Financial Stability Report · June 2015 to November 2015 as the objects of its analysis. It is hoped that this Financial Stability Report will help financial market participants,

Financial Stability Report

FinancialStabilityR

eport

December 2015

ISSN 1975-7042

m.bok.or.kr

Decem

ber 2015

*2015금안보고서표지(Dec) 2016.2.18 11:23 AM 페이지1

Financial Stability ReportDecember 2015

*금안2015(Dec)01-목차1~15 2016.2.18 11:23 AM 페이지1

*금안2015(Dec)01-목차1~15 2016.2.18 11:23 AM 페이지2

Monetary Policy Board

Chairman Lee, Juyeol

Member Ha, Sung Keun

Member Chung, Hae-Bang

Member Chung, Soon Won

Member Moon, Woosik

Member Hahm, Joon-Ho

Member Jang, Byung Wha

This Financial Stability Report is published in accordance with the provisions

of Article 96 of the Bank of Korea Act, and upon the resolution of the

Monetary Policy Board.

December 2015

Lee, Juyeol

Governor

the Bank of Korea

*금안2015(Dec)01-목차1~15 2016.2.18 11:23 AM 페이지3

*금안2015(Dec)01-목차1~15 2016.2.18 11:23 AM 페이지4

Financial stability refers to a condition in which the financial system

works smoothly with all of its key components satisfactorily performing

their roles: financial institutions carrying out their financial intermediary

functions, market participants maintaining a high level of confidence in

their financial market, and the financial infrastructure being well

developed.

Financial stability is regarded as one of the policy goals that must be

achieved, together with price stability and economic growth, for the

realization of sustainable economic development. Policy authorities

around the world thus devote great efforts to achieving financial

stability.

As part of its conduct of macroprudential policies, the Bank of Korea

has been publishing the Financial Stability Report on a biannual basis

since 2003, analyzing and assessing the potential risks inherent in the

Korean financial system and suggesting related policy challenges.

Notably, under the revised Bank of Korea Act of 2011 (Article 96),

the Bank of Korea is obliged to draw up a Financial Stability Report

and submit and report it to the Korean National Assembly at least two

times each year.

The Bank of Korea is devoting its best efforts to qualitative

improvement of the Financial Stability Report. This report takes the

potential risks to financial stability highlighted during the period from

June 2015 to November 2015 as the objects of its analysis.

It is hoped that this Financial Stability Report will help financial

market participants, regulators and policymakers to recognize the risk

factors inherent in the financial system at an early stage, and deal with

them appropriately.

*금안2015(Dec)01-목차1~15 2016.2.18 11:23 AM 페이지5

*금안2015(Dec)01-목차1~15 2016.2.18 11:23 AM 페이지6

Contents

[Financial Stability Overview]

[Korea’s Financial Stability Situations]

I. Financial Soundness of Household and Corporate Sectors··········23

1. Households·······················································································25

2. Corporations····················································································44

II. Financial System Stability································································57

1. Banks·······························································································59

2. Non-Bank Financial Institutions·························································70

3. Financial Markets·············································································78

4. Foreign Exchange Soundness·····························································84

5. Financial Market Infrastructure··························································91

[Analysis of Financial Stability Issues]

I. Effects of Population Aging on Household Debt,

and Potential Risks·········································································101

II. Status of Chronically Marginal Firms, and Assessment·············114

III. Effects of Economic Unrest in EMEs on Korean

External Soundness········································································126

[Annex 1] Monetary and Macroprudential Policy Operational

Framework···········································································139

Explanation of Terms···········································································143

*금안2015(Dec)01-목차1~15 2016.2.18 12:1 PM 페이지7

List of Figures


[Fig. I- 1] Household Financial Stability Map············································25

[Fig. I- 2] Amount and rate of increase of household debt·························25

[Fig. I- 3] Rates of increase in household loans, by financial sector

and loan type···········································································26

[Fig. I- 4] Bank proportions of fixed rate and amortizing loans,

and average home mortgage loan maturity································26

[Fig. I- 5] Household debt-to-disposable income ratio, and rates of

increase in disposable income and household debt·····················27

[Fig. I- 6] Financial liabilities-to-financial assets ratio and rates of

increase in financial assets and financial liabilities·······················27

[Fig. I- 7] Proportions of household financial assets, by type·······················28

[Fig. I- 8] Household debt ratio distributions in major countries·················28

[Fig. I- 9] Changes in household debt ratios in major countries

since global financial crisis························································29

[Fig. I-10] Debt repayment expenditure-to-disposable income ratio

and rates of increase in disposable income and debt

repayment expenditures····························································29

[Fig. I-11] Household expenditure-to-household income ratio, and rates

of increase in household income and expenditures·····················30

[Fig. I-12] Household expenditure-to-household income ratios,

by income quintile····································································30

[Fig. I-13] Corporate financial soundness map···········································44

[Fig. I-14] Rates of sales growth································································44

[Fig. I-15] Proportions of companies in different sales growth rate ranges····45

[Fig. I-16] Rates of sales growth and changes in total sales, by industry·······45

[Fig. I-17] Rates of growth in tangible assets··············································46

[Fig. I-18] Operating income-to-sales ratios················································46

[Fig. I-19] Proportions of companies in different operating income-to-sales

ratio ranges··············································································47

[Fig. I-20] Changes in operating income-to-sales ratios, by industry·············47

[Fig. I-21] Debt ratio distributions, by company size··································48

[Fig. I-22] Borrowings-to-total assets ratios, by company size······················48

[Fig. I-23] Interest coverage ratio distributions, by company size·················48

[Fig. I-24] Cash flow coverage ratio distributions, by company size·············49

[Fig. I-25] Changes in debt ratios, by industry···········································49

*금안2015(Dec)01-목차1~15 2016.2.18 11:23 AM 페이지8

[Fig. II- 1] Commercial bank soundness map·············································59

[Fig. II- 2] Commercial bank total assets····················································59

[Fig. II- 3] Changes in commercial bank loans···········································60

[Fig. II- 4] Changes in household and SME commercial bank loans············60

[Fig. II- 5] Amounts of funds in won raised by commercial banks················61

[Fig. II- 6] Changes in deposits in commercial banks··································61

[Fig. II- 7] Changes in wholesale funding of commercial banks····················62

[Fig. II- 8] Commercial bank substandard-or-below loan ratio, newly

occurring bad loans, and bad loan disposals·······························62

[Fig. II- 9] Commercial bank substandard-or-below loan ratios,

by borrowing sector··································································62

[Fig. II-10] Commercial bank substandard-or-below loan ratios,

by industry···············································································62

[Fig. II-11] Commercial bank net income composition································63

[Fig. II-12] Commercial bank profitability indicators···································63

[Fig. II-13] Commercial bank liquidity coverage ratio··································64

[Fig. II-14] Commercial bank loan-to-deposit ratio······································64

[Fig. II-15] Commercial bank provision coverage ratio and excess

coverage ratio··········································································65

[Fig. II-16] Commercial bank BIS capital ratios··········································65

[Fig. II-17] Non-bank financial institution soundness map····························70

[Fig. II-18] Non-bank financial institution total assets··································70

[Fig. II-19] Non-bank financial institution rates of total asset growth,

by financial sector····································································71

[Fig. II-20] Non-bank financial institution compositions of managed assets,

by asset type············································································71

[Fig. II-21] Non-bank financial institution delinquency rates,


[Fig. II-22] Non-bank financial institution substandard or below loan ratios,


[Fig. II-23] Non-bank financial institution net incomes·································73

[Fig. II-24] Non-bank financial institution ROAs·········································73

[Fig. II-25] Non-bank financial institution capital adequacy ratios················74

[Fig. II-26] Financial market stability map··················································78

[Fig. II-27] VIX and EMBI+ spread··························································78

[Fig. II-28] Interest rate, stock price and FX volatilities·······························79

[Fig. II-29] BOK Base Rate, Korea and U.S. Treasury bond yields·············79

*금안2015(Dec)01-목차1~15 2016.2.18 11:23 AM 페이지9

[Fig. II-30] Bond investment by foreigners··················································80

[Fig. II-31] Won / USD and won / yen exchange rates······························80

[Fig. II-32] KOSPI and global stock prices·················································81

[Fig. II-33] Foreigner net stock purchases, and holding share·······················81

[Fig. II-34] Corporate bond credit spreads and spread across

credit ratings············································································82

[Fig. II-35] Current status of corporate bond net issuance, and proportion

of prime bond issuance·····························································82

[Fig. II-36] Proportions in total corporate bond transactions,

by credit rating········································································83

[Fig. II-37] Foreign exchange soundness map··············································84

[Fig. II-38] Balance of payments·································································85

[Fig. II-39] Foreigners’ domestic investment················································85

[Fig. II-40] Residents’ overseas investment··················································85

[Fig. II-41] Net external assets····································································86

[Fig. II-42] Changes in external assets in debt instruments, by sector············86

[Fig. II-43] Foreign exchange reserves·························································86

[Fig. II-44] Changes in external debt, by sector···········································87

[Fig. II-45] External payment capacity and liquidity indicators·····················87

[Fig. II-46] Domestic banks’ foreign currency borrowing rollover ratio,

and spreads on short- and long-term borrowings························88

[Fig. II-47] CDS premium and foreign exchange swap rate·························88

[Fig. II-48] Global securities investment fund flows······································89

[Fig. II-49] Net foreign investor securities fund inflows ································89

[Fig. II-50] Foreign investor securities fund flows·········································90

[Fig. II-51] Major financial market infrastructure stability map····················91

[Fig. II-52] Ratio of settlement concentration at around closing time,

maximum intraday overdraft cap exhaustion rate and proportion

of payment orders in queue for settlement·································92

[Fig. II-53] Extensions of BOK-Wire+ operating hours································92

[Fig. II-54] Maximum net debit cap utilization rate·····································92

[Fig. II-55] Adequacy of collateral securities················································93

[Fig. II-56] Shares of FOP settlement·························································93

[Fig. II-57] CLS system use········································································94

[Fig. II-58] Foreign currency overdraft use-to-total foreign currency

funds transfer ratio···································································94

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[Fig. I- 1] Rates of population increase, by economic activities age group··102

[Fig. I- 2] Changes in financial debt, by age group··································102

[Fig. I- 3] Changes in financial debt and income, by age group················103

[Fig. I- 4] Changes in financial debt and assets, by age group··················103

[Fig. I- 5] Amounts of financial debt per household, and proportions of

households with financial debt by age group····························104

[Fig. I- 6] Financial debt-to-financial assets and financial debt-to-disposable

income ratios, by age group····················································104

[Fig. I- 7] Rates of increase in household debt and asset accumulating

population··············································································105

[Fig. I- 8] Household debt ratio, and asset accumulating population·········105

[Fig. I- 9] Major country rates of increase in household debt and asset

accumulating populations························································106

[Fig. I-10] Major country changes in household debt ratios and asset

accumulating populations························································106

[Fig. I-11] Forecasts for population and financial debt distributions,

by age group··········································································107

[Fig. I-12] Changes in distribution of average debts of U.S. households·····107

[Fig. I-13] Major country changes in financial debt distributions,

by age group··········································································108

[Fig. I-14] Asset compositions in Korea and the U.S., by age group··········108

[Fig. I-15] Financial debt-to-financial assets ratios of Korea and the U.S.,

by age group··········································································109

[Fig. I-16] Paces of decrease in proportions of asset accumulating

populations············································································109

[Fig. I-17] Paces of population aging·······················································109

[Fig. I-18] Change in asset accumulating population and

population 60 and older··························································110

[Fig. I-19] Distributions of marginal household numbers and financial

debts, by age group································································110

[Fig. I-20] Financial debt ratio and debt service ratio (DSR) of

households with financial debt, by age group···························111

[Fig. I-21] Proportions of bullet repayment and non-bank loans,

by age group··········································································111

[Fig. I-22] Proportions of households with financial debt, by work status···111

[Fig. I-23] Major country 65 and older household income compositions····112

*금안2015(Dec)01-목차1~15 2016.2.18 11:23 AM 페이지11

[Fig. II- 1] Status of chronically marginal firms·········································115

[Fig. II- 2] Proportion of chronically marginal firms by the periods of their

remaining in a state of interest coverage ratios below 100%······115

[Fig. II- 3] Chronically marginal firms’ proportions of assets, liabilities

and numbers of employees······················································116

[Fig. II- 4] Chronically marginal firms’ numbers and proportions,

by firm size············································································116

[Fig. II- 5] Chronically marginal firm proportions, by industry··················116

[Fig. II- 6] Rates of sales growth, and operating income-to-sales ratios·······117

[Fig. II- 7] Rates of sales growth and operating income-to-sales ratios,

and changes in proportions of chronically marginal firms··········117

[Fig. II- 8] Proportions of firms in different operating income-to-sales

ratio ranges············································································118

[Fig. II- 9] Firms’ financial structure stability············································118

[Fig. II-10] Chronic marginal firm credit rating and asset soundness

classification proportions·························································119

[Fig. II-11] Firms selected for restructuring, and their current situations······120

[Fig. II-12] New contracts of PEFs, and amounts of non-performing

loan disposal··········································································120

[Fig. II-13] Credit supply to chronically marginal firms by specialized banks

and policy finance-related institutions······································121

[Fig. II-14] Current situations of corporate investment and employment·····121

[Fig. II-15] Changes in corporate productivity···········································122

[Fig. II-16] Credit supply to chronically marginal firms······························122

[Fig. II-17] Proportions of credit supplied to chronically marginal firms,

by type of financial institution and form of credit·····················123

[Fig. II-18] Corporate delinquency rates and non-performing loan ratios····123

[Fig. II-19] Changes in domestic bank asset soundness and capital adequacy

following defaults by chronically marginal firms·······················124

[Fig. III- 1] Major EME exports to China, and proportion in total exports···127

[Fig. III- 2] Global economy growth rates··················································127

[Fig. III- 3] EME currency exchange rates against U.S. dollar····················127

[Fig. III- 4] EME stock prices···································································127

[Fig. III- 5] Proportions of raw material exports·········································128

[Fig. III- 6] Oil price levels required for balanced current·fiscal accounts··128

[Fig. III- 7] Non-bank sector loan balances of international

commercial banks···································································129

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[Fig. III- 8] Corporate sector international bond balances···························129

[Fig. III- 9] Amounts of securities investment fund flows to EMEs···············130

[Fig. III-10] Amounts of capital flows to EMEs···········································130

[Fig. III-11] Amounts of exports between Korea and EMEs, and proportion

of Korean exports to EMEs····················································131

[Fig. III-12] Investments between Korea and EMEs····································131

[Fig. III-13] Time-varying correlation coefficient between Korean CDS

premium and EME interest rate spread···································132

[Fig. III-14] Time-varying correlation coefficient of CDS premiums

between Korea and China······················································132

[Fig. III-15] Time-varying correlation coefficient of price-earnings ratios

between Korea and China······················································133

[Fig. III-16] Time-varying correlation coefficient of exchange rate

fluctuations between Korea and EMEs····································133

[Fig. III-17] Probability of Korean foreign currency funding conditions

weakening greatly···································································135

[Fig. III-18] Korean current account, and current account / nominal

GDP ratio··············································································135

[Fig. III-19] Korea’s foreign reserves and short-term foreign debt················135

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[Financial System Stability]

[Tab. II- 1] Leverage ratios of domestic banks and non-bank financial

institutions···············································································71

[Tab. II- 2] Proportions of payments made after settlement delay

penalty deadlines······································································93

List of Tables

*금안2015(Dec)01-목차1~15 2016.2.18 11:23 AM 페이지14

List of Boxes

<Box 1> Leverage and Interconnectedness in Financial System···············17

<Box 2> Systemic Risk Survey Results···················································19


<Box I- 1> Impacts of Structural Changes in Housing Leasehold

Market on Household Financial Soundness······························31

<Box I- 2> Current Status and Major Characteristics of Self-Employed

Business Owner Loans····························································37

<Box I- 3> Recent Trends of Group Loans Related to the New Housing

Sales Market···········································································41

<Box I- 4> Korea’s Corporate Debt Level on the World Stage···················50

<Box I- 5> Stress Testing of Firms with Liquidity Risks·····························52

<Box II- 1> Financial Institutions’ Mid-level Interest Rate on Unsecured

Household Loans····································································66

<Box II- 2> Introduction of Countercyclical Capital Buffer, and

Effects on Financial Stability····················································68

<Box II- 3> OTC Derivatives Transactions by Securities Companies,

and Assessment of Potential Risks············································75

<Box II- 4> Reform of Net Settlement Risk Management System················95

*금안2015(Dec)01-목차1~15 2016.2.18 11:23 AM 페이지15

*금안2015(Dec)02-개요1~19 2016.2.18 11:24 AM 페이지1

Financial StabilityOverview

I. Executive Summary···········································································3

II. Financial Soundness of Household and Corporate Sectors··············23

III. Financial System Stability································································59

IV. Future Policy Challenges································································127

*금안2015(Dec)02-개요1~19 2016.2.18 11:24 AM 페이지1

*금안2015(Dec)02-개요1~19 2016.2.18 11:24 AM 페이지2

Korea’s financial system has main-

tained a generally stable picture,

thanks to continuing favorable levels

of soundness among financial institu-

tions and in the foreign exchange sec-

tor. However, potential financial sys-

tem risk is judged to have increased

somewhat, as financial soundness in

the household and corporate sectors

has declined.

First, amid a lack of improvement in

household income conditions, the amount of

household debt has expanded greatly due to

increased housing purchases for example. In

the corporate sector, meanwhile, sales have

fallen greatly and financial structure stability

has lessened as well.

The slump in profitability at banks has

persisted, but amid favorable capital adequa-

cy the trend of improvement in asset sound-

ness has been sustained, even despite the

declines in household and corporate sector

financial soundness, thanks to the easing of

borrowers’ repayment burdens due to the

continuing low interest rates. At non-bank

financial institutions most management indi-

cators have shown signs of improving. The

financial markets have shown somewhat

unstable movements, meanwhile, with stock

price and exchange rate volatilities expand-

ing and credit concerns in the corporate

bond market rising. Foreign exchange

soundness has maintained a satisfactory

level, with net external assets increasing and

the ratio of short-term external debt falling.

These changes in the financial stability sit-

uation are reflected in the Financial Stability

Map.1)2) The Financial Stability Index (FSI)3),

showing the situation related to financial sta-

bility, did meanwhile rise from 3.5 in April

2015 to the 5.0 level as of October 2015,

but also remains below the “Warning” stage

threshold (8).

3

Finan

cial Stability O

verview

1) The Financial Stability Map presents a comprehensive picture of stability in six dimensions – two concerning macroprudential soundness

conditions (the debt servicing capacities of the household and business sectors) and four concerning the financial system (banks, non-bank

financial institutions, the financial markets and foreign exchange soundness). If the decile reading of a particular dimension is from 5 to 6, then

this may be seen as a degree of stability in that dimension corresponding to its average levels in the past (since 1995).

2) The financial market infrastructure has been included as a sector related to financial system stability beginning from the H1 2015 FSR. Since

this is a sector connected with the financial substructure, however, including the payment and settlement system for example, it is not included

in the Financial Stability Map.

3) The Financial Stability Index (FSI) is an index created by converting a variety of different financial stability indicators into a single index, and

can be used as one of the indicators for judging overall macroprudential conditions. Here the optimum critical threshold Warning and Crisis

stages are calculated on the basis of the “noise-to-signal ratio” approach, at 8 and 22 respectively. For further details refer to the April 2012

Financial Stability Report, <Box IV-1> 「Outline of Financial Stability Index (FSI)」.

Notes: 1) The closer to the center, the greater the degreeof stability

2) Macroprudential soundness conditiondimensions, Financial system dimensions

Financial Stability Map1)2)

Period analyzed for H1 2015 Financial Stbility ReportPeriod analyzed for H2 2015 Financial Stbility Report

Financial marketstability

Deterioration

Improvement

Bank soundness

Foreign exchange soundness

Household financialsoundness

Corporate financialsoundness

Non-bank financialinstitutionsoundness

*금안2015(Dec)02-개요1~19 2016.2.18 11:24 AM 페이지3

[Korea’s Financial Stability Situation]

1⃞ The financial soundness of the

household sector has declined, despite

improvements in the debt structure

including expanded proportions of

fixed-rate and amortizing loans, as the

pace of increase in debt has been con-

tinually accelerating.

At 1,166 trillion won as of the end of

September 2015, total household debt had

risen by 10.4% year-on-year, with its pace of

increase having continually grown since the

third quarter of 2014. The household debt-

to-disposable income ratio, at 143.0% (esti-

mated) as of the end of September 2015,

was also 5.0% points higher than at the end

of March 2015 (138.0%).

