestic impact or its role in the greater Global Financial Crisis.

Dongchul Cho, Professor at the KDI School of Public Policy and Management, concluded that implementing the series of stabilization measures “must have helped mitigate concerns of international investors” (2010). Furthermore, by the end of 2009, several domestic banks were able to access international capital markets without having to resort to the government guarantee scheme (Shabsingh 2013). Implementation of the entire stabilization package immediately boosted the won as much as 22% against the dollar (Harden 2008).

Conversely, Shenai argued that the “proximate effects of this intervention were clear: despite the announcement, the won continued to depreciate, and the stock market continued its skid. South Korea was not able to autonomously stem capital outflows” (2009). This situation was not unique to the won or Korean equity markets; many other emerging-market economies suffered similar depreciations in their local currencies and capital outflows. Shenai contends that the subsequent dollar liquidity swap agreement with the U.S. Federal Reserve was mainly responsible for calming markets (2009). Similarly, Hyekyung Cho argues in a report for the North-South Institute that although these “emergency measures temporarily stabilized the won, [they] did not help stop the massive capital outflow” (Cho 2012). These appraisals most likely reflected the strength of Korea’s domestic economy more than the actual success of the guarantee part of the government aid package, itself.

Key Program Documents

Proposed measures to overcome uncertainties in the international financial markets (Ministry of Strategy and Finance 2008)

Official government document detailing the proposed interventions intended to combat volatility in the markets in response to the global financial crisis.
The Korean Financial Market and Economy: Resilience Amidst Turbulence (Rhee 2008.)

Lecture given before the Financial Services Commission on the state of the Korean economy in the context of the global financial crisis.

Foreign Exchange Transaction Act (Ministry of Strategy and Finance 2008a)

Legal document governing the eligibility of participants in the state guarantee.
Operational Guidelines for National Guarantees of Foreign Debt Obligations of Domestic Banks (Ministry of Strategy and Finance 2009)

Official government document outlining the terms and conditions of the state guarantee (in Korean).
Operational Guidelines for National Guarantees of Foreign Debt Obligations of Domestic Banks (Ministry of Strategy and Finance 2009a)

Official government document outlining the updated terms and conditions of the state guarantee (in Korean).
Operational Guidelines for National Guarantees of Foreign Debt Obligations of Domestic Banks (Ministry of Strategy and Finance 2009b)

Official government document outlining the third iteration of the terms and conditions of the state guarantee (in Korean).

Article 92 of the National Finance Act (Ministry of Strategy and Finance 2016)

Legislation granting legal authority to the Korean government to enact the state guarantee scheme.

Press Release: Statement by IMF Managing Director Strauss-Kahn on Korea (International Monetary Fund 2008)

Official statement commending the Korean government on the implementation of the state guarantee scheme.

South Koreans reliving nightmare of last financial crisis (The New York Times – 10/24/2008)

Media story assessing Korea’s financial position during the global financial crisis in light of the Asian financial crisis.
South Korea to Give Banks $100 Billion in Loan Guarantees (The Washington Post - 10/20/2008)

Media story reporting on the initial operations of the state guarantee scheme.
14 billion won in bonds (MK News – 10/20/2008)

Media story detailing the establishment of the state guarantee scheme (in Korean).
South Korea to Guarantee Some Foreign Debt (The New York Times - 10/19/2008)

Media story announcing the establishment of the state guarantee scheme.

Korea’s Experience with Global Financial Crisis (Cho 2012)

Report for the North-South Institute on lessons learned from South Korea’s response to the global financial crisis.
Responses of the Korean Economy to the Global Crisis: Another Currency Crisis? (Cho 2010)

Paper retrospectively examining South Korea’s response to the GFC presented at the EWC/KDI Conference, Honolulu, HI.
Global Financial Crisis and the Korean Economy (Kim 2009)

Paper on the effects of the GFC on Korea’s economy presented at the Asia Economic Policy Conference, San Francisco, CA.
Financial White Paper (Korea Institute of Finance 2009)

White paper assessing the state of the Korean economy and various interventions implemented in response to the GFC.
“The Design of Government Guarantees for Bank Bonds: Lessons from the Recent Financial Crisis” (Levy and Schich 2010)

Report comparing the various bank debt guarantee schemes implemented by governments around the world in response to the GFC.
Republic of Korea: Financial System Stability Assessment (Shabsingh 2014)

IMF country report examining the state of the Korean economy in light of the recovery measures implemented in response to the global financial crisis.
The U.S.-ROK Bilateral Economic Relationship: The 2008 Crisis and Beyond (Shenai 2009)

An academic assessment of the economic relationship between the US and South Korea in light of measures taken by both countries in response to the global financial crisis.

