CONCLUSIONES Y RECOMENDACIONES

The Bank of Korea Act provides that the sole purpose of the Bank is to contribute to the sound development of the national economy by pursuing price stability through the formulation and implementation of efficient monetary and credit policies. Practically, however, the Bank’s policy objectives involve the following three:

(a) Price Stability — the Bank conducts monetary policy to pursue price stability under an inflation targeting regime,

(b) Safety and Efficiency of the Payment System — the Bank is responsible for the safety and efficiency and oversight of the payment and settlement system in Korea, and operates BOK-Wire+, which serves as the center of all payment systems,

(c) Financial stability — the Bank constantly monitors the market developments and analyses the flows of funds among financial institutions, while, if necessary, carrying out joint examinations of banks with the FSS.

3.1 As a Liquidity Provider

The Bank of Korea adjusts market liquidity including banks’ reserves through open market operations, so that the call rate does not deviate too far from the policy Base Rate set by the BOK’s Monetary Policy Committee (MPC).

There are two types of open market operations: operations involving the issuance of MSBs and the purchases and sales of securities. MSBs, which are issued only by the BOK, originated as a major tool of monetary policy during the period when the volume of government and public bonds essential for open market operations remained insufficient. These central bank obligations have relatively long maturities, and once issued are not in principle redeemable prior to maturity. Thus, they are used as a major structural adjustment tool whose policy effects are long lasting. Currently, a ceiling on the issuance of MSBs is set by the MPC every three months, in consideration of market liquidity conditions. MSBs are issued in 11 different maturities ranging from 14 days to two years.

Securities transactions, meanwhile, are employed to supply or withdraw funds through the sale and purchase of government and public bonds as a tool adjusting short-term liquidity. Securities eligible for use in such transactions are confined to government bonds, government- guaranteed bonds and MSBs, in consideration of the credit risk involved and the efficiency of open market operations.

Open market operations involve both outright transactions and repurchase agreements or Repo (RP) transactions. Among outright transactions, outright sales, which soak up liquidity, have found little use since they have the same effect as issuance of MSBs.

Outright purchases, which supply liquidity, have in contrast been employed to expand the pool of securities available for use in open market operations, although apart from that, they have not been frequently used, as market liquidity generally remains in a state of structural surplus.

Accordingly, securities transactions focus mostly on RP transactions used as an instrument for routine liquidity adjustment. The longest RP maturity stands at 91 days, however, the maturities of most RP contracts range from overnight to 14 days, as they are used as a tool for fine-tuning of shortages and excesses of reserve funds. With the reform of the monetary policy operational framework in March 2008, the carrying out of RP transactions as and when necessary was changed so that it is now done on a regular basis, with 7-day RP transactions offered once a week on Thursdays. Since then, 7-day RP transactions have become the mainstay of overall transactions.

Its lending facilities allow the central bank to provide loan support to individual banks. The loan policy of the BOK is operated by the rediscounting of bills that banks have received from corporations in return for loans, or by extending loans to banks against the collateral of eligible securities. The eligibility of securities that may be used as collateral is strictly regulated; only credit securities such as re-discountable bills, Treasury bonds, government-guaranteed bonds and MSBs are recognised as eligible collateral. When shortages of liquidity occur due to financial market instability or incidents, such as computer system failures, the MPC may temporarily extend eligibility to other assets apart from those mentioned above. The lending facilities of the BOK available to financial institutions consist of Liquidity Adjustment Loans, Aggregate Credit Ceiling Loans, Intra-day Overdrafts and Special Loans.

Figure 7

Bank of Korea Lending Facility (as of October 2009)

3.2 As a Financial Regulator

Before April 1998, the BOK Office of Bank Supervision had full authority to supervise commercial banks. Four separate supervisory agencies (the BOK, the Securities Supervisory Board, the Insurance Supervisory Board, and the Non-bank Supervisory Authority) executed sectional supervision.