4

Note: 1) The Financial Stability Index is measured basedon values from 0 (min) to 100 (max). The closerit is to 100, the higher the level of instability.<The level during the Asian financial crisis(Jan.1998) equals 100>

Source: The Bank of Korea

60

50

40

30

20

10

0

60

50

40

30

20

10

0

Financial Stability Index (FSI)1)

2008 2009 2010 2011 2012 2013 2014 2015.10

Global financialcrisis

Crisis stage

Warning stage

140.7

143.0

10.4

9.2

Notes: 1) Year-on-year2) Household credit statistics basis3) Disposable income for Q1~Q3 2015 estimated

using household disposable income-to-grossnational income ratio (average overimmediately preceding three years)


145

140

135

130

125

13

10

7

4

Amount and rate of increase1) of household debt2),and household debt-to-disposable income3) ratio

Q1 2011 Q1 2012 Q1 2013 Q1 2014 Q1 2015 Q3

(%) (100 trillion won, %)

Household debt amount (RHS)Household debt-to-disposable income ratio (LHS)Rate of household debt increase (RHS)

*금안2015(Dec)02-개요1~19 2016.2.18 11:24 AM 페이지4

The ratio of household debt repayment

expenditures to disposable income stood at

41.4% in the second quarter of 2015, having

jumped by 2.7% points year-on-year. This

was a result mainly of factors such as the

expansion in the proportion of amortizing

loans and a decline in business incomes.

The household expenditure-to-income ratio

on the other hand fell by 1.5% and 0.9%

points year-on-year respectively in the sec-

ond (76.8%) and third (76.9%) quarters, due

mainly to a decrease in consumption expen-

ditures in line with the outbreak of Middle

East Respiratory Syndrome (MERS).

The household financial debt-to-financial

assets ratio (44.0% at end-June 2015) mean-

while maintained a relatively favorable pic-

ture, in spite of the accelerated pace of

increase in household debt, owing to the

continuing high rate of increase in financial

assets. At 44.9% as of the end of 2014, this

ratio was higher than the 36.9% average of

the 23 OECD member countries.

2⃞ Profitability in the corporate sector

has improved slightly but financial

soundness has declined, with a large-

scale deterioration in growth and a

rising number of financially vulnerable

firms.

The rate of sales growth recorded a sub-

stantial negative level (-7.1%) in the first half

of 2015, and the sluggishness of growth

deepened. The operating income-to-sales

ratio was 5.6%, higher by 0.9% point than

in the first half of 2014 (4.7%), as profitabili-

ty improved. This result is seen as mainly

because of firms having pursued productivity

more than expansions in size as their busi-

ness strategy priorities, in line with the wors-

ening of external conditions.

Corporate financial structure soundness

has deteriorated somewhat, due to increases

in debt and declines in short-term repay-

5

Finan

cial Stability O

verview

41.4

76.9

76.8

Notes: 1) Amounts of loan principal and interest repayment,credit card settlement costs, etc.

2) Consumption and non-consumption (taxes, pension /insurance payments, interest costs, etc.) expenditures

3) Earned income, business income, property income,transfer income, etc.

Sources: The Bank of Korea, Statistics Korea

45

40

35

30

85

80

75

70

Household debt repayment expenditure1)-to-disposableincome and household expenditure2)-to-income3) ratios

Q1 2011 Q1 2012 Q1 2013 Q1 2014 Q1 2015 Q3

(%) (%)

Debt repayment expenditure-to-disposable income ratio (LHS)

Household expenditure-to-income ratio (RHS)

Notes: 1) First-half basis 2) Year-on-yearSource: KIS-Value

10

8

6

4

2

0

-2

-4

25

20

15

10

5

0

-5

-10

Corporate growth and profitability1)

2010 2011 2012 2013 2014 2015

(%) (%)

Operating income-to-sales ratio (LHS)

Rate of sales increase (RHS)2)

*금안2015(Dec)02-개요1~19 2016.2.18 11:24 AM 페이지5

ment capacities and so on. The proportion

of corporations with debt ratios of 200% or

above has risen (end-2014 12.3% → end-

June 2015 12.9%), and that of companies

with interest coverage ratios below 100%

has also shown a slight increase.

Looking at the individual industries’ debt

ratios, meanwhile, most industries except for

shipbuilding and shipping have not seen any

great changes. In the case of the shipbuild-

ing industry, however, its debt ratio has

exceeded 200% in 2015, in line with a

slump in overall business conditions.

3⃞ Banking sector soundness has

shown a generally favorable picture

despite a structural slump in prof-

itability, with asset soundness improv-

ing and so on.

Profitability has expanded, centering

around loans, and asset soundness has also

shown a trend of improvement due to a

continuing trend of decline in substandard-

or-below loan ratios for example. With

financial soundness in the household and

corporate sectors declining, however, poten-

tial default risks are seen to have increased.

6

Notes: 1) Debt / Equity 2) End-period basis 3) First-half basisSource: KIS-Value

15

14

13

12

11

10

15

14

13

12

11

10

36

34

32

30

28

26

36

34

32

30

28

26

Indicators of corporate financial structure soundness

2011 2013 2015.6 2011 2013 2015

(%) (%) (%) (%)

12.9

35.3

<Debt ratio 200% or above1)2)> <Interest coverage ratio below 100%3)>

(57.8) (28.1) (14.1)

Note: 1) Figures in parentheses are the proportions inthe total debt of all industries accounted for bythe debts in the groups of industries indicated.

Source: KIS-Value

600

400

200

100

0

600

400

200

100

0

Changes1) in debt ratios, by major industry

Electr

onics

Autom

obile

s

Steel

Chem

icals

Mac

hinery

Oilre

fining

Cons

tructi

on

Shipb

uildin

g

Shipp

ing

Texti

les&

appa

rel

Who

lesale

&ret

ail

(%) (%)

End-June 2015

End 2014

<Below 100%> <100~200%> <200% or above>

*금안2015(Dec)02-개요1~19 2016.2.18 11:24 AM 페이지6

Profitability has continued its trend of

decline, with the return on assets (ROA)

falling from 0.48% in the first quarter of

2015 to 0.44% in the third quarter for

example. Banks’ structural margin ratio,

indicating their capacities for generating sus-

tainable profits, has continued to decrease,

with declines in their loan-to-deposit interest

rate spreads and net interest margins, and

recorded 0.8% in the third quarter of 2015,

the lowest level since compilation of this sta-

tistic began in 1999.

Capital soundness has remained at a satis-

factory level. At 14.67% as of the third

quarter of 2015, the BIS total capital ratio

was lower by 0.18% point than in the previ-

ous quarter but still greatly above the regu-

latory standard (8.0%). The provision cover-

age ratio, which shows banks’ capacities for

absorbing expected losses, was 141.5% (esti-

mated) in the third quarter and had also

sustained its trend of increase.

7

Finan

cial Stability O

verview

Note: 1) Year-on-yearSource: Commercial banks’ business reports

3

2

1

0

10

8

6

4

2

0

-2

Commercial bank substandard-or-below loan ratio,and rate1) of lending increase

Q1 2011 Q1 2012 Q1 2013 Q1 2014 Q1 2015 Q3

(%) (%)

Substandard-or-below loan ratio (RHS)

Rate of lending increase (LHS)

Notes: 1) Accumulated quarterly records annualized2) (Interest income + Fee income + Trust account

income – Operating expenses) / Total assetsSources: The Bank of Korea, Commercial banks’ business

reports

4

3

2

1

0

4

3

2

1

0

Commercial bank profitability indicators

Q1 2011 Q1 2012 Q1 2013 Q1 2014 Q1 2015 Q3

(%, %p) (%, %p)

ROA1) Structural profitability1)2)

Loan-to-deposit spread Net interest margin

*금안2015(Dec)02-개요1~19 2016.2.18 11:24 AM 페이지7

4⃞ Non-bank financial sector sound-

ness has improved overall, with trends

of growth being sustained and capital

adequacy showing favorable levels.

Rates of total asset growth have fallen

slightly in some non-bank financial institu-

tion sub-sectors, but as of the end of

September 2015 the sector as a whole was

sustaining its trend of growth and showing a

high level of 10.5% year-on-year.

Profitability has generally improved.

Return on assets (ROA) have risen, owing to

declines in loan loss provisions at mutual

credit cooperatives, to expansions in fee

incomes and decreases in interest expenses

at securities companies, to increases in inter-

est earnings and declines in loan loss provi-

sions following reductions in bad loans at

mutual savings banks, etc. These improve-

ments in non-bank financial institution prof-

itability owe mainly to the declines in mar-

ket interest rates, however, and so the

volatility of profits can expand in line with

any changes in the financial market environ-

ments in the future.

8

Notes: 1) Period-end basis2) Basel II basis until Q3 2013, Basel III basis from

Q4 20133) Loan loss provisions (including loan loss

reserves) / Substandard-or-below loansSources: Commercial banks’ business reports

16

14

12

10

8

200

150

100

50

0

Commercial bank BIS total capitaland provision coverage ratios1)

Q1 2011 Q1 2012 Q1 2013 Q1 2014 Q1 2015 Q3

(%) (%)BIS total capital ratio (LHS)2)

Provision coverage ratio (RHS)3)

Note: 1) Year-on-year, excluding increases due to newmarket entries (NongHyup Life Insurance,NongHyup Property & Casualty Insurance, KBKookmin Card, Woori Card and Hana Card) andaccounts receivable of securities companies

Sources: Financial institutions’ business reports

20

15

10

5

0

20

15

10

5

0

30

15

0

-15

-30

30

15

0

-15

-30

Non-bank financial institution rates of total asset growth, by financial sector1)

2011.3 2013.3 2015.9 2011.3 2013.3 2015.9

(%) (%) (%)(%)

Insurance cos.Mutual credit cooperativesCredit-specialized financial cos.

Securities cos.Savings banks

*금안2015(Dec)02-개요1~19 2016.2.18 11:24 AM 페이지8

Capital adequacy ratios have fallen slightly

in some sectors, but are maintaining satisfac-

tory levels greatly exceeding the financial

supervisory standards in all sectors.

5⃞ The domestic financial markets

have shown some degree of instability,

with the volatility of market prices

expanding and credit concerns grow-

ing for example.

Stock price and exchange rate volatilities

have increased, on concerns about a global

economic slowdown and expectations of a

policy interest rate hike by the U.S. Federal

Reserve among other factors.

The Treasury bond (3-year) yield had fall-

en, due to spreading economic unrest in

China and other emerging market

economies, but has reversed to an increase

since October 2015 on expectations of a

domestic economic recovery and the possi-

bility of a Fed rate hike.

9

Finan

cial Stability O

verview

Note: 1) Net incomes for past one year / Average totalassets for past one year


2

1

0

-1

-2

6

4

2

0

-2

-4

-6

Non-bank financial institution ROAs1)

Insurance cos. Mutual credit securities cos. Credit- Savings banks(LHS) cooperatives (LHS) specialized (RHS)

(LHS) financial cos.(RHS)

(%) (%)

Q1 2011 Q1 2013

Q1 2015 Q3 2015

Notes: 1) mutual credit cooperatives’ net capital ratio (2%;community credit cooperatives 4%; agriculturalcooperatives 5%), credit-specialized financialcompanies’ adjusted-capital ratio (7%; credit cardcompanies 8%), savings banks’ BIS capital ratio(6%; companies with assets over 2 trillion won7%), Insurance companies’ risk-based capitalratio (supervisory standard 100%), securitiescompanies’ net operating capital ratio (150%)

2) Dotted lines indicate the relevant supervisorycapital adequacy standards.


25

20

15

10

5

0

600

400

200

0

Non-bank financial institution capital adequacy ratios1)2)

Mutual credit Credit-specialized Savings Insurance cos. Securities cos. cooperatives (LHS) financial cos. (LHS) banks (LHS) (RHS) (RHS)

(%) (%)

December 2013

December 2014

March 2015

June 2015

September 2015

Note: 1) Daily volatility calculated using exponentialweighted moving average (EWMA) method


3

2

1

0

3

2

1

0

Interest rate, stock price and FX volatilities1)

2013.1 7 2014.1 7 2015.1 7 11

(%) (%)

Interest rate (3-yr Treasury bond yield)

Stock price (KOSPI)

Exchange rate (won / USD)

*금안2015(Dec)02-개요1~19 2016.2.18 11:24 AM 페이지9

The won / U.S. dollar exchange rate has

fluctuated sharply, in line with changes in

expectations related to monetary policies at

home and abroad, while the won / yen rate,

after having risen on a trend of safe asset pref-

erence, has reversed to a decline since October

2015 as global risk preferences have improved.

In the corporate bond market, meanwhile,

owing to increased credit concerns following

the slumps in corporate business conditions,

credit spreads on both prime and non-prime

corporate bonds have widened rapidly.

6⃞ Foreign exchange soundness has

shown a favorable picture overall.

The net external assets have continued to

grow while the external payment capacity

has maintained sound conditions, with the

ratios of short-term external debt relative to

foreign exchange reserves and to total exter-

nal debt sustaining their low levels.

10


1,400

1,200

1,000

800

1,400

1,200

1,000

800

Won / USD and won / yen exchange rates

2013.1 7 2014.1 7 2015.1 7 11

(won / USD, won / 100 yen) (won / USD, won / 100 yen)

Won / USD Won / 100 yen

Sources: Korea Financial Investment Association,Bloomberg

4

3

2

1

4

3

2

1

BOK Base Rate, Korea and U.S. Treasury bond yields

2013.1 7 2014.1 7 2015.1 7 11

(%) (%)

BOK Base Rate

Korea Treasury (3-yr) yield

U.S. Treasury (10-yr) yield

Source: The bank of Korea

4,000

3,000

2,000

1,000

0

60

50

40

30

20

Net external assets, and liquidity indicators

Q1 2011 Q1 2012 Q1 2013 Q1 2014 Q1 2015 Q3

(100 million dollars) (%)

Net external assets (LHS)Short-term external debt / Foreign exchange reserves (RHS) Short-term external debt / Total external debt (RHS)

Note: 1) 3-year maturity basisSource: Korea Financial Investment Association

100

80

60

40

20

0

160

140

120

100

80

60

Corporate bond credit spreads1), and spread across credit ratings

2013.1 7 2014.1 7 2015.1 7 11

(bp) (bp)

Corporate bonds (A-) - Corporate bonds (AA-) (RHS)

Corporate bonds (A-) - Treasury bonds (RHS)

Corporate bonds (AA-) - Treasury bonds (LHS)

*금안2015(Dec)02-개요1~19 2016.2.18 11:24 AM 페이지10

Domestic banks’ foreign currency funding

conditions have shown temporary deteriora-

tions in the second half of 2015, with the

highlighting of the likelihood of a policy rate

hike by the U.S. Federal Reserve and of

concerns about the economic slump in

China, but have shown a favorable picture

overall. In particular, although the spread

on long-term foreign currency borrowings

rose to 79 basis points in September 2015, it

then fell from October with the continuation

of the current account surplus and so on,

and has since then shown a trend of small

fluctuations at around the 60bp range.

The volatility of foreigners’ securities

investment fund flows has expanded, on the

influence of changes in global fund flows,

etc. From June 2015 these funds showed a

large-scale outflow, influenced by interna-

tional financial market instability. Since

October, however, foreigners’ securities

investment funds have shown small degrees

of net inflows and net outflows, in line with

the expectations of a Fed rate hike within

this year and so on.

7⃞ Settlement risk in the major pay-

ment and settlement systems has been

managed stably.

The maximum intraday overdraft cap

exhaustion rate and the proportion of pay-

ment orders in queue for settlement, which

reveal the levels of secured settlement liquid-

ity of institutions participating in the large-

value payment system, BOK-Wire+, have

shown generally favorable pictures.

Moreover, since the second quarter of 2015

there have been zero cases of operating

hours extension due to computer system fail-

ures at participant institutions.

11

Finan

cial Stability O

verview

Notes: 1) Borrowing spreads based on LIBOR (ninedomestic bank basis); calculated by amount-weighted averaging

2) Based on simple average of CDS premiums ofKookmin Bank, Industrial Bank of Korea,Shinhan Bank, Woori Bank, and KEB Hana Bank

Sources: The Bank of Korea, Bloomberg

140

120

100

80

60

40

20

0

140

120

100

80

60

40

20

0

Domestic bank long-term borrowing spread1)

and CDS premium2)

2013.1 2013.7 2014.1 2014.7 2015.1 2015.7 11

(bp) (bp)

Long-term borrowing spread

CDS premiumNote: 1) Monthly amounts of net inflows and outflowsSource: The Bank of Korea

80

60

40

20

0

-20

-40

-60

80

60

40

20

0

-20

-40

-60

Net foreign investor portfolio investment fund flows1)

2013.1 2014.1 2015.1 11

(100 million dollars) (100 million dollars)

Bond funds

Stock funds

*금안2015(Dec)02-개요1~19 2016.2.18 11:24 AM 페이지11

The proportion of foreign currency settle-

ments carried out through the CLS system

has fallen since the first quarter of 2015,

owing for example to an increase in transac-

tions involving the Chinese yuan, a non-

CLS settlement currency, but has still main-

tained a high level in the 70% range. In the

retail payment systems operated by the

Korea Financial Telecommunications &

Clearings Institute, the number of cases of

net settlement participants’ net debit cap uti-

lization rates exceeding the 70% warning

level has meanwhile risen since the second

quarter of 2015, in line for example with

temporary large-scale fund transfers due to

some companies’ subscriptions to public

offerings and the related refunds.

The securities settlement systems have

been operated stably, with a decrease in the

proportion of payments for settlement of

exchange-traded and over-the-counter stock

and government bond transactions made

after the settlement delay penalty deadline,

etc.

12


25

20

15

10

5

0

80

76

72

68

64

Retail payment and foreign exchange settlementsystem risk indicators

Q1 2012 Q1 2013 Q1 2014 Q1 2015 Q3

(frequency) (%)

Frequency of net debit cap utilization rate exceeding 70% (LHS)

Proportion of settlements made using CLS system (RHS)

Securities settlement system risk indicators

Exchange-traded stocks 16:00 16:00 – – – – –

Exchange-traded 16:00 17:00 0.11 – 0.04 – –government bonds

OTC stocks4) 16:50 16:50 – 0.08 0.01 0.001 –

Payment shares3)

Payment Penalty 2014 2015deadline1) deadline2)

Q3 Q4 Q1 Q2 Q3

(%)

Notes: 1) Settlement deadline under system operating rules 2) Deadline after which settlement delay penalty assessed3) Shares of payment funds paid after the settlement deadlines4) Institutional investors



70

60

50

40

30

20

15

10

5

0

Large-value payment system risk indicators

Q1 2012 Q1 2013 Q1 2014 Q1 2015 Q3

(%) (%)Ratio of settlement concentration at around closing time (LHS)Maximum intraday overdraft cap exhaustion rate (LHS)Proportion of payment orders in queue for settlement (RHS)

*금안2015(Dec)02-개요1~19 2016.2.18 11:24 AM 페이지12


1⃞ Compared to the cases of major

countries the speed of population

aging in Korea is rapid, and so its

effects on overall household debt

through a variety of channels can

become large.

Population aging is foreseen as likely to

cause a slowdown in the pace of household

debt growth – due to a decrease in the asset

accumulating population aged 35 to 59, the

core group with demand for debt, and to an

increase in the population aged 60 and

above, who have higher propensities to

reduce their debts. But even if members of

the elderly cohort liquidate parts of their

debt after retirement, the proportion in total

financial debt accounted for by this group

appears likely to rise, as members of the 50s

age cohort, the current main holders of

financial liabilities, enter their 60s. It has

been analyzed that Korean households in

fact expand their debts up until the age of

57, after which they are repaying their debts

through means such as disposals of real

assets.

Meanwhile, population aging can cause

risks of declines in real estate prices stem-

ming from increased disposals of real assets

in the process of debt deleveraging, and of

increased numbers of vulnerable elderly

families. These risks can be particularly large

13

Finan

cial Stability O

verview

Notes: 1) Household credit statistics basis2) Projections calculated to reflect changes in the

distribution compared to 2014Sources: The Bank of Korea, Statistics Korea (Survey of

Household Finances and Living Conditions)

16

12

8

4

0

6

4

2

0

-2

100

80

60

40

20

0

100

80

60

40

20

0

Rates of increase in household debt1) and populationstructure, and financial debt distribution2)

2004 2009 2014 2019 2024 30s~50s 60s~70s

(%) (%) (%) (%)

Rate of household debt increase (LHS) Shares in total debt (2014)Rate of increase in asset accumulating age group (RHS) Shares in total debt (after 5 years)Rate of increase in population 60 years and older (RHS) Shares in total debt (after 10 years)

Note: 1) Based on average yearly changes in debt andassets by age group, between 2010 and 2014

Sources: The Bank of Korea, Statistics Korea (Survey ofHousehold Finances and Living Conditions)

2,000

1,500

1,000

500

0

-500

-1,000

2,000

1,500

1,000

500

0

-500

-1,000

Changes1) in financial debt and assets, by age group

30~39 40~49 50~57 58~64 65~70 71~79

(10 thousand won) (10 thousand won)

Real assets Financial assets Financial debt

*금안2015(Dec)02-개요1~19 2016.2.18 11:24 AM 페이지13

because the speed of Korean population

aging is rapid and the 50s and 60s age

cohorts, whose demand for debt deleverag-

ing is great, are holding mainly real assets,

while the proportion of marginal households

in this group is also high. The effects of

population aging are expected to be felt full-

scale within three to four years, and since

responding within a short period of time will

be difficult it is necessary to respond pre-

emptively, through continuing household

debt management, the revitalization of real

estate finance by the introduction of reverse

mortgages, the creation of specially designed

jobs for the elderly, and so on.