The State Guarantee of External Debt of Korean Banks: South Korea Context

GDP

(SAAR, Nominal GDP in LCU converted to USD)

$1.2 trillion in 2007

$1.0 trillion in 2008

Source: Bloomberg

GDP per capita

(SAAR, Nominal GDP in LCU converted to USD)

$24,086 per capita in 2007

$21,350 per capita in 2008

Source: Bloomberg

Sovereign credit rating (5-year senior debt)

As of Q4, 2007:

Fitch: AA

Moody’s: A2

S&P: A+

As of Q4, 2008:

Fitch: AA

Moody’s: A2

S&P: A+

Source: Bloomberg

Size of banking system

$1.1 trillion in total assets in 2007

$1.1 trillion in total assets in 2008

Source: Bloomberg

Size of banking system as a percentage of GDP

94.2% in 2007

101.5% in 2008

Source: Bloomberg

Size of banking system as a percentage of financial system

Banking system assets equal to 100% of financial system

Source: World Bank Global Financial Development Database

5-bank concentration of banking system

79.3% of total banking assets in 2007

Data not available for 2008

Source: World Bank Global Financial Development Database

Foreign involvement in banking system

12% of total banking assets in 2007

13% of total banking assets in 2008

Source: World Bank Global Financial Development Database

Government ownership of banking system

Data not available for 2007

22.2% of bank assets owned by the state in 2008

Source: World Bank Global Financial Development Database

Existence of deposit insurance

100% insurance on deposits up to $44,792 in mid-September 2008

Source: Financial Crisis: Deposit Insurance and Related Financial Safety Net Aspects, OECD

Taxonomy

Intervention Categories:

Bank Debt Guarantee Programs

Countries and Regions:

Korea

Crises:

Global Financial Crisis

The State Guarantee of External Debt of Korean Banks

Purpose

Key Terms

Abstract

At a Glance

Summary Evaluation

Key Design Decisions

Related Programs 1

The State Guarantee was announced as part of a package of proposed stabilization measures released by the Korean Ministry of Strategy and Finance on October 19, 2008.

Legal Authority 2

The Korean government implemented the State Guarantee using its authority under Article 92 of the National Finance Act, the Enforcement Decree of the National Finance Act, and The Rules for the Management of State Guarantees.

The State Guarantee would be financed by Korea Development Bank or Korea Eximbank until approved by the National Assembly

Program Size 1

Up to $100 billion in debt could be guaranteed under the program.

Eligible Institutions 1

All domestic banks and foreign branches of those domestic banks were eligible for the State Guarantee.

Eligible Debt - Type 1

Initially, eligible debt included any debt denominated in foreign currency issued by a domestic Korean bank or its overseas branches and owed to a “non-resident” institution (excluding foreign currency deposits and subordinated debt).

Eligible Debt - Maturities 1

Initially, the State Guarantee would cover eligible debt for up to three years from the date of debt issuance or acquisition before this was later extended to five years.

Eligible Debt - Currencies 1

All foreign currencies were eligible.

Participation Limits for Individual Firms 1

There were individual guarantee limits imposed on each bank based on the amount of such bank’s foreign debt maturing by June 30, 2009.

Fees 1

Participating banks were required to pay a standardized guarantee (participation) fee of 1% per annum of guaranteed debt, subject to increase. The guarantee fee was later reduced to 0.7% per annum on February 16, 2009.

Other Conditions 1

Participating banks were required to sign a Memorandum of Understanding (MOU) with the Financial Supervisory Services and report to them on a daily basis the usage of the guaranteed funds.

Process for Exercising Guarantee 1

The State Guarantee was designed to cover 100% of principal and accrued interest, including default interest and related expenses.

Program Issuance Window 1

The issuance window was extended past its original date of June 30, 2009, to December 31, 2009.

Evaluation

References 18

Key Program Documents

Program Summaries 2

Implementation Documents 4

Legal/Regulatory Guidance 1

Press Releases/Announcements 1

Media Stories 4

Reports/Assessments 7

Appendices

Taxonomy

Intervention Categories:

Countries and Regions:

Crises:

Notes