Since April 1998, however, the Financial Services Commission (FSC) and the Financial Supervisory Service (FSS), as a consolidated body, have had the supervisory power. The BOK exercises supervision- related functions within a limited scope. It has the right to request materials, the right to undertake joint examinations, and the right to appeal for reconsideration of a decision of the FSC.

The role of ensuring financial stability is the central bank’s original role, irrespective of its having full financial supervisory authority or not. The role includes monitoring of the financial system and evaluation of its stability, analysis of management statuses and conduct of joint examinations of financial institutions, operation and supervision of the payment and settlement system, provision of emergency liquidity assistance, and publication of the Financial Stability Report. More specific details follow.

The BOK monitors the financial system and evaluates its stability. It reviews domestic and overseas economic conditions, analyses the financial market environment and examines the debt servicing capacity of the household and business sectors to get an overall picture of financial

institution soundness. The Bank also contributes to the maintenance of financial stability by identifying and publicising potential risk factors in the financial sector, to prevent them from causing financial system unrest. The BOK analyses the management statuses of financial institutions and evaluates their soundness, based upon information collected from reports and surveys, while, if necessary, conducting joint examinations of institutions with the FSS. These efforts enhance the effectiveness of the BOK’s monetary policy and contribute to the maintenance of financial system stability, by allowing the Bank to more accurately understand the business conditions of individual financial institutions and to collect and evaluate various kinds of on-site information.

The BOK publishes a regular Financial Stability Report, which includes analysis of the current status and potential risks of Korea’s financial system and an overall assessment of its stability. The main purpose of the report’s publication is to further strengthen financial system stability, by stimulating the market participants’ active discussion of a wide range of risk factors in the financial sector under the rapidly changing global financial environment. The BOK began to publish the Financial Stability Report, the first of its kind in Asia, from April 2003, and has since then continued to publish it twice a year.

3.3 Collateral Criteria for Borrowing from the Central Bank

In November and December 2008, to facilitate the movement of funds into the bond market, the BOK included bank debentures and certain government agency bonds among securities eligible for use in open market operations which were originally Treasury bonds, government-guaranteed bonds and MSBs. In December, additional 12 securities companies were selected to join the existing 19 banks, one securities company, and the Korea Securities Finance Corporation as the BOK’s counterparts for RP transactions.

Figure 8

Expansion of Eligible Securities and Counterparts of Open Market Operations

Note: 1) Debentures issued by financial institutions subject to ‘Banking Act’, Korea Development Bank, Industrial Bank of Korea, National Agricultural Cooperative Federation, National Federation of Fisheries Cooperatives, and Export-Import Bank of Korea

The BOK drew up a plan for improvement of the collateral system for its lending facilities,which it then put into effect from February 9 this year. Credit instruments2 _{held by financial institutions were allowed} to be used as collateral for the Bank’s lending facilities3 _{-- its Liquidity}

Adjustment Loans and Intra-day Overdrafts, in addition to its Aggregate Credit Ceiling Loans. Moreover, by abolishing conditions for the eligibility of credit instruments, the BOK allowed as acceptable collateral all credit instruments with remaining maturities of not more than one year acquired by financial institutions against loans.

A haircut ratio scheme was also introduced for marketable and non-marketable securities. According to this, the collateral value of a marketable security is assessed on a mark-to-market basis, with adjustment by a certain haircut depending upon the remaining maturity and the method of principal and interest repayment. For non-marketable government and public bonds, 80% of the face value (the issue price in the case of discounted bonds) is recognised as the collateral value. For credit instruments, 70% of the financial institution’s loan principal is recognised.

2. Promissory notes and bills of exchange accepted by banks when making loans to firms.

3. Liquidity Adjustment Loans, Intra-day Overdrafts and Aggregate Credit Ceiling

Figure 9 Haircut Ratios

Notes: 1) Remaining maturity is fixed on the day the market price is appraised. 2) Coupon bond basis, figures in parentheses are discount bonds and other

securities without coupons.

3) Promissory notes and bills of exchange accepted by banks when making loans to firms.