2⃞ The number of chronically margin-

al firms unable to cover their interest

expenses with operating incomes for a

long period of time since the global

financial crisis is increasing, and they

are working as a factor burdening the

macro–financial economy.

Among corporations subject to external

audits, the proportion of chronic marginal

firms rose by 2.4% points between 2009 and

2014 - from 8.2% (1,851 companies) to

10.6% (2,561). Among the different indus-

tries, this proportion increased by large

extents in the shipbuilding, transportation,

steel and construction industries. As of the

end of 2014, chronically marginal firms

accounted for levels of 7.8% (239 trillion

won) of the total assets of all corporations

subject to external audits, 14.1% (228 tril-

lion won) of their total liabilities, and 5.4%

(191,000 people) of their total employees.

Compared to normal companies, chronically

marginal firms have low degrees of contribu-

tion to the real economy, while their levels

of dependence on debt are high.

14

66.4

33.625.9

17.6

12.613.7

18.6

74.182.4

Notes: 1) End-March 2014 basis2) Shares of marginal households in the different

borrower age groupsSources: The Bank of Korea, Statistics Korea (Survey of


100

80

60

40

20

0

100

80

60

40

20

0

20

15

10

5

0

20

15

10

5

0

Asset composition and shares1)2) of marginal households, by age group

30s~40s 50s 60s and 30s~40s 50s 60s andabove above

(%) (%) (%) (%)

Financial assets Real assets

<Asset composition> <Marginal households>

Notes: 1) Changes in proportions between 2009 and 20142) End-2014 per-industry averages

Source: KIS-Value

10

8

6

4

2

0

10

8

6

4

2

0

2,000

1,500

1,000

500

0

2,000

1,500

1,000

500

0

Status of chronically marginal firms

Assets Debts Total employees(LHS) (LHS) (RHS)

(%p) (%p) (100 million won) (persons)

Normal firms

Chronically marginal firms

<Changes1) in proportions of firms, by industry> <Assets, debts and numbers of employees2)>

Shipb

uildin

g

Shipp

ing Steel

Cons

tructi

on All

*금안2015(Dec)02-개요1~19 2016.2.18 11:24 AM 페이지14

Due to worsening cash flows stemming

from their slumps in profitability, the major-

ity of chronic marginal firms are managing

to survive through reliance on borrowings.

Financial institutions have continued their

credit supply to these firms, based mainly on

collateral and guarantees, in line with their

practices of forbearance lending character-

ized by tendencies toward leniency in the

rating of firms’ credit levels and in their own

management of asset soundness. The ongo-

ing low interest rates have also worked as a

factor intensifying chronically marginal

firms’ reliance on borrowings, by alleviating

their interest payment burdens.

As the number of chronically marginal

firms increases, their negative effects on

investment and employment can expand

and resource allocation efficiency can fall,

thus constraining economic growth.

Moreover, since chronically marginal firms’

financial conditions are weak, their large-

scale defaults at times of domestic or exter-

nal shock occurrence could work as a factor

of destabilizing the financial system. Efforts

will thus have to be redoubled to ensure that

corporate restructuring can be pushed ahead

with, preemptively and effectively, through

for example improvement of the restructur-

ing system and strengthening of the role of

the creditor financial institutions.

3⃞ Emerging market economies have

shown trends of instability recently,

with the values of their currencies

falling and capital flowing out from

them. In line with these developments

there is a possibility of substantial

effects on the Korean economy, which

has close connections with EMEs.

Looking at the factors causing instabilities

in emerging economies, the strengthened

interlinkages with China in their real

economies and financial sectors since the

financial crisis have raised the possibilities of

the slowdown in Chinese economic growth

spreading rapidly to affect them. Since the

second half of 2014, concerns have

increased that EMEs’ international credit

standings will decline as the current and fis-

cal balances of raw material-exporting coun-

tries deteriorate due to the slowdown in

Chinese economic growth. Moreover, capital

liberalization in EMEs has progressed great-

ly and their external borrowings have also

expanded since the global financial crisis,

centering around their corporate sectors.

Owing to these factors there are potential

risks of foreign debt repayment burdens and

capital outflow volatility becoming large

when the U.S. Federal Reserve raises its pol-

icy rate in the future.

15

Finan

cial Stability O

verview

Notes: 1) Firms that averaged negative (-) operatingincome-to-sales ratios between 2009 and 2014

2) Based on chronically marginal firms that haverecorded three consecutive years of operatingdeficits and of debt ratios above 200% (fivedomestic bank basis, as of end-June 2015)

Sources: KIS-Value, The Bank of Korea

80

60

40

20

0

80

60

40

20

0

Chronically marginal firmloan soundnessclassifications2)

Proportions of firmsin deficit1)

Chronically Normal marginal firms firms

(%) (%)

Substandard-or-below

(32.8%)Normal(63.7%)

Precautionary(3.5%)

*금안2015(Dec)02-개요1~19 2016.2.18 11:24 AM 페이지15

Given the steadily expanded size of trade

and capital transactions between Korea and

other emerging market countries, instabilities

in EMEs could not only have adverse

impacts on the Korean real economy, but

also cause pressures for outflows of foreign-

ers’ securities investment funds.

Empirical analysis has also shown that the

Korean economy, even if its economic fun-

damentals are sound, can experience greatly

worsening foreign currency funding condi-

tions in times of international financial mar-

ket instability. This is because, due to

Korea’s high interconnectedness with EMEs

in the real and financial sectors, as well as to

the trend of strengthening financial market

synchronization, global risk aversion can

spread to the domestic economy if factors

such as an economic slowdown in China, a

U.S. interest rate hike and instabilities in

EMEs should appear together. As of

September 2015 it was analyzed that the

probability of Korea’s foreign currency

funding conditions (CDS premium) worsen-

ing in the existing conditions was 23.2%,

but that this would increase to 48.0% in the

case where financial instabilities in EMEs

expanded, and increase greatly to 75.0%

should upward pressures on international

interest rates rise due to rate hikes by the

U.S. Federal Reserve appear.

16

Note: 1) Shares of exports to China based on India,Indonesia, Malaysia, Thailand, Brazil, Turkey,Russia, the Republic of South Africa and Korea,while Corporate sector foreign currencyborrowings add China as well


16

12

8

4

0

8,000

6,000

4,000

2,000

0

External dependency of major EMEs1)

2008 2014 2008 2015.9

(%) (100 million dollars)

<Shares of exports to China (LHS)>

<Corporate sector foreigncurrency borrowings (RHS)>

Note: 1) Sum of International Investment Positions (IIP)of China, Southeast Asia, Central and SouthAmerica, and the Middle East area; applicableyear accumulation basis


4,000

2,000

0

2,000

4,000

4,000

2,000

0

2,000

4,000

Investments1) between Korea and EMEs

2003 2006 2009 2012 2014


Korea → EMEs

Direct investment

Securities investment

Other investment

EMEs → Korea

*금안2015(Dec)02-개요1~19 2016.2.18 11:24 AM 페이지16

From the standpoint of quantitative indicators of risk

related to leverage1) and interconnectedness2), the

degree of risk accumulation in the Korean financial sys-

tem is analyzed as not high at present.

(Risks from leverage perspective)

First, from the perspective of leverage, the private

credit-to-nominal GDP ratio decreased in the first quarter

of 2015 compared to the quarter before. The ratio how-

ever then reversed to an increase from the second quar-

ter and hit its all-time high (182.6%) in the third quarter.

The private credit-to-nominal GDP gap, which fell into

negative territory in the first quarter, also recorded a

modest positive figure from the second quarter (+2.2%p

in the third quarter).

By sector, the credit-to-nominal GDP ratios of house-

holds and corporations stood at 74.3% and 108.3%

respectively as of the third quarter of 2015, up by 1.7%

points and 2.3% points compared to the end of 2014. As

for the credit-to-nominal GDP gaps, the positive gap in

the household sector has grown compared to the fourth

quarter of 2014, while in the corporate sector the nega-

tive gap has reversed to a positive one.

17

Finan

cial Stability O

verview

Leverage and Interconnectedness in FinancialSystem

1BOX

Notes: 1) Sum of household and corporate credits heldby deposit-taking institutions

2) Based on seasonally adjusted nominal GDP3) Difference between private credit-to-nominal

GDP ratio and its HP filtered long-term trendSource: The Bank of Korea

200

180

160

140

120

100

40

30

20

10

0

-10

-20

Private credit1)-to-nominal GDP2) ratio, and gap3)

1991 1995 1999 2003 2007 2011 Q3 2015

(%) Asian financialcrisis (Nov. ’97)

Lehman Brotherscollapse (Sep. ’08)

Korean credit cardcrisis (Mar. ’03)

(%p)

Private credit / Nominal GDP gap (RHS) Private credit / Nominal GDP (LHS) Long-term trend (LHS)

Notes: 1) Based on seasonally adjusted nominal GDP2) Difference between credit-to-nominal GDP

ratio and its HP filtered long-term trendSource: The Bank of Korea

80

70

60

50

40

30

10

5

0

-5

-10

130

110

90

70

50

30

20

10

0

-10

-20

Credit-to-nominal GDP1) ratios and gaps2), by sector

1991 1999 2007 Q3 2015 1991 1999 2007 Q3 2015

(%) (%) (%p)(%p)

Credit / Nominal GDP gap (RHS) Credit / Nominal GDP (LHS) Long-term trend (LHS)

<Households> <Corporations>

1) Refers to the risks triggered by an oversupply or a sudden contraction in credit due to the herd behaviors or pro-cyclical actions of economic agents.

2) Refers to risks from deteriorations in asset soundness or liquidity crunches at individual companies spreading to the overall financial system,

through direct or indirect exposures across financial institutions.

*금안2015(Dec)02-개요1~19 2016.2.18 11:24 AM 페이지17

Given that the private credit-to-nominal GDP ratio is

not much different from its long-term trend, it is judged

that potential leverage-related systemic risks in Korea’s

financial system are not considerably high. However, not

only is the private credit-to-nominal GDP ratio high and

growing, but the credit-to-nominal GDP gaps in both the

household and the corporate sectors are also positive.

More caution is thus needed concerning the possibility of

a future build-up of risks.

(Risks from interconnectedness perspective)

A look at the financial sector interconnectedness

matrix shows that the volume of assets and liabilities

interconnected across financial institutions reached 411

trillion won as of the end of the third quarter of 2015, up

by about 7 trillion won compared to the end of 2014

(404 trillion won). By sector, while the volume of inter-

connectedness across banks had decreased (-9 trillion

won), interconnectedness across non-bank institutions

(+4 trillion won) and between banks and non-bank insti-

tutions (+12 trillion won) had increased. Meanwhile, the

proportion in total financial sector assets of the volume

interconnected across financial institutions stood at

7.8%, down by 0.5% point compared to that (8.3%) at

the end of 2014. This owed to the rate of growth (8.9%)

in total assets having greatly exceeded that in the vol-

ume of interconnectedness (1.8%).

Although the volume of financial sector interconnect-

edness has expanded, given its decreased proportion rel-

ative to total assets the risks from the financial sector

interconnectedness are not believed to be high.

However, given that the volume of interconnectedness

between banks and non-bank financial institutions is

increasing3), led by asset management companies, con-

tinuing caution in this regard is merited.

18

3) As of end-September 2015 the volume of interconnectedness across banks, across non-banks, and between banks and non-banks was estimated

to be 61 trillion won, 118 trillion won, and 231 trillion won respectively.

404411

8.37.8

324

308

11.2

8.5

Note: 1) Volumes of funding and operation throughmarketable financial products such as financialdebentures, RPs, CDs and CP

Sources: Estimations reflecting financial institutions’business reports, Korea Securities Depositorydata, and The Bank of Korea estimates (usingflow of funds statistics)

450

400

350

300

250

25

20

15

10

5

Volumes1) of interconnectedness of financial sectorassets and liabilities

2007 2009 2011 2013 Q3 2015

(trillion won) (%)

Interconnectedness volume (LHS)

Proportion in total assets (RHS)

Notes: 1) Based on volumes of sectoral interconnectednesscalculated on basis of marketable deposits(excluding the public sector such as pension funds)

2) Total amounts of funding in parentheses ( )3) Q3 2015 basis

Sources: Estimations reflecting financial institutions’ businessreports, Korea Securities Depository data, and The Bankof Korea estimates (using flow of funds statistics)

Interconnectedness map1)2)3)

Banks(2,527.3)

Insurancecos.

(658.4) Mutual credit

cooperatives(445.5)

Securities cos.

(415.2)

Credit-specialized

financial cos. (133.2)

65.9

60.4

47.0

49.9

19.216.2

19.4

6.4

15.3

10.5 7.5

20.3

2.5

Assetmanagement cos. (420.9)

(trillion won)

*금안2015(Dec)02-개요1~19 2016.2.18 11:24 AM 페이지18

According to the results of the Bank of Korea’s survey

on systemic risks1) conducted in October 2015, the

key risks2) to Korea’s financial system are ① a Chinese

economic slowdown (90%), ② U.S. interest rate normal-

ization (72%), and ③ the Korean household debt prob-

lem (62%). In terms of their time horizons, the Chinese

economic slowdown is recognized as a risk over the

short to medium term (within 3 years), and U.S. interest

rate normalization and the Korean household debt prob-

lem as risks that could materialize in the short term

(within one year) and the medium term (within 1~3

years), respectively.

In terms of the possibility of financial systemic risks

materializing in the short term (within one year), the pro-

portion of respondents considering that possibility low

stood at 44%, greatly exceeding that of respondents

considering it high (15%). As to the possibility of such

risks materializing in the medium term (within 1~3

years), however, the proportion of respondents consider-

ing it high (37%) was larger than that of those saying

that it was low (19%). The share of respondents feeling

that financial systemic risks could materialize in the short

term has risen compared to the first half of 2015, while

that of those feeling that they could materialize in the

medium term has also increased slightly.

19

Finan

cial Stability O

verview

Systemic Risk Survey Results2BOX

1) To help accurately identify the potential risk factors affecting the Korean financial system, the Bank of Korea conducts a ‘Systemic Risk

Survey’ of domestic and foreign financial market experts twice each year.

2) Risks recognized in 50% or more of the responses are regarded as key risks. The proportions of responses are calculated based on the multiple

response method, by asking each respondent to identify the five greatest risks and then dividing the total number of responses per risk by the

total number of respondents (81 people).

62%

72%

90%

Key risks, and time horizons1) ofmaterialization

Note: 1) Short-term is within 1 year, short- to medium-termwithin 3 years, and medium-term 1 to 3 years

Chineseeconomicslowdown

Koreanhousehold

debt problem

U.S. interest ratenormalization

Short- to medium-term

Short-term

Medium-term

Proportions of responses Time horizons of materialization 5844

36

41

615

24 19

4444

32 37

100

80

60

40

20

0

100

80

60

40

20

0

Possibilities1) of systemic risk materialization

H1 2015 H2 2015 H1 2015 H2 2015

(%)(%)High Medium Low High Medium Low

<Short-term> <Medium-term>

Note: 1) Proportions of respondents in the surveys in H1 andH2 2015

*금안2015(Dec)02-개요1~19 2016.2.18 11:24 AM 페이지19

*금안2015(Dec)03-1장20~55 2016.2.18 11:24 AM 페이지20

Korea’s Financial StabilitySituations

I. Financial Soundness of Household and Corporate Sectors··············23

II. Financial System Stability································································57

*금안2015(Dec)03-1장20~55 2016.2.18 11:24 AM 페이지21

*금안2015(Dec)03-1장20~55 2016.2.18 11:24 AM 페이지22

Financial Soundness of Household andCorporate Sectors

Ⅰ

1. Households························································································25

2. Corporations······················································································44

*금안2015(Dec)03-1장20~55 2016.2.18 11:24 AM 페이지23

*금안2015(Dec)03-1장20~55 2016.2.18 11:24 AM 페이지24

1. Households

Decline in household financialsoundness

Household financial soundness has deterio-

rated. Household income growth has stagnat-

ed, and as the pace of increase in house-

holds’ debts accelerates the household debt-

to-disposable income ratio has sustained an

upward trend and the ratio of debt repay-

ment expenditures to disposable income has

also risen greatly. The debt structure has

however improved, with the proportion of

fixed interest rate and amortizing loans

increasing, and the financial debts-to-finan-

cial assets ratio has fallen slightly (Figure I-1).

Accelerated pace of householddebt increase

At 1,166 trillion won as of the end of

September 2015, total household debt

(household credit statistics basis) had

increased by 10.4% year-on-year, with its

pace of growth having accelerated since the

third quarter of 2014. On a value basis

household debt expanded by 35 trillion won

in the third quarter of 2015 – the largest

quarterly increase since compilation of these

statistics began in 2002. This was a result

mainly of housing transactions expanding

due to the improvement in the housing

economy1), amid the LTV and DTI regula-

tions having been eased and lending interest

rates having fallen, and of steadily increased

extensions of group loans2) due to the robust-

ness of new housing sales (Figure I-2).

25

I. Finan

cial Sou

nd

ness o

f Ho

useh

old

and

Co

rpo

rate Sectors 1. H

ou

seho

lds

Ko

rea’s Finan

cial Stability Situ

ation

s

Note: 1) Extents of change in April 2015~September 2015 period(January~June 2015 period for debt repayment expenditure-to-disposable income ratio, and as of end-June 2015 for ratioof financial liabilities to financial assets and end-September2015 for ratio of household debt to disposable income)compared to April 2014~September 2014 period(January~June 2014 period for debt repayment expenditure-to-disposable income ratio, and as of end-June 2014 for ratioof financial liabilities to financial assets and end-March 2014for household debt-to-disposable income ratio) indexed


<Figure I- 1> Household Financial Stability Map1)

Baseline

2015.4~9Rate of increase in

household debt

Householddebt /

Disposableincome

Debt repaymentexpenditure /Disposable

income

Financial liabilities /Financial assets

Household expenditure/ Household income

Deterioration

Improvement

1) The likelihood is not high of the housing market, the main factor behind the increase in household debt, being adjusted within a short period

of time, but in the medium to long term the possibility does remain of increased downside risks to housing prices, stemming for example from

an increase in housing supply, from population aging or from a strengthening of financial institutions’ loan screening.

2) For details refer to <Box I-3> 「Recent Trends of Group Loans Related to the New Housing Sales Market」.

1,132

1,166

9.2

10.4

Notes: 1) Year-on-year2) Household credit statistics basis


1,300

1,150

1,000

850

700

14

12

10

8

6

4

<Figure I- 2> Amount and rate1) of increase of household debt2)

Q1 2011 Q1 2012 Q1 2013 Q1 2014 Q1 2015 Q3

(trillion won) (%)

Household debt amount (LHS)

Rate of household debt increase (RHS)

*금안2015(Dec)03-1장20~55 2016.2.18 11:24 AM 페이지25

Looking at the situations of household

loan in the different financial sectors, from

the second quarter of 2015 the rate of

increase in household lending by banks

slowed somewhat, while that among non-

bank financial institutions accelerated great-

ly. This was a result of the transfer to the

Korea Housing Finance Corporation (HF)3)

of a large amount of Mortgage Refinancing

Program that were extended between March

and April 2015 (Figure I-3).4)

Meanwhile, among total home mortgage

loans extended by banks the proportions of

fixed rate and amortizing loans have contin-

ued rising, under the influence for example of

the government’s household debt manage-

ment measures5) including its supply of

Mortgage Refinancing Program, to stand at

33.6% and 37.5% respectively as of the end

of September 2015. The average remaining

maturity of bank home mortgage loans has in

addition lengthened rapidly, from 11.6 years

at the end of 2010 to 17.5 years as of the end

of September 2015, and the debt structure

has improved (Figure I-4).

26

3) Among 31.7 trillion won in Mortgage Refinancing Program extended by banks, 31.5 trillion won were transferred to HF between May and

September of 2015. If bank home mortgage loans are transferred to this public corporation, then at the time of household credit statistics

compilation the funds concerned are reclassified from among ‘Home mortgage loans of deposit banks’ into the ‘Public financial institutions’

item of other financial institutions (‘Non-bank financial institution’ household loans in <Figure I-3>).

4) If the portion transferred to HF is included, the rate of total bank household lending growth has been accelerating (Q1 2015 9.1% → Q2

12.3% → Q3 13.9%, year-on-year basis).

5) Through its July 2015 「Household Debt Management Measures」, the government adjusted upward the performance targets (proportions of

fixed-rate and amortizing loans) in order to improve the bank home mortgage loan structure.

Fixed rate 25% → 35% 30% → 37.5% 40%Amortizing 25% → 35% 30% → 40% 40% → 45%

DivisionYearly target

End-2015 End-2016 End-2017 and after

Notes: 1) Year-on-year2) Depository institutions, National Housing Fund,

Korea Housing Finance Corporation, etc.3) Based on depository institutions’ household

lending (unsecured loans, guaranteed loans, etc.)Source: The Bank of Korea

16

12

8

4

0

16

12

8

4

0

<Figure I- 3> Rates1) of increase in household loans, by financial sector and loan type

Q1 2011 Q1 2012 Q1 2013 Q1 2014 Q1 2015 Q3

(%) (%)

Banks Non-bank financial institutions

Home mortgage loans2) Other loans3)

33.637.5

11.6

17.5

Sources: Financial Services Commission, The Bank of Korea

50

40

30

20

10

0

20

15

10

5

0

<Figure I- 4> Bank proportions of fixed rate and amortizing loans, and average home mortgage loan maturity

2010 2011 2012 2013 2014 Sep. 2015

(%) (year)

Fixed rate (LHS) Amortizing (LHS)

Average maturity (RHS)

*금안2015(Dec)03-1장20~55 2016.2.18 11:24 AM 페이지26

Large increase in household debtcompared to income

The household debt-to-disposable income

ratio (household credit statistics basis) stood

at 143.0% (estimated6)) at the end of

September 2015, up by 5.0% points com-

pared to the end of March (138.0%). This

greatly exceeded the average annual extent

of increase in the 2003~2014 period

(+2.4%p), which was a result of the pace of

increase in household debt having accelerat-

ed despite the stagnation in household dis-

posable income growth due to the slow-

down in the economic recovery (Figure I-5).

Decline in financial liabilities-to-financial assets ratio

Households’ financial liabilities-to-financial

assets ratios (flow of funds statistics basis)

stood at 44.0% at the end of June 2015,

having fallen by 1.0% point since the end of

June 2014 (45.0%). This resulted from

household financial assets having also sus-

tained a high rate of growth despite the

accelerated pace of increase in household

financial debt. As regards the proportions of

household financial assets by type, as of the

second quarter of 2015 cash and deposits

made up the highest proportion at 41.7% of

the total, with insurance & pensions next at

31.2% (Figures I-6, I-7).

27

I. Finan

cial Sou

nd

ness o

f Ho

useh

old

and

Co

rpo

rate Sectors 1. H

ou

seho

lds

Ko

rea’s Finan

cial Stability Situ

ation

s

6) As the household disposable income statistics are aggregated annually, quarterly disposable income is estimated by multiplying the annual

household disposable income-to-gross national income ratio (52.5% in 2015, as the 2012~2014 average) by gross national income.

140.7143.0

10.4

4.3

Notes: 1) Household credit statistics basis2) Disposable income for Q1~Q3 2015 estimated using

the household disposable income-to-gross nationalincome ratio (average for preceding three years)

3) Year-on-yearSource: The Bank of Korea

150

140

130

120

110

100

15

12

9

6

3

0

<Figure I- 5> Household debt1)-to-disposable income2)

ratio, and rates3) of increase in disposable income and household debt

Q1 2011 Q1 2012 Q1 2013 Q1 2014 Q1 2015 Q3

(%) (%)

Household debt-to-disposable income ratio (LHS)

Rate of disposable income increase (RHS)

Rate of household debt increase (RHS)

45.0

44.0

10.7

8.3

Notes: 1) 1993 SNA basis before 2012, and 2008 SNAbasis since 2013

2) Year-on-yearSource: The Bank of Korea

50

48

46

44

42

40

15

12

9

6

3

0

<Figure I- 6> Financial liabilities-to-financial assets ratio1)

and rates2) of increase in financial assets and financial liabilities

Q1 2011 Q1 2012 Q1 2013 Q1 2014 Q1 2015 Q2

(%) (%)

Financial liabilities-to-financial assets ratio (LHS)Rate of financial assets increase (RHS)Rate of financial liabilities increase (RHS)

*금안2015(Dec)03-1장20~55 2016.2.18 11:24 AM 페이지27

Meanwhile, as of the end of 2014 Korean

households’ debt-to-disposable income ratio

showed 164.2% (on a flow of funds statistics

basis) and their financial liabilities-to-finan-

cial assets ratio 44.9% – 33.7% points and

8.0% points higher respectively than the 23

OECD member country7) averages (130.5%

and 36.9%) (Figure I-8).8)

Comparing countries’ changes in house-

hold debt indicators since the global finan-

cial crisis, Korea’s household debt-to-dispos-

able income ratio rose by 19.9% points

between the end of 2008 and end-2014,

greatly exceeding the OECD member coun-

try average rate of increase (+1.6%p).

Korea’s financial liabilities-to-financial assets

ratio in contrast fell by 6.1% points over

this period, to show a level similar to the

OECD member country average (-6.2%p)

(Figure I-9).

28

20.5

5.9

31.2

41.7

Note: 1) Direct investment, other financial assets,derivatives, etc.


100

80

60

40

20

0

100

80

60

40

20

0

<Figure I- 7> Proportions of household financial assets, by type

2000 2005 2010 Q1 2015 Q2

(%) (%)

Cash, deposits Insurance, pensions Bonds Stocks Others1)

7) Based on 23 among the 34 OECD countries for which securing of statistics was possible. Among these countries, the household debt-to-

disposable income ratios for Greece, Switzerland and Poland are end-2013 basis.

8) In Denmark and Norway the tax burden ratios are high and the proportions of public pensions and insurance are high as well, and so

households’ disposable incomes and financial assets are quite low compared to those in other nations. In line with this households’ ratios of

debt to disposable income and of financial liabilities to financial assets are greatly exceeding the OECD member country averages.

Notes: 1) Flow of funds statistics basis 2) End-2014 basis, end-2013 for household debt-

to-disposable income ratios of Greece,Switzerland and Poland

Sources: The Bank of Korea, OECD

350

300

250

200

150

100

50

0

<Figure I- 8> Household debt ratio distributions1)2)

in major countries

0 20 40 60 80

Financial liabilities-to-financial assets (%)

Denmark

Netherlands

Norway Switzerland

Sweden U.K.

130.5% (23 OECD membercountry average)

36.9% (23 OECD member country average)

Korea

Portugal Finland

GreeceSpain U.S.

Belgium Italy

Hungary

Czech republic

Slovenia Austria

FranceGermany

Estonia

Poland Slovak republic Hous

ehol

d de

bt-to

-disp

osab

le in

com

e (%

)

*금안2015(Dec)03-1장20~55 2016.2.18 11:24 AM 페이지28

Rise in household debt repaymentexpenditure burdens, and declinein household expenditure-to-income ratio

The household ratio9) of debt repayment

expenditures to disposable income was

41.4% in the second quarter of 2015, having

jumped by 6.0% points since the first quar-

ter of 2015 (35.4%) and by 2.7% points

compared to the second quarter of 2014

(38.7%). This is seen to have been a result

mainly of a decline in household business

incomes due for example to a shrinkage in

consumption following the MERS outbreak,

on top of an increase in loan principal

repayments due to the expansion in the

amount of amortizing home mortgage loans

(Figure I-10).

The household expenditure-to-income

ratio10) was 76.8% in the second quarter of

2015 and 76.9% in the third, decreased by

1.5% points and 0.9% point respectively

year-on-year (Figure I-11). This ratio has

since the second quarter of 2014 shown a

picture of generally declining, as the rate of

increase in household expenditures has been

below that in household incomes. By income

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Note: 1) End-2014 basis compared to end-2008, end-2013 compared to end-2008 for householddebt-to-disposable income ratios of Greece,Switzerland and Poland

Sources: The Bank of Korea, OECD

30

20

10

0

-10

-20

-30

<Figure I- 9> Changes1) in household debt ratios in major countries since global financial crisis

-25 -20 -15 -10 -5 0 5 10

Change in financial liabilities-to-financial assets (%p)

Greece

Netherlands

Norway

SwitzerlandSweden

U.K.

+1.6%p (23 OECD membercountry average)

-6.2%p (23 OECD membercountry average)

Korea

Portugal

Finland

Denmark Spain

U.S.

Belgium

Italy

Hungary

Czech republic

Slovenia

Austria

France

Germany

Estonia

Poland

Slovak republic

Chan

ge in

hou

seho

ld d

ebt-t

o-di

spos

able

inco

me

(%p)

9) To evaluate households’ debt repayment burdens related to their incomes, the debt service ratio (DSR: ratio of principal and interest

repayments to disposable income) is generally used, but as this is released annually (from Statistics Korea’s Survey of Household Finances and

Living Conditions) we have used the household debt repayment expenditure-to-disposable income ratio (from Statistics Korea’s Household

Income and Expenditure Survey) as a substitute indicator. There is meanwhile a need to keep in mind that the debt repayment expenditure-

to disposable income ratio of the Household Income and Expenditure Survey differs from the DSR of the Survey of Household Finances and

Living Conditions (which was 21.5% in 2013). For example, while the former includes the total amount of all credit card repayments

including lump sum settlement costs, the latter in contrast includes only the credit card repayment amounts related to cash advance services

and installment purchases.

10) The household expenditure-to-income ratio is calculated based on Statistics Korea’s quarterly Household Income and Expenditure Survey.

Here household expenditures encompass not only consumption expenditures, but also non-consumption expenditures such as taxes, public

pension and insurance payments, interest expenses, etc.

38.7

35.4

41.4

3.1

10.4

Notes: 1) Debt repayments, credit card payments, etc.2) Year-on-year

Source: Statistics Korea

45

40

35

30

30

20

10

0

-10

<Figure I-10> Debt repayment expenditure1)-to-disposableincome ratio and rates2) of increase in disposable

income and debt repayment expenditures

Q1 2011 Q1 2012 Q1 2013 Q1 2014 Q1 2015 Q2

(%) (%)

Debt repayment expenditure-to-disposable income ratio (LHS)

Rate of disposable income increase (RHS)

Rate of debt repayment expenditure increase (RHS)

*금안2015(Dec)03-1장20~55 2016.2.18 11:24 AM 페이지29

quintile, amid the household expenditure-to-

income ratios having fallen in most income

quintiles, the extent of decline has appeared

relatively large in the first income quintile in

particular (Figure I-12).

Due to this revitalization of housing trans-

actions as well as to changes in the leasehold

deposit market, the pace of increase in

household debt has accelerated greatly. But

since the improvements in household

incomes are relatively weak, household

financial soundness has declined on the

whole. Under these circumstances, should a

future macroeconomic shock such as a sud-

den rise in interest rates occur there will be

a possibility of increased numbers of insol-

vent households, centering around small self-

employed business operators and other vul-

nerable groups, and there is thus a need to

devote continuing attention to household

financial soundness.

30

78.377.8

76.876.9

-0.5

0.7

Note: 1) Year-on-yearSource: Statistics Korea

85

82

79

76

73

70

12

9

6

3

0

-3

<Figure I-11> Household expenditure-to-household income ratio, and rates1) of increase in household income and expenditures

Q1 2011 Q1 2012 Q1 2013 Q1 2014 Q1 2015 Q3

(%) (%)

Household expenditure-to-household income ratio (LHS)Rate of household income increase (RHS)Rate of household expenditure increase (RHS)


120

100

80

60

120

100

80

60

<Figure I-12> Household expenditure-to-household income ratios, by income quintile

Quintile 1 Quintile 2 Quintile 3Quintile 4 Quintile 5 Overall

(%) (%)

Q2 2014 Q3 2014

Q2 2015 Q3 2015

*금안2015(Dec)03-1장20~55 2016.2.18 11:24 AM 페이지30

As leasehold deposit prices have continued to

increase, the ratio of nationwide apartment lease-

hold deposit prices to sales prices rose from 52.3% in

January 2009 to 73.7% in November 2015 (+21.4%p),

the highest since these statistics were first compiled in

December 1998.1)

Since this high leasehold deposit-to-sales price ratio

may lead to a situation in which lessees are unable to

receive their deposits back on time in cases of shock

such as sharp declines in housing prices, there is a need

to examine the related risks. This report also considers

the effects on household financial soundness of recent

changes in the housing leasehold market structure,

including the shifts from deposit-based leaseholds to

housing purchases or monthly payment-based rentals.

1. Scale of deposit- and monthly rental-based tenancy deposits, and potentialrisks related to their return

( Scale of deposit- and monthly rental-based tenancy deposits )

The total number of lessee households that have paid

housing deposits stands at 7.46 million (3.53 million

households that have paid leasehold deposits, and 3.93

million households that have paid security deposits on

monthly rental housing), to account for 41.4% of total

domestic households (18 million households, based on

2014 Korea Housing Survey). Estimation using micro data

from the Korea Housing Survey and the housing market

price DB of the Ministry of Land, Infrastructure and

Transport finds the deposits of these households to total

around 530 trillion won (about 440 trillion won for lease-

hold deposits, and 90 trillion won for monthly rental securi-

ty deposits, as of end-June 2014).2) By region, Seoul and its

surrounding areas account for the largest part (408.5 tril-

lion won, 76.5%) of this, and by housing type, apartments

(378.4 trillion won, 70.9%) make up the greatest share.

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I-1BOX

Impacts of Structural Changes in Housing LeaseholdMarket on Household Financial Soundness

1) The total housing leasehold deposit-to-sales price ratio (based on data compiled by Kookmin Bank) also stood at 66.2% as of November 2015,

the highest since compilation of these statistics began in June 2011. This rise in leasehold deposit prices since the financial crisis is attributable

mainly to a deepening of the supply and demand imbalance in the housing leasehold market, as demand for leasehold housing has increased

due for example to the weakening of expectations of a rise in housing prices, while leasehold supply has declined owing among other factors to

lessor preference for monthly rentals.

2) For the number of households by residential type, by region, and by type of housing, the micro data of the 2014 Korea Housing Survey of the

Ministry of Land, Infrastructure and Transport was used. For the average deposits for deposit-based and monthly payment-based tenancies per

household, estimation was carried out using the micro data (on about 2 million contracts, based on the housing market price DB of the Ministry of

Land, Infrastructure and Transport) on deposits for deposit- and monthly payment-based tenancies paid during the period between July 2012 and

June 2014 for apartments, row houses and multiplex houses, and the micro data of the Korea Housing Survey for single-family living detached

houses, multi-family living detached houses and officetels. However, in cases of deposit- and monthly payment-based tenancies for which the deposits

are small, many lessees do not register the fixed dates for their leasehold contracts at their area civic service offices, and so when the housing market

price DB (which is based on the fixed dates) is used, the average deposits for deposit- and monthly payment-based tenancies can be overestimated.

*금안2015(Dec)03-1장20~55 2016.2.18 11:24 AM 페이지31

( Potential risks related to deposit return )

This section estimates the scale of deposits for

deposit- and monthly payment-based tenancies that

could possibly fail to be returned on time or be lost,

using the micro data of the 2014 Survey of Household

Finances and Living Conditions (2014).3)

First, looking at the distribution of lessor households’

deposit debt-to-financial assets4) ratios, 43.6% of all

lessor households hold deposits in excess of their finan-

cial assets. However, given that in many cases lessors

return lessees’ deposits using the subsequent lessees’

deposits, there will not be many lessor households that

actually fail to return these deposits on time.

In a stress situation in which deposit prices for

deposit- and monthly payment-based tenancies fell

sharply by 20%5), it is estimated that 11.9% of all lessor

households would need to borrow additional funds (in

the amount of 1.9% of total deposits) (Situation ①). It is

in addition estimated that 5.1% of lessor households

would find it difficult to return their deposits held even

through borrowing6) (affecting 0.9% of total deposits)

(Situation ②). The net amount of deposits carrying high

risk related to their return is not large at present. Given

the substantial number of households occupying housing

through deposit- and monthly payment-based tenancy

contracts, however, should the deposit- and monthly

payment-based rental markets become strained going

forward, this could place burdens on the financial and

real transactions of households overall.

32

408.5

67.6 57.6

378.4

89.9 65.4

533.7

Notes: 1) End-June 2014 basis 2) Figures in ( ) represent the numbers of lessee

households that have paid security depositsSources: The Bank of Korea, Ministry of Land, Infrastructure

and Transport (Korea Housing Survey, HousingMarket Price DB)

600

400

200

0

600

400

200

0

Deposit- and monthly payment-based tenancy deposits,by residential type, region and housing type1)2)

Total Seoul and Provincial Provinces Apartments Detached Row houses,its surrounding metropolitan houses etc.

areas cities

(trillion won) (trillion won)

Monthlyrentals with

securitydeposits

96.4(3.93 million)

Deposit-based

leaseholds437.3

(3.53 million)

(4.42 million)

(1.44 million)(1.60 million)

(3.07 million)

(3.18 million)(1.21 million)

<By region> <By housing type>

3) To ensure accurate analysis, there is a need for detailed financial information on lessors, such as their financial assets and liabilities and the

amounts of bonds they have issued to creditors with rights to collateral security, as well as the scales of deposits paid for individual deposit-

based and monthly payment-based tenancies. It is however difficult to obtain such information.

4) Financial assets in this report exclude premiums and other savings from the financial asset item of the Survey of Household Finances, and are

defined as follows:

Financial assets = Installment savings + Time deposit savings – Premiums + Deposit assets held for deposit- and monthly payment-based

tenancies at current residences

5) Immediately after the Asian Currency Crisis, nationwide leasehold deposit prices for apartments fell by 20.2% year-on-year in 1998.

6) Real LTVs were calculated in consideration of lessors’ housing assets other than their residences, the amounts of their loans secured against

these assets, and their debts on deposits held. For a real LTV below the current regulatory level (70%), it was assumed that additional

borrowing could be taken out.

56.4

18.6

13.1 11.9


60

40

20

0

60

40

20

0

Distribution of lessor household deposits held-to-financial assets ratios

Less than one time One to two times Two to five times More than five times

(%) (%)

(Deposits held-to-financial assets ratio)

Households whose deposits(debts) held exceed their financial assets (43.6%)

*금안2015(Dec)03-1장20~55 2016.2.18 11:24 AM 페이지32

In addition, in cases where lessors go bankrupt, due

for example to defaults on their loans, if there are senior

bonds issued to them by creditors with rights to prefer-

ential payment then their lessees may be unable to

receive their deposits back. In events of applications by

senior creditors for compulsory housing sales, depending

upon the housing auction sales prices subordinate

lessees of deposit- and monthly payment-based tenan-

cies7) may be unable to receive parts of their deposits

back. The closer the housing leasehold prices are to the

actual housing sales prices, the greater lessees’ risks of

not receiving their deposits back even if housing prices

decline only slightly.8)

2. Examination of possibility of additionalborrowings in cases of shifts byhouseholds from deposit-based tenanciesto purchases of their own homes or tomonthly payment-based rentals

( Deposit-based tenancies → own homepurchases )

As households shift from deposit-based tenancies to

purchases of their own homes or to monthly payment-

based rentals, there may be effects on their overall finan-

cial soundness owing to changes in their asset and debt

structures. Using the micro data of the 2014 Korea Housing

Survey, this report targets deposit-based lessee households

judged highly likely to shift to home ownership9), and calcu-

lates the number of them that will need additional loans as

well as the amounts of loans needed. According to the

results of analysis, 430 thousand households (12.1% of the

total of 3.53 million households) are likely to shift to own-

ing their own homes, and among them 260 thousand,

about 60%, are analyzed as likely to be in need of loans at

the times when they make those shifts. A shift of a deposit-

based lessee household to home ownership is found to

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7) Since there is no per-house information in the Survey of Household Finances and Living Conditions on the amounts of bonds issued by

lessors to creditors with rights to collateral security, it is difficult to accurately identify whether deposits for deposit-based and monthly

payment-based tenancies are subordinated or not. However, in the cases of lessor households that have taken out collateralized loans for

purposes of purchasing real estate other than residential housing, they are highly likely to have borrowed funds from financial institutions

when purchasing their housing for rental. And so their mortgage loans other than those for their own residential housing can be indirectly

identified as senior bonds. Through this method of estimation, the proportion of households that have taken out loans secured against rental

housing they have purchased(i.e. lessor households whose senior bonds are held by financial institutions) is found to reach 16.2% of the total

number of lessor households, and 20.5% in terms of the value of the rental housing.

8) Meanwhile, individuals are showing a lackluster performance in subscribing to guarantee insurance against the risk of failing to receive back

their deposits for deposit- and monthly payment-based tenancies, due mainly to the high insurance premiums. There is thus a limitation on

the hedging such risk for the moment. At Seoul Guarantee Insurance, which has been selling deposit insurance since 1995, there were about

47,000 new contracts (for about 4.8 trillion won in value) during the 2010~14 period, but about 85% of the policy holders (based on new

subscribers in 2014) are corporate subscribers, and the share of individual subscribers is not high.

9) Lessee households planning to move to their own houses within five years (by purchasing newly build houses, purchasing existing houses, or

moving into houses that they already own) are defined as highly likely to shift to statuses of homeowners. The amounts that they will need to

borrow are estimated by taking into account the prices, sizes, and types of houses that they plan to purchase, together with the financial

conditions of the individual households.

1.9

11.9

0.9

5.1

Notes: 1) Proportions in total deposits and in total lessorhouseholds

2) Situation ①: Amounts of borrowing needed incases where lessors must return deposits ofexisting lessees, using deposits from subsequentlessees whose deposit prices are 20% lower thanexisting ones (80% of existing deposit amounts)Situation ②: Shortfalls in cases where lessors takeout additional borrowing up to the LTV regulatoryceiling (70%), using their houses as collateral


20

15

10

5

0

20

15

10

5

0

Households1)2) with concerns related to returns ofdeposits in cases of sharp declines

in leasehold deposit and monthly rental prices

Situation ① Situation ②

(%) (%)

Proportion of the number of households

Proportion of deposits

*금안2015(Dec)03-1장20~55 2016.2.18 11:24 AM 페이지33

trigger demand for additional lending averaging 130 mil-

lion won (equivalent to about 44% of the LTV), and if these

households all shifted to home ownership it is estimated

that the lending amount would reach about 34 trillion

won.10) Given that, since the end of June 2014 when analy-

sis took place the leasehold deposit-to-sales price ratio has

continued to rise11), and that the demand for housing trans-

actions has increased, due mainly to the easing of the

LTV·DTI regulations and declines in interest rates, it is

possible that the additional lending volume required due to

shifting by deposit-based lessee households to home own-

ership can be much greater than the above estimate.

( Deposit-based → monthly payment-based tenancies )

Considering that in the recent shifting from deposit-

based leaseholds there has been an increased preference

for semi-deposit- or semi-monthly payment-based tenan-

cies, rather than simple monthly payment-based

rentals12), there seems unlikely to be any great change in

household debt due to households shifting from deposit-

based to monthly-payment based rentals. Looking at the

average deposit amounts for the various different rental

types, that for semi-deposit-based tenancies rose by 59

million won from 88 million won in the first half of 2013

to 147 million won in the first half of 2015 – which was

well above the extent of increase in deposits for deposit-

based tenancies (+26 million won) – while the changes

in deposits for semi-monthly and monthly payment-

based rentals were in contrast not large. The great

increase in the average deposit for semi-deposit-based

tenancies seems to be attributable to the fact that some

of the previous high-value deposit-based leasehold con-

tracts have been shifted to semi-deposit-based ones,

under which the increases in deposit amounts are paid in

the form of monthly rents.

34

10) The additional lending amount required by households shifting from monthly rentals for which they have put down security deposits to house

ownership is estimated at about 19 trillion won. Changes in the debts of households shifting from homeowners to homeowners or selling their

existing houses are meanwhile hard to estimate at present, due to a lack of micro data related to disposal of existing houses.

11) According to the 2014 Survey on Demand for Housing Finance and Bogeumjari (cheap public housing) Loans, by the Korea Housing

Finance Corporation, lessee households’ desires to purchase their own houses increase dramatically once the leasehold deposit-to-sales price

ratio exceeds 70%. (Percentages of lessee households desiring to purchase their own houses depending upon leasehold deposit-to-sales price

ratio: 38.5% when ratio is 50% → 49.1% when ratio is 60% (+10.6%p) → 69.2% when ratio is 70% (+20.1%p).

12) According to the Housing Market Price DB, the share in all rental contracts involving security deposits accounted for by deposit-based

tenancies fell from 65.0% in H1 2013 to 59.6% during H1 2015 (-5.4%p), that of semi-deposit-based tenancy contracts (with deposit fees 240

times higher than the monthly rents) from 5.8% to 8.2% (+2.4%p), that of semi-monthly payment-based rental transactions (with deposits 12

times or more but 240 times or less than the monthly rents) from 26.0% to 28.3% (+2.3%p), and that of monthly payment-based rental

transactions (with deposits less than 12 times the monthly rents) from 3.2% to 3.9% (+0.7%p).

353

43 26

(12.1%)(59.9%)

Note: 1) End-June 2014 basisSources: The Bank of Korea, Ministry of Land, Infrastructure

and Transport (Korea Housing Survey)

400

300

200

100

0

400

300

200

100

0

Estimated numbers1) of lessee households shifting tohome ownership

Deposit-based Households highly Households in lessee households likely to shift to need of lending

home ownership

(10 thousand households) (10 thousand households)

Additional loans

130 million won per householdAverage LTV 44%

*금안2015(Dec)03-1장20~55 2016.2.18 11:24 AM 페이지34

Based on this, we have calculated the per-household

differences in deposits that lessor households had to pay

when deposit-based leasehold contracts signed in the

first half of 2013 expired and were shifted to semi-

deposit-based leaseholds, semi-monthly payment-based

rentals, or monthly payment-based rentals in the first

half of 2015. It is as a result estimated that lessors will

have to pay 108 million won in the case of semi-month-

ly-payment based contracts, and 132 million won for

monthly-payment-based ones. For semi-deposit-based

leaseholds, in contrast, it is estimated that the lessor

households will receive an average of 12 million won. In

events of shifts to semi-monthly payment-based or

monthly payment-based contracts, the amounts of

deposits that must be returned are large. Even so, how-

ever, given the scales of financial assets of the lessor

households, such shifts are unlikely to have great effects

on total household debt.13) Considering the average total

financial assets (118 million won) of lessor households

(excluding those that are lessee households as well),

identified in the Survey of Household Finances and Living

Conditions, it is estimated that they will be able to return

the differences in the deposit amounts (of 108 million

won for semi-monthly payment-based, and 132 million

won for monthly payment-based rentals) without any

need for large-scale borrowing. With regard to semi-

deposit-based leaseholds, given the average financial

assets of the lessee households (excluding those that are

also lessors), which stand at 31 million won, they seem

likely to be able to afford to pay additional deposits (12

million won) to their lessors without having to borrow

from financial institutions.

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3

25

88

135

3

27

147

161

Note: 1) Average deposits for nationwide apartments, rowand multiplex houses, and single-family living andmulti-family living detached houses during thegiven periods

Sources: The Bank of Korea, Ministry of Land, Infrastructureand Transport (Housing Market Price DB)

200

150

100

50

0

200

150

100

50

0

Average deposits1), by rental type

Monthly rentals Semi-monthly Semi-deposit- Deposit-basedrentals based leaseholds leaseholds

(million won) (million won)

H1 2013

H2 2013

H1 2014

H2 2014

H1 2015

13) This report conducts analysis mainly from the perspective of the lessor, given the limitations in the micro data related to whether lessee

households that have shifted from deposit-based to monthly payment-based rentals have moved to new housing, and to how they have used

the deposits refunded to them.

118118

31

Note : 1) Difference in deposits in H1 2015 (for monthlyrentals) compared to those in H1 2013 (forleaseholds)

Sources : The Bank of Korea, Statistics Korea (Survey ofHousehold Finances and Living Conditions),Ministry of Land, Infrastructure and Transport(Housing Market Price DB)

150

100

50

0

150

100

50

0

Differences1) in deposits by type of shift in tenancy,and average financial assets

of lessee and lessor households

Deposit-based → Deposit-based → Deposit-based →Monthly payment-based Semi-monthly payment-based Semi-deposit-based

(million won) (million won)Difference in deposit pricesAverage financial assets of lessor householdsAverage financial assets of lessee households

(+)12

(-)108

(-)132

*금안2015(Dec)03-1장20~55 2016.2.18 11:24 AM 페이지35

With regard meanwhile to semi-deposit-based lease-

holds, for which the existing deposits remain unchanged

and the increases in the deposit amounts are shifted to

monthly rental payments, the rise in monthly rents is

steeper than those in other contracts. The consequent

increases in housing costs may cause a worsening of

these lessee households’ finances, thus leading to further

growth in their borrowing for living expenses.

36

40.244.2

17.0

40.0

46.3

24.9

Note:1) Average deposit for nationwide apartments, rowand multiplex houses, and single-family living andmulti-family living detached houses during thegiven periods

Sources: The Bank of Korea, Ministry of Land, Infrastructureand Transport (Housing Market Price DB)

60

50

40

30

20

10

0

60

50

40

30

20

10

0

Average monthly rental fees1), by type of borrowing involving security deposits

Monthly payment-based Semi-monthly payment-based Semi-deposit-based


H1 2013

H2 2013

H1 2014

H2 2014

H1 2015

*금안2015(Dec)03-1장20~55 2016.2.18 11:24 AM 페이지36

As bank lending to individual entrepreneurs (self-

employed business owner1) corporate loans) has

grown even more rapidly in 2015, concerns are being

raised about the risks of default on self-employed busi-

ness owner loans as a whole. In this regard, using the

results of the Bank of Korea’s joint inspections of finan-

cial institutions2), together with Consumer Credit Panel

data recently obtained by the Bank, this article estimates

the total volume of lending to the self-employed, and

analyzes its major characteristics.

( Current situation )

As of the end of June 2015 the volume of lending to the

self-employed (self-employed business owner corporate

and household loans) was estimated at 519.5 trillion won

(and the number of borrowers at 2,527 thousands).3)

37

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s

I-2BOX

Current Status and Major Characteristics of Self-Employed Business Owner Loans

1) The number of self-employed business owners in Korea stood at 5.65 million (22.1 percent of the total number of persons employed, according

to Statistics Korea) as of 2014, and has shown a downward trend since peaking at 6.19 million (27.9 percent of all persons employed) in 2002.

2) In October 2015 the Bank of Korea conducted joint inspections (together with the Financial Supervisory Service) of five domestic banks, to

examine their situations related to lending to the self-employed.

3) However, the debt held by those engaged in the agriculture, forestry and fishing industries, who account for 16.4 percent of self-employed

business owners (as of August 2015, Statistics Korea), seems to be considerably missing in this estimate. This is because the rate of business

registration by non-paid workers (self-employed and unpaid family workers) engaged in the agriculture, forestry and fishing industries is a mere

4.0 percent, far below the average for industry as a whole (68.5 percent). The self-employed business owners engaged in these industries are

very likely to borrow from mutual credit cooperatives such as the National Agricultural Cooperative Federation, and considering the rates of

household and member loans of the National Agricultural Cooperative Federation, the National Federation of Fisheries Cooperatives and the

National Forestry Cooperative Federation, the volume of their debt is estimated at about 55 trillion won (as of end-June 2015).

Notes: 1) Year-on-year changes2) Figures since 2013 include policy mortgage

loans assigned to the KHFCSources: Financial institutions’ business reports, The

Bank of Korea

16

12

8

4

0

-4

16

12

8

4

0

-4

Rates1) of growth in domestic bank lending toindividual entrepreneurs

Q1 2010 Q1 2011 Q1 2012 Q1 2013 Q1 2014 Q1 2015 Q3

(%) (%)

Lending to individual entrepreneurs

Lending to SMEs

Lending to households2)

*금안2015(Dec)03-1장20~55 2016.2.18 11:24 AM 페이지37

Lending to the self-employed through both household

(including those by loan companies) and corporate loans

accounted for 63.6 percent of the total volume, equivalent

to 330.5 trillion won (with the number of borrowers 1,008

thousands, 39.9%), while lending through corporate loans

only totaled 60.1 trillion won, or 11.6 percent (252 thou-

sands, 10.0%), and that through household loans only4)

was 128.9 trillion won, accounting for 24.8 percent (1,267

thousands, 50.1%).

( Major features )

1⃞ By type of financial institution, banks account for

67.4 percent of loans extended to the self-employed, and

non-bank financial institutions 32.6 percent. By type of

loan, the majority of lenders to those holding both

household and corporate loans and those holding corpo-

rate loans only were banks (72.9 percent and 90.6 per-

cent, respectively). Non-bank financial institutions mean-

while accounted for 57.4 percent of all loans extended to

self-employed business owners holding household loans

only.

2⃞ In terms of loan type and credit rating, a majority of

borrowers holding household loans only have middle and

low credit scores, while those that have taken out both

household and corporate loans have middle and high

credit scores and those holding corporate loans only

mostly high scores. Those who have borrowed only

household loans appear to have vulnerable financial

strength, as they have lower credit scores and rely more

on non-bank financial institutions that extend loans at

higher rates of interest than other borrowers.

38

4) The volume of lending to self-employed business owners with corporate loans can be identified by information on borrowers, but it is difficult

to identify the volume of lending to them through household loans only, since when extending household loans financial institutions do not

check identifiable information such as whether the borrowers have completed business registrations. For this article the volume of lending to

self-employed business owners through household loans only is estimated based on the number of borrowers with histories of having taken out

individual entrepreneur loans during the past five years (Q1 2010~Q1 2015), or who have used automobile leases or have held mortgage loans

for purposes such as business funds as of end-Q2 2015

265.6

136.7 128.9

253.9

193.8

60.1

(252.7)519.5

(100.8)330.5

(25.2)

(126.7)

Notes: 1) Figures in ( ) represent the numbers ofborrowers, in ten thousands

2) End-June 2015 basis

600

400

200

0

600

400

200

0

Volumes1) of self-employed business owner loans, by type

Total Both household Corporate Household and corporate loans loans only loans only


Household loans

Corporate loans

32.6(169.3)

27.1(89.7)

72.9(240.8)

9.4(5.6)

90.6(54.5)

57.4(74.0)

42.6(54.9)

67.4(350.2)

Notes: 1) Relative to total lending, by loan type2) Figures in ( ) represent the outstanding

amounts of loans, in trillion won

100

80

60

40

20

0

100

80

60

40

20

0

Bank and non-bank financial institution shares1)2) ofhousehold and corporate loans, by loan type

Total Both household Corporate Household and corporate loans loans only loans only

(%) (%)Bank Non-bank financial institution

*금안2015(Dec)03-1장20~55 2016.2.18 11:24 AM 페이지38

Loans extended to small-scale business owners and high

interest rate household loan5) are found to account for the

largest shares (15.5 percent and 19.9 percent, respectively)

of all loans extended to those self-employed business own-

ers who have taken out household loans only.6)

3⃞ Looking at the trends of self-employed business loans

by industry, loans extended to the real estate leasing

industry have been leading the overall increase.

Domestic bank lending to the real estate leasing industry

grew by an annual average of 14.3 percent between

2010 and 2014, far exceeding the rates of growth in the

food services & accommodation (8.4 percent), manufac-

turing (6.1 percent) and wholesale & retail (5.4 percent)

industries, and showed an even faster pace of growth, of

24.5% year-on-year, from Q1 to Q3 2015. The results of

the Bank of Korea’s joint inspections of five domestic

banks showed that this growth in lending to the real

estate leasing industry has centered around loans for

purchases of non-residential property such as shopping

centers. This seems attributable mainly to the increased

demand for investment in real estate, as well as to the

related tax incentives.7)

39

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sNote: 1) Relative to the total loan amounts outstanding,by loan type

100

80

60

40

20

0

100

80

60

40

20

0

Proportions1) of loans outstanding, by loan type andborrower credit rating

High (1~4) Middle (5~6) Low (7~10)

(%) (%)

Total

Both household and corporate loans

Corporate loans only

Household loans only

5) Small-scale business owners are those with annual incomes of 45 million won or less and credit ratings from 6 to 10, while borrowers of high-

interest rate household loans are those holding loans from loan companies, unsecured loans from savings banks and installment finance

companies, and card loans.

6) The joint inspections of five domestic banks showed as well that individual entrepreneur loans extended to small-scale business owners are very

likely to go bad, as loans extended to the wholesale & retail and the food services & accommodation industries, which are vulnerable to

economic fluctuations, account for 44.3 percent of these loans, while their delinquency rate on loans to small-scale business owners has also

risen (1.63% at end-2011 → 2.09% at end-Q2 2015).

7) When a real estate lessor takes out a loan, he/she can receive a tax refund, with the interest paid on that loan recognized as an expense.

8.87.3

2.8

15.5

17.116.0

19.9

Note: 1) Relative to the total outstanding amounts, by loan type

20

10

0

25

20

15

10

Shares1) of loans to small-scale business owners and of high-interest household loans

(%) (%)

<Small-scale business owner loans> <High-interest rate household loans>

Tota

l

Both

hous

ehol

dan

dco

rpor

ate

loan

s

Corp

orat

elo

anso

nly

Hous

ehol

dlo

anso

nly

Tota

l

Both

hous

ehol

dan

dco

rpor

ate

loan

s

Hous

ehol

dlo

anso

nly

Notes: 1) Year-on-year2) Based on domestic bank lending to individual

entrepreneursSources: Financial institutions’ business reports

16

12

8

4

0

16

12

8

4

0

40

30

20

10

0

40

30

20

10

0

Rates1) of growth in self-employed business ownerlending2), by industry

Q1 2010 Q1 2013 Q3 2015

Real

estat

elea

sing

Manu

factur

ing

Who

lesale

&ret

ail

Food

servi

ces&

acco

mmod

ation

(%) (%) (%) (%)

Real estate leasing

Non-real estate leasing

<Annual average rates of growth during 2010~2014> <Quarterly growth rates>

*금안2015(Dec)03-1장20~55 2016.2.18 11:24 AM 페이지39

As a result, the share in total domestic bank lending

to individual entrepreneurs of that to the real estate leas-

ing industry has risen significantly, from 24.4 percent at

the end of the first quarter of 2010 to 34.4 percent as of

the end of the third quarter of 2015. The shares of lend-

ing to the manufacturing (25.0 percent → 21.3 percent)

and wholesale & retail (20.7 percent → 16.9 percent)

industries have on the other hand declined, while that

going to the food services & accommodation industry

has remained at 10.2 percent.

The soundness of lending to self-employed business

owners seems good, given that the delinquency rate on

loans to individual entrepreneurs has continually

declined.8) However, as lending to the real estate leasing

industry has grown significantly since 2011, and that to

industries sensitive to the business cycle, such as the

wholesale & retail and food services & accommodation

industries, accounts for a large share, self-employed

business owner loans may show higher vulnerability

depending upon future economic circumstances. If so,

defaults on loans, particularly those extended to small-

scale business owners, can materialize, and so close

monitoring of the trends of lending to the self-employed

needs to be strengthened, along with efforts to expand

information on self-employed business owning borrow-

ers.

40

1.9

16.5

8.87.2

40.0

9.9

Notes: 1) End-period basis2) Includes offices, shopping centers, officetels

(multi-purpose buildings with residential andcommercial units), and factories

3) Includes land and mining rightsSources: Results of joint inspections of five domestic

banks

50

40

30

20

10

0

50

40

30

20

10

0

Outstanding amount1) of lending to real estate leasing industry, by purpose of leasing

Residential Non-residential2) Others3)


2010 2011 2012

2013 2014 2015.9

+5.3 trillion won

+23.5 trillion won

+1.1 trillion won

Note: 1) Based on domestic bank lending to individualentrepreneurs


100

80

60

40

20

0

100

80

60

40

20

0

Proportions of self-employed business owner loans1), by industry

Q1 2010 Q3 2015

(%) (%)

Real estate leasing Manufacturing Wholesale & retail

Food services & accommodation Others

24.434.4

21.3

16.9

10.2

17.2

(+10.0%p)

(-3.7%p)

(-3.8%p)

(0.0%p)

(-2.5%p)

25.0

20.7

10.2

19.7

8) The delinquency rate on loans extended to individual entrepreneurs by domestic banks (based on principal and interest overdue for one month

or longer) declined from 0.87 percent in Q3 2010 to 0.69 percent in Q3 2013, and then to 0.44 percent in Q3 2015.

*금안2015(Dec)03-1장20~55 2016.2.18 11:24 AM 페이지40

As conditions in the real-estate market improved

from the second half of 2014, the number of new

apartments for sale increased and the volume of group

loans1) related to them did as well. For this article we

took stock of the recent trends in the new home sales

market and in group loans, and estimated the demand

for group loans going forward.

( New housing sales market trends )

Real estate transactions have increased since the sec-

ond half of 2014, in line with the easing of the LTV and

DTI regulations and with the low market interest rates.

Between January and October 2015 there were 1.01 mil-

lion housing transactions, as annual sales exceeded 1

million for the second year in a row. The figure for 2015

as a whole is expected to be the highest annual one

since compilation of these statistics was begun in 2006.

The new apartment sales market has also enjoyed a

boom. The volume of new apartments for sale in 2014

was approximately 330 thousand units, the highest since

2004, and that figure for 2015 has reached an all-time

record high of 460 thousand units (as of November

2015) since compilation of the statistics. This is seen to

owe to the improved incentives for supply of housing by

construction companies, in line with the easing of regu-

lations on reconstruction2) and the repeal of upper limits

on newly built apartment prices (in April 2015) for exam-

ple, amid increased demand for new apartments stem-

ming from factors such as the easing of conditions for

subscription3), continuing problems in the leasehold

deposit market, and an increase in investment demand.4)

41

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I-3BOX

Recent Trends of Group Loans Related to the NewHousing Sales Market

1) Group loans are batch-type loans approved for provision to groups of borrowers meeting certain requirements for receiving mortgage loans,

such as intentions to reside in new, reconstructed or redeveloped apartments. They are divided up into loans for moving costs, for intermediate

payments and for final balance payments. The payments are generally made over two years – via an initial downpayment (10~20%),

intermediate payments (of up to a total 60%, generally paid on four or more occasions from the sixth month after signing of the contract), and

the final balance payment (20~30%).

2) The time after original apartment construction that must pass before reconstruction can be undertaken was shortened (40 years → 30 years,

September 2014), implementation of an excess earnings withdrawal system was postponed (2014 → 2017), and the number of new housing

units that reconstruction union members are allowed to buy was increased (1 unit → 3 units, December 2014).

3) In March 2015 the time required for establishing a first priority right to purchase of newly build apartments was changed from two years after

the opening of a housing subscription account to one year, as second priorities were integrated with first priorities.

4) Investment demand has increased driven by that in certain local areas where public institutions are being relocated, industrial complexes are being

established and subway and other transportation networks are being expanded in line with the government’s designation of innovation cities.

101 1012)

18.0 19.4

1201)

108

74

-19.8

-25.1

Notes: 1) Figures for 2015 are estimates (Korea HousingInstitute, May 2015)

2) Performances between January and October 2015Source: Ministry of Land, Infrastructure and Transport

150

120

90

60

30

0

-30

-60

Housing sales transaction volume

2006 2008 2010 2012 2014 2015

(10 thousand transactions) (%)

Transaction volumes (LHS)

Year-on-year growth rates (RHS)

*금안2015(Dec)03-1장20~55 2016.2.18 11:24 AM 페이지41

( Group loan trends and outlook )

As a result, banks’ group loans related to new housing

sales and reconstruction are increasing rapidly. The bal-

ance of group loans extended by domestic banks rose

from 101.5 trillion won at the end of 2014 to 104.6 tril-

lion won as of the end of September 2015 (an increase

of 3.1 trillion won). In line with the supply of Mortgage

Refinancing Program in the first half of 2015, some

group loans were transferred to individual loans of the

Korea Housing Finance Corporation, and given these cir-

cumstances the actual increase in group loans during

this period is estimated to have exceeded 10 trillion won.

Once group loans are approved, loans for moving

costs, intermediate payments and final balance pay-

ments gradually occur on a massive scale over the course

of the two-year period from the signing of the contract

until the tenant moves in. Therefore, given the volume of

existing group loans as well as the trend of increase in

the amount of new housing for sale, we expect a trend

of increase in group loans for a considerable time.

Estimates of group loan demand during 2016 and 2017,

reflecting the past and scheduled future amounts of new

housing for sale, show the amount of increase in home

mortgage loans fueled by group loans reaching a month-

ly average of 3 to 4 trillion won.5)

( Implications )

The recent boom in new apartment sales is expected

to work as an underlying factor causing the total amount

of household debt to expand through a rapid increase in

group loans. It may also have negative effects on the

qualitative structure of household debt.6)

Meanwhile, in certain regions that have seen over-

heated competition for purchases of new housing units

recently, concentrations of tenants moving in during sim-

ilar periods of time might work to put downward pres-

sures on home prices. This could lead to escalated con-

flicts related to apartment sales and worsen the balance

sheets of construction firms and developers, put a bur-

den on organizations guaranteeing group loans7), and

increase the rate of mortgage loan default.

42

21

35

17

26

33

46

Note: 1) Annual basis (January~November for 2015)Source: Real estate 114

50

40

30

20

10

0

50

40

30

20

10

0

Volume1) of new apartments for sale

2000 2003 2006 2009 2012 2015

(10 thousand units) (10 thousand units)

5) However, the actual amount of the future increase in group loans may differ from this estimate – owing for example to changes in the actual

homeowners following resales of rights to purchase of newly build apartments, to purchasers shifting to individual loans when moving in, and

to loan repayments.

6) Since group loans take the form mainly of bullet repayment loans and have variable rates, while borrower screenings take place on a group

basis and DTIs cannot be applied, individuals’ debt servicing capacities related to group loans are monitored in a relatively looser fashion than

those in cases of ordinary home mortgage loans.

7) In the past the method of group loan credit preservation centered on joint and several guarantees of developers, but more recently mortgage

credit guarantees make up the lion’s share. The guarantee organizations (Korea Housing Finance Corporation, Korea Housing & Urban

Guarantee Corporation) may hence feel more burdened than before.

*금안2015(Dec)03-1장20~55 2016.2.18 11:24 AM 페이지42

43

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ou

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Ko

rea’s Finan

cial Stability Situ

ation

s

+4.5

+1.6

-3.4

+0.9+3.1

Notes: 1) The dotted lines and the shaded parts includegroup loans that have been transferred to theKorea Housing Finance Corporation (individualloans) in line with the supply of MortgageRefinancing Program

2) The Bank of Korea estimatesSource: Financial Supervisory Service

115

110

105

100

95

15

10

5

0

-5

Balances and changes of volumes in domestic bank group loans

2010 2011 2012 2013 2014 Q3 20151)


Group loan balances (LHS)

Group loan changes (RHS)+8.02)

Note: 1) Year-on-yearSource: Financial Supervisory Service

50

25

0

-25

50

25

0

-25

Rates1) of growth in loans for intermediate payments,moving costs and final balance payments

2012.1 2013.1 2014.1 2015.1 9

(%) (%)

Moving costs

Intermediate payments

Final balance payments

*금안2015(Dec)03-1장20~55 2016.2.18 11:24 AM 페이지43

2. Corporations

Slight decline in corporatefinancial soundness

Corporations’11) financial soundness has

fallen somewhat overall. Profitability has

improved a bit in some industries but

growth has deteriorated greatly, with rates of

sales growth recording large-scale negative

figures for example. Financial structure sta-

bility has declined as well, with the propor-

tion of companies recording debt ratios of

200% or higher increasing (Figure I-13).

Greatly worsened growth

The slump in corporate growth has deep-

ened. Companies’ sales growth rate recorded

a large-scale minus figure (-7.1%) during the

first half of 2015. By corporation size, the

rate of sales growth at large enterprises con-

tracted at a greatly accelerated pace in the

first half (H1 2014 -1.2% → H1 2015

-7.3%), while among small and medium-

sized enterprises (SMEs) it was a mere 1.2%

in the first half and had slowed compared to

the first half of 2014 (3.8%) (Figure I-14).

Looking at the sales growth rates ranges in

the first half of 2015 compared to the first

half of 2014, as the extent of increase

(+3.5%p) in the share of firms with low sales

growth (below 5%) exceeded that (+0.5%p)

in the share of those with high sales growth

(20% or above), the quality of corporate

44

11) Listed companies preparing and announcing financial statements in accordance with the 「Act on External Audit of Stock Companies」(H1

2015 basis, 1,552 companies) were analyzed, along with portions of the unlisted enterprises representing the different industries (excluding the

financial and insurance industries) (H1 2015 basis, 279 companies).

Notes: 1) Extents of change in H1 2015 (as of end-June 2015 fordebt ratio) compared to H1 2014 (end-2014 for debtratio) indexed

2) Proportion of firms with debt ratios of 200% or above3) Proportion of firms with interest coverage ratios below

100%Source: The Bank of Korea

<Figure I-13> Corporate financial soundness map1)

Baseline

2015.1~6Operating income-

to-sales ratio

Debt ratio2)

Interest coverageratio3)

Rate of growthin tangible assets

Rate of salesincrease

Deterioration

Improvement

Notes: 1) First half basis 2) Year-on-year Source: KIS-Value

25

20

15

10

5

0

-5

-10

25

20

15

10

5

0

-5

-10

<Figure I-14> Rates of sales growth1)2)

2009 2010 2011 2012 2013 2014 2015

(%) (%)

Large enterprises

SMEs

All

*금안2015(Dec)03-1장20~55 2016.2.18 11:24 AM 페이지44

growth has become worse. During the 2010

to 2015 period, the proportion of firms with

low rates of sales growth climbed by 28.6%

points (34.8% → 63.4%), while the share of

firms with high rates in contrast shrank by

25.1% points (41.8% → 16.7%) (Figure I-15).

By industry, sales have expanded slightly

in some industries such as automobiles and

machinery, while on the other hand con-

tracting greatly in most industries including

oil refining, chemicals and electronics to

lead a worsening of profitability in industry

as a whole. The large extents of sales decline

seen in the electronics, shipbuilding and steel

industries have been due to intensified com-

petition at home and abroad as well to as

slumps in demand, and those in petroleum

refining to the drastic drop in crude oil

prices12) (Figure I-16).

The rate of growth in tangible assets,

which reflects companies’ investment, mean-

while recorded 3.4% at the end of June

2015, having reversed to a slight increase

from its trend of decline seen until that time.

By company size, the rate of tangible asset

growth at large enterprises had risen by

0.8% point year-on-year (end-June 2014

2.6% → end-June 2015 3.4%), and that of

SMEs as well by 0.5% point (1.5% → 2.0%)

(Figure I-17).

45

I. Finan

cial Sou

nd

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and

Co

rpo

rate Sectors 2. C

orp

oratio

ns

Ko

rea’s Finan

cial Stability Situ

ation

s

34.8

59.9 63.4

41.8

16.2 16.7

Notes: 1) First half basis2) Including companies with negative (-) rates of

sales growthSource: KIS-Value

100

80

60

40

20

0

100

80

60

40

20

0

<Figure I-15> Proportions1) of companies in different sales growth rate ranges

2009 2010 2011 2012 2013 2014 2015

(%) (%)20% or above 10~20% 5~10% Less than 5%2)

12) The crude oil price (Dubai oil basis) fell from an average of 105.2 dollars per barrel in H1 2014 to an average 56.8 dollars per barrel in H1

2015 – a drop of 46.0%.

Note: 1) Rates of sales growth and changes in total sales inH1 2015 compared to H1 2014

Source: KIS-Value

10

0

-10

-20

-30

-40

10

0

-10

-20

-30

-40

<Figure I-16> Rates of sales growth and changes1) in total sales, by industry

Oilref

ining

Steel

Chem

icals

Whole

sale&

retail

Shipb

uilding

Electr

onics

Const

ructio

n

Shipp

ing

Autom

obiles

Mach

inery

Textil

es&a

ppare

l

(%, trillion won) (%, trillion won)

Rates of sales growth

Changes in total sales

*금안2015(Dec)03-1장20~55 2016.2.18 11:24 AM 페이지45

Slightly improved profitability

Corporate profitability has improved

slightly. This seems to be a result mainly of

companies’ management strategies having

focused on productivity rather than expan-

sions in size, due to the worsening of exter-

nal conditions. During the first half of 2015

the operating income-to-sales ratio showed

5.6%, up by 0.9% point compared to the

first half of 2014 (4.7%). By company size,

the large enterprise operating income-to-

sales ratio increased by a comparatively

large extent of 1.0% point (4.7% → 5.7%).

Among SMEs, its rate of increase on the

other hand was a mere 0.2% (3.9% →

4.1%). As a result of this the gap in prof-

itability between large enterprises and SMEs

(1.6%p) expanded relative to the first quar-

ter of 2014 (0.8%p) (Figure I-18).

Looking at the different operating income-

to-sales ratio ranges in the first half of 2015,

the proportion of firms with high ratios

(10% or above) rose to 2.5% points higher

than in the first half of 2014 (18.1% →

20.6%), to exceed the extent of increase

(0.2%p) in firms with low ratios (below 3%,

including firms in deficit). During the 2010

to 2015 period the share of firms with low

ratios jumped by 10.6% points (36.5% →

47.1%), while that of those having high

ratios fell by 3.5% points (24.1% → 20.6%).

This shows that the trend of deterioration in

corporate structural profitability since the

global financial crisis has continued (Figure

I-19).

46

Notes: 1) First half basis 2) Year-on-year Source: KIS-Value

32

24

16

8

0

32

24

16

8

0

<Figure I-17> Rates1)2) of growth in tangible assets

2009 2010 2011 2012 2013 2014 2015

(%) (%)

Large enterprises SMEs All

Notes: 1) Operating income / Sales 2) First half basis

Source: KIS-Value

9

6

3

0

9

6

3

0

<Figure I-18> Operating income-to-sales ratios1)2)

2009 2010 2011 2012 2013 2014 2015

(%) (%)

Large enterprises SMEs All

*금안2015(Dec)03-1장20~55 2016.2.18 11:24 AM 페이지46

By industry, the oil refining and the trans-

portation industries, which had shown low

operating income-to-sales ratios in the first

half of 2014, showed year-on-year increases

of 6.3% points and 3.7% points respectively,

under the influences of the drops in oil

prices. The shipbuilding industry’s operating

income-to-sales ratio declined to a large

extent (H1 2014 -3.8% → H1 2015

-17.7%), however, while those of the

machinery and electronics industries fell

slightly (Figure I-20).

Slight decline in financial structurestability

The stability of corporate financial struc-

tures has deteriorated somewhat, as the pro-

portion of firms with debt ratios exceeding

200% rose by 0.6% point (12.3% at end-

2014 → 12.9% at end-June 2015). In the

case of large enterprises, their debt ratio

increased from 15.0% to 15.5% during this

period, while that among SMEs jumped

from 8.6% to 9.7% – for rises of 0.5% point

and 1.1% points respectively (Figure I-21).

47

I. Finan

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nd

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and

Co

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rate Sectors 2. C

orp

oratio

ns

Ko

rea’s Finan

cial Stability Situ

ation

s

36.546.9 47.1

24.1 18.1 20.6

Notes: 1) First half basis 2) Including companies in deficit

Source: KIS-Value

100

80

60

40

20

0

100

80

60

40

20

0

<Figure I-19> Proportions1) of companies in different operating income-to-sales ratio ranges

2009 2010 2011 2012 2013 2014 2015

(%) (%)

10% or above 5~10% 3~5% Less than 3%2)

Note: 1) Operating income-to-sales ratios in H1 2015minus those in H1 2014

Source: KIS-Value

15

10

5

0

-5

-10

-15

-20

15

10

5

0

-5

-10

-15

-20

<Figure I-20> Changes1) in operating income-to-sales ratios, by industry

Shipb

uildin

g

Mach

inery

Electr

onics

Who

lesale

&ret

ail

Autom

obile

s

Texti

les&

appa

rel

Cons

tructi

on

Steel

Chem

icals

Shipp

ing

Oilre

fining

(%, %p) (%, %p)

Changes

2015

2014

*금안2015(Dec)03-1장20~55 2016.2.18 11:24 AM 페이지47

With regard meanwhile to the corporate

borrowings-to-total assets ratio, as it fell

from 23.7% at the end of 2014 to 23.4% at

the end of June 2015 at large enterprises,

and from 23.0% to 20.9% over this same

time span at SMEs, the overall rate declined

by 0.4% point (end-2014 23.7% → end-

June 2015 23.3%) (Figure I-22).

Corporate short-term debt repayment

capacities have not improved. The proportion

of firms with interest coverage ratios below

100%, which are thus unable to cover their

interest expenses with operating incomes, rose

by 1.8% point from 33.5% in the first half of

2014 to 35.3% in the first half of 2015. While

the share of large enterprises fell by 0.1%

point, from 27.9% to 27.8% during this time,

that of SMEs climbed by 2.6% points from

42.0% to 44.6% (Figure I-23).

The proportion13) of companies unable to

repay their short-term borrowings and cover

their interest expenses with cash flows gener-

ated through business activities fell by 2.2%

points, from 70.6% in the first half of 2014

to 68.4% in the first half of 2015. While this

proportion fell to a large extent (-4.2%p) in

the case of large enterprises, it decreased by

only a small amount (-0.1%p) among SMEs

(Figure I-24).

48

Notes: 1) Debt / Equity 2) End-period basisSource: KIS-Value

100

90

80

70

60

100

90

80

70

60

<Figure I-21> Debt ratio1)2) distributions, by company size

2011 2013 2015.6 2011 2013 2015.6 2011 2013 2015.6

(%) (%)200% or above Less than 200%

<All> <Large enterprises> <SMEs>

13) This refers to enterprises with cash flow coverage ratios [(Cash flow from business operations + Interest expenses) / (Short-term borrowings +

Interest expenses)] below 100%.

Notes: 1) (Borrowings + Corporate bonds) / Total assets 2) End-period basis

Source: KIS-Value

30

25

20

15

10

30

25

20

15

10

<Figure I-22> Borrowings-to-total assets ratios1)2), by company size

All Large enterprises SMEs

(%) (%)

2013 2014 June 2015

Notes: 1) Operating income / Interest expenses2) First half basis

Source: KIS-Value

100

80

60

40

20

0

100

80

60

40

20

0

<Figure I-23> Interest coverage ratio1)2)

distributions, by company size

2011 2013 2015 2011 2013 2015 2011 2013 2015

(%) (%)100% or above 0~100% Operating losses


*금안2015(Dec)03-1장20~55 2016.2.18 11:24 AM 페이지48

There were meanwhile no big changes in

debt ratios in most industries excepting ship-

building and shipping. The shipping indus-

try’s debt ratio fell by 123.9% points (end-

2014 510.5% → end-June 2015 386.6%),

owing to improvements in profitability, while

that in the shipbuilding industry on the

other hand rose by 77.1% points (168.9%

→ 246.0%). In the shipbuilding industry,

notably, the debt ratio surpassed 200% in

2015 as sluggishness in overall business con-

ditions appeared (Figure I-25).

As the slumps in corporate sales since

2013 have gradually worsened worries about

weakened corporate growth power have

increased, and profitability has also not

shown a clear trend of improvement.

Although company debt ratios are sustaining

trends of decline overall, the proportion of

firms with debt ratios of 200% or above has

risen and the share of companies with inter-

est coverage ratios below 100% is sustaining

a high level even despite the low interest

rate conditions. In addition, as the numbers

of marginal and chronically marginal firms

are continuing to expand, it is judged that

not only will corporate default concerns

grow, but these firms can be a factor greatly

burdening the maintenance of financial sys-

tem stability in times of occurrence of

domestic or external shocks.

49

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s

Notes: 1) (Cash flows from business operations +Interest expenses) / (Short-term borrowings +Interest expenses)

2) First half basis Source: KIS-Value

100

80

60

40

20

0

100

80

60

40

20

0

<Figure I-24> Cash flow coverage ratio1)2)

distributions, by company size

2011 2013 2015 2011 2013 2015 2011 2013 2015

(%) (%)100% or above Less than 100%


-123.9

386.6

510.5

Note: 1) Debt ratios at end-June 2015 minus those at end 2014Source: KIS-Value

600

400

200

100

0

-100

400

300

200

100

0

-200

<Figure I-25> Changes1) in debt ratios, by industry

Shipp

ing

Oilre

fining

Who

lesale

&ret

ail

Electr

onics

Cons

tructi

on

Mach

inery

Steel

Autom

obile

s

Texti

les&

appa

rel

Chem

icals

Shipb

uildin

g

(%) (%p)

Changes (RHS)

End-June 2015 (LHS)

End-2014 (LHS)

*금안2015(Dec)03-1장20~55 2016.2.18 11:24 AM 페이지49

Concerns are growing about corporate debt defaults

by Korean companies, whose performances have

been sluggish recently. Considering that external shocks

such as interest rate hikes in the U.S. or the economic

slowdown in China could work to burden business going

forward, for this article we have compared Korean com-

panies’ debt levels with those of companies in other

major countries.

( Debt Level )

Korean companies’ core debt1)-to-GDP ratio stood at

105.3% as of the end of 2014, thus exceeding the OECD

average (97.1%, based on 28 member countries). In com-

parison with major advanced countries, Korea’s corporate

debt level is similar to Japan’s (104.8%), and substantial-

ly higher than those of the U.S. (69.2%), the U.K. (75.0%)

and Germany (54.5%). This ratio increased by 2.1%

points in Korea between 2009 and 2014, showing that

the corporate debt which grew greatly before the global

financial crisis has not been adjusted smoothly2) (OECD

average: +0.8%p). In contrast, corporate debt deleverag-

ing in the U.K. (-20.1%p), Japan (-5.2%p), Germany

(-3.6%p) and the U.S. (-1.1%p) was carried out relatively

actively during same period, under the influence of the

global financial crisis.

The core debt-to-funding balance3) ratio, an indicator of

dependency on external borrowings, stood at 37.0% as of

the end of 2014, exceeding the OECD average (34.3%)

and even higher than those of major advanced countries

such as the U.S. (22.0%), the U.K. (29.2%), Germany

(29.2%) and Japan (31.9%). In terms of the degree of

change as well, the ratio climbed by 0.9% point from

2011 to 20144) at Korean companies, showing that their

dependency on foreign borrowings has not weakened

50

I-4BOX

Korea’s Corporate Debt Level on the World Stage

1) According to the BIS standards, core debt is defined as loans (including government loans) and securities other than shares among non-

financial corporations’ financial liabilities in the flow of funds statistics.

2) Korean companies’ core debt-to-GDP ratio increased by 27.2% points (76.0% → 103.2%) between 2005 and 2009.

3) This is the total amount of financial debt in the flow of funds data, which in addition to core debt also includes equity capital, direct

investment and trade credit.

4) Analysis is based on figures from 2011, given that the changes in the compilation standards of the flow of funds statistics (1993 SNA → 2008

SNA) have led to big differences between the funding balance time series before and after that year.

Notes: 1) Non-financial corporations’ loans (includinggovernment loans) and securities other thanshares in the flow of funds statistics

2) Levels based on end-2014 figures, and changeson the period from 2009 to 2014

Sources: OECD, The Bank of Korea, Bank of Japan

250

200

150

100

50

0

Corporate core debt1)-to-GDP ratio levels, and extents of change2)

(levels, %)

(changes, %p)

-30 -20 -10 0 10 20 30 40

Japan Korea

U.K.

Germany

U.S.

Average of 28 OECDmember countries : 97.1%

Average of 28 OECDmember countries : +0.8%p

*금안2015(Dec)03-1장20~55 2016.2.18 11:24 AM 페이지50

unlike in the cases of companies in Japan (-11.0%p),

Germany (-3.0%p), the U.S. (-2.8%p) and the U.K.

(-2.6%p) (OECD average: -2.1%p).

( Debt structure and debt repayment capacity )

Comparing Korean companies’ core debt structure with

those of companies in major advanced countries, as of the

end of 2014 loans accounted for 64.2% of Korean corpo-

rate debt and bonds 35.8%, with the share of bonds the

second highest following that of U.S. corporations. In terms

of maturity, 20.5% of Korea’s corporate debt was short-

term and 79.5% of it long-term - the latter a higher figure

than those of companies in major advanced nations.

Looking at companies’ capacities for repayment of

interest through business activities, Korean companies’

operating surplus to paid interest ratio was 4.3 times as

of 2013, higher than that of U.S. companies (3.9 times)

but lower than those in Japan (14.3 times), Germany

(10.2 times) and the U.K. (6.0 times).5) In the cases of

other major countries, the global financial crisis forced

their companies to restructure their debts and improve

their interest repayment capacities, while in Korea the

trends of improvement in these areas have been slight.

51

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orp

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Ko

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ation

s

Notes: 1) Non-financial corporations’ loans (includinggovernment loans) and securities other thanshares in the flow of funds statistics

2) Total amount of financial liabilities of non-financialcorporations in the flow of funds statistics

3) Levels based on end-2014 figures, and changeson the period from 2011 to 2014

Sources: OECD, The Bank of Korea, Bank of Japan

60

50

40

30

20

10

0

Corporate core debt1)-to-funding balance2)

ratio levels, and extents of change3)

(levels, %)

(changes, %p)

-20 -15 -10 -5 0 5 10

Japan

Korea

U.K.Germany

U.S.

Average of 28 OECD membercountries : 34.3%

Average of 28 OECD membercountries : -2.1%p

5) The interest repayment capacities of Japan and Germany turned out to be relatively higher than those of other countries - owing to the effects

of low interest rates in the former case and of the low corporate debt ratio (54.4% of GDP) in the latter. The bank lending rate in Japan is

1.6% (2005~2014 monthly average basis), a much lower level than that in Korea (6.0%).

Notes: 1) End-2014 basis 2) Excluding Japan, as its core debt could not be

classified into short- and long-term maturities Sources: OECD, The Bank of Korea, Bank of Japan

100

80

60

40

20

0

100

80

60

40

20

0

100

80

60

40

20

0

100

80

60

40

20

0

Proportions1) of core debt, by type and maturity2)

(%) (%)(%) (%)

U.S.

Korea U.K.

Japan

Germ

any

Korea U.S.

Germ

any

U.K.

Loans Bonds Short-term debt Long-term debt

Notes: 1) Operating surplus / Paid interest (Operatingsurplus = Value added - Compensation ofemployees – Taxes on production and imports –Fixed capital consumption)

2) Based on income accounts by institutional sectorSources: The Bank of Korea, U.S. FRB, Office for National

Statistics of U.K., Deutsche Bundesbank, CabinetOffice of Japan

16

12

8

4

0

16

12

8

4

0

Corporate interest repayment capacities1)2)

Korea U.S. U.K. Germany Japan

(times) (times)

2005 2006 2007 2008 2009

2010 2011 2012 2013

*금안2015(Dec)03-1장20~55 2016.2.18 11:24 AM 페이지51

Amid the continuing sluggishness since the global

financial crisis in not only the construction but also

the shipbuilding and shipping industries, there are signs

of business conditions worsening for even core growth

industries including electronics and automobiles.

Concerns are therefore growing about the liquidity risks

of the corporate sector. Related to this, for this paper we

have examined the statuses of the companies facing liq-

uidity risks (hereafter ‘companies at risk’) and conducted

stress tests to look into the effects of macro-economic

shocks on the corporate sector.1)

( Liquidity risk status )

Looking at the statuses of companies at risk2) that can

suffer temporary liquidity shortages, their proportion has

declined since 2014 while the proportion of their debt at

risk has exceeded its global financial crisis level (16.9%)

ever since 2012. Despite a slight decline in the propor-

tion of companies at risk in 2015, that of debt at risk

climbed. This implies that liquidity risk has been grow-

ing, led mainly by companies with relatively large

amounts of liabilities.

By industry, the proportion of companies at risk is

highest in the shipbuilding industry (62.5%), followed in

order by those in construction (28.7%) and steel

(24.2%), while the share of debt at risk is highest in

shipbuilding (93.7%), transportation (53.9%) and

machinery (38.5%). In the shipbuilding, machinery, and

transportation industries the liquidity risks are high in

large enterprises having large amount of liabilities, and

so their proportions of debt at risk greatly exceed those

of their companies at risk.

52

I-5BOX

Stress Testing of Firms with Liquidity Risks

1) We analyzed non-financial corporations (excluding public corporations) subject to outside audits, whose first half financial statements were

available.

2) This paper defined companies at risk as ① those that cannot afford to pay their interest expenses with revenues generated (those with interest

coverage ratios (EBIT/interest expenses) below 100%), and ② those at risk of temporary liquidity shortages since their short-term liabilities

exceed their short-term liquid assets (those with liquidity ratios (short-term liquid assets/short-term debts) below 100%).

21.2

15.916.9

21.2

Notes: 1) Based on H1 each year2) Number of companies at risk / Total number of

companies3) Debt held by companies at risk / Debt held by

all companiesSource: KIS-Value

30

20

10

0

30

20

10

0

Proportions1) of companies2) and debt at risk3)

2007 2009 2011 2013 2015

(%) (%)

Number of companies at risk Debt at risk

*금안2015(Dec)03-1장20~55 2016.2.18 11:24 AM 페이지52

( Stress testing )

Stress tests3) were carried out to review the effects of

a domestic economic slowdown and interest rate hikes

on the corporate sector. First, it was estimated that

declines of 1.0% point and 1.5% points in domestic GDP

growth over the coming year would lead to increases in

the proportion of companies at risk (debt at risk) by

2.3% points (1.8%p) and 3.4% points (3.8%p), respec-

tively.

Moreover, 100bp and 150bp increases in interest rates

over the coming year were estimated to push the propor-

tion of companies at risk (debt at risk) higher by 2.8%

points (2.1%p) and 5.3% points (7.7%p), respectively.

With the proportion of debt at risk exceeding that dur-

ing the global financial crisis, a 1.5% points decline in

GDP growth or a 150bp hike in interest rates would

result in the proportion of companies at risk nearing its

level (21.2%) seen during the crisis.

Meanwhile, if a combined shock were to occur, in

which the GDP growth rate fell by 1.5% points and the

market interest rate rose by 150bp, our analysis showed

that the proportions of companies and debt at risk would

jump by 8.2% points and 11.4% points respectively. In

the cases of individual GDP and interest rate shocks,

there were not much differences found between the

extents of increase in the proportions of companies and

debt at risk. If a combined shock were to occur, however,

large corporations having high levels of debt would be

affected to the greatest extent, and so the increase in the

proportion of debt at risk was found to exceed that in

the proportion of companies at risk.

By industry, the transportation, construction, oil refin-

ing & chemicals and automobile industries were most

vulnerable to a combined shock in terms of the numbers

of companies at risk, while the machinery, transporta-

tion, oil refining & chemicals and construction industries

were weak in terms of their amounts of debt. With

regard to shipbuilding, more than one-half of companies

are already categorized as at risk, and so the number

that would be newly included in the category due to

macroeconomic shocks was found to be relatively small.

53

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Note: 1) H1 2015 basisSource: KIS-Value

100

80

60

40

20

0

100

80

60

40

20

0

Proportions1) of companies and debt at risk, by industry

(%) (%)

Number of companies at risk

Debt at risk

Shipb

uildin

g

Autom

obile

s

Mach

inery

Electr

onics

Steel

Cons

tructi

on

Who

lesale

&ret

ail

Trans

porta

tion

Oilre

fining

&ch

emica

ls

3) In order to assess the impacts of macroeconomic risk factors on corporate insolvencies, the stress test model for the corporate sector was

designed so that the relationship between real and financial market variables and corporate financial accounts was first estimated, and the

macroeconomic shocks then affected corporate liquidity risks through changes in the interest coverage and liquidity ratios of individual

companies.

Results1) of corporate sector stress tests

H1 2015 15.9 21.2

GDP -1.0%p 18.3 (+2.3) 23.0 (+1.8)shocks -1.5%p 19.4 (+3.4) 25.0 (+3.8)

Interest rate +100bp 18.8 (+2.8) 23.3 (+2.1)shocks +150bp 21.2 (+5.3) 28.9 (+7.7)

Combined shock2) 24.1 (+8.2) 32.5 (+11.4)

Proportion of Proportion of companies at risk debt at risk

Notes: 1) Figures in ( ) show the changes in the proportions ofcompanies at risk (debt at risk), compared to H1 2015

2) A 1.5%p decline in GDP growth and a 150bp increase ininterest rates happening at the same time


(%, %p)

*금안2015(Dec)03-1장20~55 2016.2.18 11:24 AM 페이지53

Liquidity risks in the corporate sector have been wors-

ening somewhat recently, especially among highly

indebted large corporations and tendencies in some

industries such as shipbuilding and construction are

materializing. Further shocks going forward, due for

example to a rapid economic slowdown or to increases

in interest rates, could cause a spreading of liquidity risk

across the corporate sector. A shock from rising interest

rates, in particular, could greatly affect corporate finan-

cial solvency in the short term, by increasing companies’

principal and interest repayment burdens. Tighter moni-

toring of liquidity risks in the corporate sector, and regu-

lar restructuring of insolvent companies are therefore

required.

54

Stress test results under combined shock1)

Shipbuilding 62.5 +0.0 93.7 +0.0

Automobiles 10.6 +9.6 4.1 +1.9

Machinery 16.3 +9.5 38.5 +30.7

Electronics 22.0 +7.2 5.4 +3.6

Oil refining & chemicals 10.1 +10.1 8.5 +16.2

Steel 24.2 +7.7 11.7 +12.5

Construction 28.7 +12.6 25.3 +15.6

Wholesale & retail 16.9 +4.9 6.6 +10.1

Transportation 13.9 +13.9 53.9 +21.0

Proportion of Proportion of companies at risk debt at risk

H1 2015After

H1 2015After

shock shock

Note: 1) A 1.5%p decline in GDP growth and a 150bp increase ininterest rates happening at the same time


(%, %p)

*금안2015(Dec)03-1장20~55 2016.2.18 11:24 AM 페이지54

*금안2015(Dec)03-1장20~55 2016.2.18 11:24 AM 페이지55

*금안2015(Dec)04-2장56~97 2016.2.18 11:25 AM 페이지56

Financial System Stability

Ⅱ

1. Banks········································································59

2. Non-Bank Financial Institutions··········································70

3. Financial Markets··························································78

4. Foreign Exchange Soundness·············································84

5. Financial Market Infrastructure···········································91

*금안2015(Dec)04-2장56~97 2016.2.18 11:25 AM 페이지57

*금안2015(Dec)04-2장56~97 2016.2.18 11:25 AM 페이지58

1. Banks

Generally satisfactory banksoundness

Commercial bank soundness has shown a

picture of improving on the whole. Growth

has accelerated and asset soundness has sus-

tained its trend of improvement. Profitability

has however not pulled out from its slump,

even despite an increase in securities-related

profits for example. Liquidity and capital

adequacy indicators have declined somewhat

but maintained satisfactory levels as before

(Figure II-1).

Sustained trend of growth

Commercial banks’ total assets (banking

account basis) amounted to 1,390 trillion

won as of the end of September 2015,

higher by 56 trillion won compared to the

end of March 2015 (1,334 trillion won), led

by loans, as their trend of increase since

the third quarter of 2014 continued (Figure

II-2).

On the funding side, the pace of expan-

sion in loans has been sustained, centering

around lending to households and small and

medium-sized enterprises. Commercial

banks’ household loan volume had been

maintaining quarterly year-on-year growth

of 30 trillion won since the fourth quarter

of 2014, and this extent of increase has

recently expanded. In particular, if the por-

tion of Mortgage Refinancing Program

transferred to the Korea Housing Finance

Corporation is included, then the quarterly

amount of increase has been exceeding 50

59

II. Finan

cial System Stab

ility 1. Banks

Ko

rea’s Finan

cial Stability Situ

ation

s

Notes: 1) Extents of change in April~September 2015 periodcompared to October 2014~March 2015 periodindexed (liquidity of September 2015 compared to thatof March 2015)

2) Rate of increase in asset management volume3) Return on assets4) Substandard-or-below loan ratio5) Total capital ratio6) Liquidity Coverage Ratio (LCR)


<Figure II- 1> Commercial bank soundness map1)

Baseline

2015.4~9

Growth2)

Profitability3)

Capital adequacy5) Liquidity6)

Assetsoundness4)

Deterioration

ImprovementNotes: 1) End-period banking account balance basis

2) Year-on-yearSources: Commercial banks’ business reports

1,600

1,200

800

400

0

10

8

6

4

2

0

-2

<Figure II- 2> Commercial bank total assets1)

2011.3 2012.3 2013.3 2014.3 2015.3 9

(trillion won) (%)

Cash and due from banks (LHS) Securities (LHS)

Loans (LHS) Other assets (LHS)

Rate of increase in total assets (RHS)2)

*금안2015(Dec)04-2장56~97 2016.2.18 11:25 AM 페이지59

trillion won since the second quarter of

2015. The extent of growth in SME loans

also expanded from 22.0 trillion won in the

first quarter of 2015 to 31.0 trillion won in

the third. Loans to large enterprises have

however shown only a small degree of

decrease in 2015 (Figure II-3).

In more detail, the growth in lending has

been led by home mortgage loans in the

case of household loans, and by lending to

individual entrepreneurs in the case of SME

loans (Figure II-4).1)

Together with the trend of growth in their

asset volumes, bank funding amounts have

also expanded. The amount2) of won-denom-

inated funds raised by commercial banks

totaled 1,025 trillion won at the end of

September 2015, with deposits accounting

for 87.9% of this, wholesale funding 8.5%

and borrowings in won 3.6% (Figure II-5).

60

1) Of the total amount of increase in household loan during the Q1~Q3 2015 period, 84.8% was home mortgage loans, and of the total increase

in SME loans 64.7% was loans to individual entrepreneurs.

2) Based on banking account won-denominated deposits, CDs (certificates of deposit), RPs (repurchase agreements), promissory notes, bank bonds

(financial bonds issued in won), and won-denominated borrowings (including call money in won)

Notes: 1) The dotted lines show the totals with the MortgageRefinancing program Loan transferred to KHFC(Korea Housing Finance Corporation) included

2) Year-on-year3) Based on loans in won

Sources: Commercial banks’ business reports

100

80

60

40

20

0

-20

20

16

12

8

4

0

-4

<Figure II- 3> Changes1)2) in commercial bank loans3)

Q1 2011 Q1 2012 Q1 2013 Q1 2014 Q1 2015 Q3

(trillion won) (%)

Households (LHS) SMEs (LHS)

Large enterprises (LHS) Rate of loan increase (RHS)

50

40

30

20

10

0

50

40

30

20

10

0

50

40

30

20

10

0

50

40

30

20

10

0

<Figure II- 4> Changes1) in household and SME commercial bank loans2)

<Loans to households> <Loans to SMEs>

Q4 2014 Q1 2015 Q2 Q3 Q4 2014 Q1 2015 Q2 Q3

(trillion won) (trillion won)(trillion won) (trillion won)

Home mortgage loans

Other loans

Self-employed business owners

Incorporated SMEs

Notes: 1) Year-on-year2) Based on loans in won


*금안2015(Dec)04-2장56~97 2016.2.18 11:25 AM 페이지60

Commercial bank deposits continued on a

trend of increase at the 5~6% year-on-year

level in 2015, centering around transferable

deposits3), although time deposits did con-

tract somewhat due for example to the

declines in interest rates (Figure II-6).

The trend of contraction in commercial

bank wholesale funding persisted until the

first quarter of 2015, but entering the sec-

ond quarter then reversed to an increase

centering around bank bonds. In the third

quarter the extent of increase then accelerat-

ed, as CD issuance also grew (Figure II-7).

These increases in issuance of bank bonds

and CDs appear to have resulted from

banks’ needs to secure financial resources to

respond to the rising demand for loans4), in

addition to their reduced funding expenses.5)

61

II. Finan

cial System Stab

ility 1. Banks

Ko

rea’s Finan

cial Stability Situ

ation

s

Notes: 1) End-period banking account balance basis 2) Year-on-year3) Deposits in won4) CDs, RPs, cover bills, bank bonds5) Including call money in won6) Subtotal of deposits, wholesale funding and

borrowings in wonSources: Commercial banks’ business reports

1,200

900

600

300

0

10

8

6

4

2

0

<Figure II- 5> Amounts1)2) of funds in won raised by commercial banks

Q1 2011 Q1 2012 Q1 2013 Q1 2014 Q1 2015 Q3

(trillion won) (%)

Deposits (LHS)3) Wholesale funding (LHS)4)

Borrowings in won (LHS)5) Rate of won funding increase (RHS)6)

3) Including demand deposits, transferable savings deposits, corporate free deposits, etc.

4) This expansion in funding through wholesale finance can, in any time of deterioration in domestic or overseas conditions, become a factor

causing banks’ funding stability to worsen.

5) As of end-September 2015 the yield on bank bonds (AAA, one-year maturity), at 1.59%, had fallen by 0.61%p compared to end-December

2014 (2.20%), and the CD (91-day) interest rate had also declined by 0.54%p (2.13% → 1.59%) over this same period.

Notes: 1) Year-on-year2) Based on loans in won 3) Demand deposits, savings deposits and corporate

free deposits4) Periodic installment savings, mutual installment

deposits, etc.Sources: Commercial banks’ business reports

100

80

60

40

20

0

-20

-40

15

12

9

6

3

0

-3

-6

<Figure II- 6> Changes1) in deposits2) in commercial banks

Q1 2011 Q1 2012 Q1 2013 Q1 2014 Q1 2015 Q3

(trillion won) (%)

Time deposits (LHS)

Transferable deposits (LHS)3)

Other deposits (LHS)4)

Rate of deposit increase (RHS)

*금안2015(Dec)04-2장56~97 2016.2.18 11:25 AM 페이지61

Continuing trend of assetsoundness improvement

Asset soundness continued on its trend of

improvement seen since the end of 2013,

with the substandard-or-below loan ratio

falling to 1.17% in the third quarter of 2015

for example (Figure II-8).

By borrowing sector, the substandard-or-

below loan ratios have shown decreases in the

large enterprise, SME and household sectors

(Figure II-9). Even in the case of lending to

enterprises, where the substandard-or-below

loan ratio is high compared to those in other

sectors, a look at the various individual industries

finds the ratios in shipbuilding and construction6)

to have fallen by large extents of 2.27% points

and 2.07% points respectively compared to the

end of 2014, while those in the real estate and

shipping sectors fell by 0.53% point and 0.16%

point respectively as well (Figure II-10).

62

Notes: 1) Year-on-year2) Bank bonds, CDs, RPs, cover bills


40

0

-40

-80

25

0

-25

-50

<Figure II- 7> Changes1) in wholesale funding2)

of commercial banks

Q1 2011 Q1 2012 Q1 2013 Q1 2014 Q1 2015 Q3

(trillion won) (%)

Bank bonds (LHS) CDs (LHS)

RPs (LHS) Cover bills (LHS)

Rate of wholesale funding increase (RHS)

6) Among total commercial bank corporate lending as of end-September 2015, the proportions extended to these industries were 3.9% to

shipbuilding, 5.0% to construction, 1.0% to shipping, etc.

15

10

5

0

-5

-10

2.5

2.0

1.5

1.0

0.5

0

<Figure II- 8> Commercial bank substandard-or-below loan ratio1), newly occurring bad loans, and bad loan disposals

Q1 2011 Q1 2012 Q1 2013 Q1 2014 Q1 2015 Q3

(trillion won) (%)

Newly occurring bad loans (LHS)

Bad loan disposals (LHS)

Substandard-or-below loan ratio (RHS)

Note: 1) End-period basis Sources: Commercial banks’ business reports


5

4

3

2

1

0

5

4

3

2

1

0

<Figure II- 9> Commercial bank substandard-or-below loan ratios1), by borrowing sector

Q1 2011 Q1 2012 Q1 2013 Q1 2014 Q1 2015 Q3

(%) (%)

Large enterprises SMEs Households


12

9

6

3

0

12

9

6

3

0

<Figure II-10> Commercial bank substandard-or-below loan ratios1), by industry

Shipbuilding Construction Shipping Real estate Total

(%) (%)

Q4 2014 Q1 2015

Q2 2015 Q3 2015

*금안2015(Dec)04-2장56~97 2016.2.18 11:25 AM 페이지62

Continuing slump in profitability

The structural slump in profitability7) has

continued. Commercial bank net income

increased by a small amount (0.4 trillion

won) year-on-year in the second quarter of

2015 (1.9 trillion won), thanks to temporary

factors such as increases in securities-related

income, but then reversed to a 0.5 trillion

won decline in the third quarter (Figure II-

11).

Return on assets (ROA)8) rose temporarily

from 0.48% in the first quarter of 2015 to

0.52% in the second, but then fell again to

0.44% in the third quarter. Banks’ structural

profitability, indicative of their capacities for

generating sustainable profits, continued to

fall, on the narrowing of the loan-to-deposit

interest rate spread, and recorded 0.80% in

the third quarter of 2015. This was the low-

est level since compilation of these statistics

began in 1999 (Figure II-12).

Maintenance of satisfactoryliquidity levels

The liquidity coverage ratio (LCR), which

indicates a bank’s capacity for responding to

a sudden, short-term outflow of liquidity

under conditions of stress, recorded 103.8%

as of the end of September 2015. This was

3.8% points lower than at the end of

March, but higher than the required ratio

for 2015 (80%) as well as the threshold level

(100%) being applied from 2019

(Figure II-13). The slight drop in the LCR

compared to the end of March 2015 was a

result of expected net cash outflows having

increased much more than highly-liquid

63

II. Finan

cial System Stab

ility 1. Banks

Ko

rea’s Finan

cial Stability Situ

ation

s

7) In line with the merger between Korea Exchange Bank and Hana Bank (September 1, 2015) the indicators used in analysis of profitability

differ from the data being reported in commercial banks’ business reports, based on going concerns, and so for our estimates we have used

separate data (the sums of the business results of Korea Exchange Bank and Hana Bank from January through September 2015).

8) Based on cumulative quarterly results converted to annualized rates.


12

9

6

3

0

-3

-6

-9

12

9

6

3

0

-3

-6

-9

<Figure II-11> Commercial bank net income composition

Q1 2011 Q1 2012 Q1 2013 Q1 2014 Q1 2015 Q3

(trillion won) (trillion won)Interest income Fee incomeSecurities-related income General and administrative expensesLoan loss provisions Net income

Notes: 1) Accumulated quarterly records annualized2) (Interest income + Fee income + Trust account

income – Operating expenses) / Total assetsSources: The Bank of Korea, Commercial banks’ business

reports

4

3

2

1

0

4

3

2

1

0

<Figure II-12> Commercial bank profitability indicators

Q1 2011 Q1 2012 Q1 2013 Q1 2014 Q1 2015 Q3

(%, %p) (%, %p)

ROA1) Structural profitability1)2)

Loan-to-deposit spread Net interest margin

*금안2015(Dec)04-2장56~97 2016.2.18 11:25 AM 페이지63

assets, owing to expanded deposits9) by

financial institutions and corporations –

which have high possibilities of flowing out

in conditions of stress.

The loan-to-deposit ratio10), applied as a

new standard from 2015, stood at 97.3% in

the third quarter of 2015, up slightly com-

pared to the first quarter (96.9%) but still

running below the regulatory standard

(100% or below) (Figure II-14).

Satisfactory loss absorptioncapacities

Commercial banks’ loss absorption capaci-

ties have maintained satisfactory pictures.

The provision coverage ratio11), which shows

banks’ capacities12) for absorbing expected

losses, sustained a trend of increase to stand

at 141.5% as of the third quarter of 2015.

The ratio of excess loan loss provision accu-

mulation, meanwhile, at 107.9% in the third

quarter, was in excess of 100% and had also

climbed by 1.0% point compared to the

same period the year previous (Figure II-15).

64

Note: 1) Highly-liquid assets / Net cash outflows withremaining maturities of 30 days or less


300

200

100

0

-100

-200

-300

120

110

100

90

80

<Figure II-13> Commercial bank liquidity coverage ratio1)

2015.1 2 3 4 5 6 7 8 9

(trillion won) (%)

Highly-liquid assets (LHS) Net cash outflows (LHS)

Liquidity coverage ratio (RHS)

Note: 1) Due to a change in the standard for calculation ofthe loan-to-deposit ratio in won, there is a breakin the time series between Q4 2014 and Q1 2015


1,000

500

0

500

1,000

120

110

100

90

80

<Figure II-14> Commercial bank loan-to-deposit ratio1)

Q1 2011 Q1 2012 Q1 2013 Q1 2014 Q1 2015 Q3

(trillion won) (%)

Loans in won (LHS) Deposits in won (LHS)Loan-to-deposit ratio (RHS)

9) The commercial banks’ balance of deposits by other financial institutions and corporations (operational deposits excluded) expanded steadily

from 52.6 trillion won at end-March 2015 to 55.7 trillion won at end-June and 61.2 trillion won as of end-September.

10) From 2015 the standard for calculation of the won-denominated loan-to-deposit ratio was changed from (Loans in won / Deposits in won) to

(Loans in won - Onlending loans - Agriculture and forestry policy fund loans - New Hope Spore Loans) / (Deposits in won + Amount issued

of won-denominated covered bonds with five-year or longer maturities <up to a maximum of 1% of deposits in won>). Due to the exclusion

of policy fund loans under the new standards, it is estimated that the 2015 loan-to-deposit ratio has declined by about 1.4%p compared to

that previously.

11) The third quarter 2015 provision coverage ratio is an estimated figure based on banks’ business reports obtained through November, and so

can be revised after the Financial Supervisory Service’s announcement of external sector statistics.

12) Expected losses are prepared for by the accumulation of loan loss provisions for the assets concerned, while unexpected losses must be able to

be covered by capital.

*금안2015(Dec)04-2장56~97 2016.2.18 11:25 AM 페이지64

The Basel III13) basis total capital ratio,

indicative of banks’ absorption capacities

related to unexpected losses, was 14.67% as

of the third quarter of 2015, having fallen14)

by 0.18% point compared to the second

quarter (14.85%) but still well above the reg-

ulatory standard (8.0%). Moreover, the Basel

III standard common equity capital ratio,

implemented since year-end 2013 as banks’

core capital, was also very high compared to

the regulatory requirement (4.5%) at

11.45% in the third quarter (Figure II-16).

But as the financial soundness of households

and corporations declines, it seems that

potential default risks have grown.

Therefore, inasmuch as non-performing

loans can increase greatly at times of future

domestic or external shock occurrence,

shock absorption capacities will have to be

raised preemptively, through means such as

a strengthening of loan loss provision accu-

mulations.

65

II. Finan

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ility 1. Banks

Ko

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ation

s

Notes: 1) Loan loss provisions (including loan loss reserves)/ Substandard-or-below loans

2) Loan loss provisions (including loan loss reserves)/ Required coverage (larger of minimum loan lossprovisions by asset soundness classification, orexpected loss calculated through internal ratingsmethod of the commercial bank itself)

3) End-period basisSources: Financial Supervisory Service, Commercial

banks’ business reports

190

160

130

100

70

190

160

130

100

70

<Figure II-15> Commercial bank provision coverage ratio1) and excess coverage ratio2)3)

Q1 2011 Q1 2012 Q1 2013 Q1 2014 Q1 2015 Q3

(%) (%)

Provision coverage ratio Excess coverage ratio

Notes: 1) End-period basis2) Basel II basis before Q3 2013, and Basel III basis

after Q4 20133) Minimum capital requirements: Common equity

capital ratio of 4.5% or above, Tier 1 capital ratio of6.0% or above, Total capital ratio of 8.0% or above


16

14

12

10

8

16

14

12

10

8

<Figure II-16> Commercial bank BIS capital ratios1)2)3)

Q1 2011 Q1 2012 Q1 2013 Q1 2014 Q1 2015 Q3

(%) (%)

Total capital ratio Tier 1 capital ratio Common equity capital ratio

13) In Korea the Basel III capital regulations, including the strengthening of capital quality requirements, the new establishment of the common

equity capital ratio, etc., were implemented from December 1, 2013. Common equity capital means that which can be used first to preserve

banks from losses, and at the time of bank liquidation has the lowest priority for reimbursement and except at times of liquidation is not

redeemable. Capital and earned surpluses fall in this category.

14) This is due mainly to the fact that, although capital has expanded, through capital increases and issuance of capital securities, etc. to boost

banks’ loss absorption capacities, risk-weighted assets have increased even more owing to expansions in won-denominated loans for example.

*금안2015(Dec)04-2장56~97 2016.2.18 11:25 AM 페이지65

This article reviews the unsecured household loan market,

in consideration of the upcoming establishment of

Internet-only banks1) adopting platforms focused on mid-level

interest rate lending to individuals in Korea. Looking at the

proportions of financial institutions’ unsecured loans in the

different interest rate ranges, as of the end of the third quar-

ter 2015 42.0% (73.9 trillion won, balance basis) had interest

rates of less than 5%, while 24.9% (43.8 trillion won) had

rates ranging from 5% to 10% and 28.0% (49.3 trillion won)

rates of 15% or above. A mere 5.1% (9.1 trillion won) of

loans were in the 10~15% mid-level interest rate range.

The average lending rate gap among credit ratings

was found to be around 2.5% points. The gap between

grades 5 and 6, however, the medium level credit rat-

ings, recorded a substantial 5.9% points (11.9% →

17.8%). This is a result mainly of the fact that the share

of borrowers using mutual savings banks and money

lenders (financial institutions that usually charge much

higher rates on loans) increases greatly beginning from

grade 6.2)

66

II-1BOX

Financial Institutions’ Mid-level Interest Rate onUnsecured Household Loans

1) Two Internet-only banks (Kakao Bank and K-Bank) are scheduled to be launched in Korea in 2016.

2) A look into the shares of borrowers using mutual savings banks and money lenders, by credit rating, shows that as of end-September 2015

24.9% of grade 6 borrowers used mutual savings banks or money lenders, while only 5.0% of borrowers having grade 5 used them.

42.0

24.9

5.1

14.9

7.55.6

28.0%

Note: 1) Figures for banks are based on their loan balance byinterest rate range data, while those for other sectorsare based on the average interest rates by sector,which are 5~10% for credit unions and cooperatives;10~15% for insurance companies; 15~20% forcredit card companies; 20~25% for leasing andinstallment finance companies and savings banks,and 25% or above for money lenders.

Sources: Financial institutions’ business reports, NICE CreditInformation, Federations or associations of thesectors concerned

50

40

30

20

10

0

50

40

30

20

10

0

Household unsecured loan balance distribution1), by interest rate range

~5% 5~10% 10~15% 15~20% 20~25% 25%~

(%) (%)

3.85.9

7.5

9.6

11.9

17.8

21.223.5

25.826.7

Note: 1) Considering the range of interest rates onunsecured loans extended by each financial sector,the lowest interest rate was set at grade 1 and thehighest at grade 10. The lending interest rates forgrades 2 to 9 in each sector were estimated by thelinear interpolation method, and the interest ratesfor all unsecured household loans in each creditrating were then calculated based on the averagerates weighted by the numbers of borrowers.

Sources: NICE Credit Information, Federations orassociations of the sectors concerned

30

25

20

15

10

5

0

15

12

9

6

3

0

Average unsecured household loan interest rates1), by borrower credit rating

1 2 3 4 5 6 7 8 9 10

High Credit rating Low

(%) (%p)

Average interest rates, by credit rating (LHS)

Interest rate gaps (against one-step lower ratings, RHS)

5.9%p (grades 5 → 6)

2.5%p on average

*금안2015(Dec)04-2장56~97 2016.2.18 11:25 AM 페이지66

Mid-rate household unsecured lending in the banking

sector is sluggish, a fact that is attributable mainly to

banks’ business practices of focusing on secured loans as

well as to the difficulties in setting proper interest rates

for managing the risks of borrowers with medium or low

credit ratings. Moreover, it seems that the possibility of

reputation risk, if banks’ publicly announced average

lending rates should rise due to increased extensions of

mid-interest rate loans, is another factor limiting their

handling of such loans.

67

II. Finan

cial System Stab

ility 1. Banks

Ko

rea’s Finan

cial Stability Situ

ation

s

*금안2015(Dec)04-2장56~97 2016.2.18 11:25 AM 페이지67

The countercyclical capital buffer (CCyB) is a macro-

prudential policy instrument that the Basel

Committee on Banking Supervision (BCBS, hereafter)

decided to introduce following the global financial crisis,

which will come into effect from 2016 in Korea. With its

introduction, the policy authorities will be able to flexibly

adjust the level of capital requirements in the banking

sector in response to time-varying systemic risk(s).

Introduction of the CCyB is aimed at enhancing banks’

loss absorbency against possible risks of serious loss that

could arise after periods of excessive credit expansion.1)

( CCyB operation )

The CCyB is imposed based on a judgment by the poli-

cy authorities during times of systemic risk accumulation,

and lifted when these risks have either eased or materi-

alized as financial instability. The CCyB is imposed in the

range of 0 ~ 2.5% of total risk-weighted assets, and

banks must meet this requirement with common equity.

In order for the policy authorities to determine the

buffer level appropriate to the degree of accumulated

financial imbalances or systemic risk, they need to close-

ly examine and analyze a variety of information including

financial and economic indicators. In line with this, the

advice from the BCBS is to use the credit-to-nominal

GDP gap, i.e. the gap between the credit-to-nominal

GDP ratio and its long-term trend, as a common refer-

ence index for systemic risk evaluation. In addition to

this index, the BCBS advises that policy authorities use

diverse other indicators and information (asset prices,

household debt, wholesale funding weights, debt repay-

ment capacity, financial market volatility, banking sector

soundness, etc.) in determining the level of CCyB imposi-

tion.2)

Looking at the trend of the credit-to-nominal GDP

ratio3) in Korea, it had declined from the fourth quarter of

2009, immediately after the financial crisis, then

rebounding from the first quarter of 2011. The negative

gap subsequently widened somewhat, but has narrowed

again as the ratio has returned to an increase since the

third quarter of 2014, suggesting a need for stronger sys-

temic risk monitoring.

68

II-2BOX

Introduction of Countercyclical Capital Buffer, andEffects on Financial Stability

1) This process is expected to affect banks’ funding costs, and thereby mitigate any sudden changes in their volumes of lending.

2) The Bank of England distinguishes four different stages of systemic risk accumulation and its possibility of materialization, and differentiates the

levels of CCyB imposition based on these different stages.

3) The credit-to-nominal GDP ratio can be calculated in various ways, depending upon the coverage of the credit statistics and the detrending

method. In this report the ratio is calculated in accordance with the standard recommended by the BCBS, unlike the “private sector credit-to-

GDP ratio” mentioned in <Box 1> for which the credit statistics are chosen in consideration of timeliness of statistics. The BCBS’s

recommendation is to set the range of credit as wide as possible in calculation of the credit-to-nominal GDP gap for CCyB operation. The aim

is to identify crises that may arise in various sectors due for example to financial innovation, and to curb incentives for banks to expand their

supplies of credit using the non-banking sector.

*금안2015(Dec)04-2장56~97 2016.2.18 11:25 AM 페이지68

( Effects on Financial and MacroeconomicStability )

If the policy authorities adjust the CCyB requirement

upward during times of credit expansion, banks’ capital

levels rise and their loss absorbencies increase. In addi-

tion, if banks issue new shares, retain earnings or reduce

their risk-weighted assets so as to meet the CCyB

requirements, this will work as a factor boosting their

funding costs and curbing their lending. If the policy

authorities on the other hand adjust the CCyB require-

ment downward in a period of credit contraction, this

will lessen banks’ burdens of building up capital reserves

and prevent their lending activities from shrinking drasti-

cally. By providing information on financial and econom-

ic conditions and their evaluations that form the back-

ground to CCyB operation, the policy authorities will also

be able to influence the behaviors of banks and other

market participants in directions that enhance financial

stability.

It should meanwhile be noted that the CCyB may

affect the target variables of monetary policy such as

economic growth and inflation, as the CCyB works

through the credit channel, which is of course one of the

major channels of monetary policy transmission. This

suggests a need for establishing a framework for effi-

cient communication and cooperation among the policy

authorities, since the interactions between the CCyB and

monetary policy should be considered if seamless CCyB

operation is to be achieved. This is because operating

the CCyB without such communication and cooperation

among the related authorities may cause the policies’

effects to conflict, thus undermining their effectiveness

and sometimes even undermining macroeconomic stabil-

ity.

69

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Ko

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ation

s

Notes: 1) Sum of household debt, loans extended bydepository institutions to non-financialcorporations, government loans, and corporate billsand bonds issued by non-financial corporations

2) Sum of nominal GDP during the four previousquarters, seasonally adjusted

3) Long-term credit-to-nominal GDP ratio trend,calculated by one-sided HP filter


200

180

160

140

120

100

200

180

160

140

120

100

Credit1)-to-nominal GDP2) ratio, and long-term trend3)

1990 1995 2000 2005 2010 2015

(%) (%)Asian financial crisis(1997.11)

Global financial crisis(2008.9)

Long-term trend

Credit / Nominal GDP ratio

CCyB Transmission Channel

CCyBBank

capitalratio

Earningsretention, newstock issuance

Risk-weightedasset

adjustment

Marketexpectations

Financial system

resilience

Creditactivities

Fundingcosts

*금안2015(Dec)04-2장56~97 2016.2.18 11:25 AM 페이지69

2. Non-bank FinancialInstitutions

Generally improved managementsoundness

Non-bank financial institution soundness

has continued on its trend of improvement.

Amid sustained paces of growth and

improved profitability and asset quality, cap-

ital adequacy has maintained satisfactory

levels (Figure II-17).

Sustained trends of growth

Non-bank financial institution trends of

growth have been sustained. The rate of

increase in total assets15) stood at a year-on-

year 10.5% as of the end of September

2015, down slightly from the 12.5% figure

at the end of March but still showing a high

level (Figure II-18).

By individual non-bank financial sector,

the rate of total asset growth (year-on-year)

at insurance companies fell (end-March

2015 13.7% → end-September 2015

11.4%), in line for example with a

slowdown16) in sales of savings insurance

products. At mutual credit cooperatives the

rate also declined slightly (6.2% → 6.1%),

on a decrease in deposits for example. Total

asset growth slowed at securities companies

as well (22.2% → 18.0%), as issuance of

structured notes contracted17) somewhat, but

70

Savingsbanks

Insurance cos.

Insurance cos.

Securities cos.

Insurance cos.

Mutual credit cooperatives

Growth

Improvement

Deterioration

Asset quality

Capital adequacy

Baseline

2015.4~2015.9

Credit-specialized financial cos.

Profitability




Securities cos.

Securities cos.

<Figure II-17> Non-bank financial institution soundness map1)

Note: 1) Extents of change in April~September 2015 periodcompared to October 2014~March 2015 period indexed


15) Looking at the total asset amounts by sector, as of end-September 2015 insurance companies had the largest amount at 927 trillion won

(44.9% of total non-bank financial sector assets), followed by mutual credit cooperatives (524 trillion won, 25.4%), securities companies (371

trillion won, 18.0%), credit-specialized financial companies (201 trillion won, 9.7%) and savings banks (41 trillion won, 2.0%).

16) The rate of increase (year-on-year) in security insurance accelerated from 6.0% as of end-March 2015 to 7.9% at end-September, but that of

savings insurance fell from 8.6% to 5.4%.

17) The amount of structured note sales (based on securities company financial statements) stood at 88.9 trillion won as of end-September 2015,

having fallen by 4.4% since the end of March.

Notes: 1) End-quarter basis 2) Year-on-year


25

20

15

10

5

0

15

12

9

6

3

0

<Figure II-18> Non-bank financial institution total assets1)

2011.3 2012.3 2013.3 2014.3 2015.3 9

(100 trillion won) (%)Insurance cos. (LHS) Mutual credit cooperatives (LHS)Securities cos. (LHS) Credit-specialized financial cos. (LHS)Savings banks (LHS) Rate of total asset increase (RHS)2)

*금안2015(Dec)04-2장56~97 2016.2.18 11:25 AM 페이지70

as funding through customer deposits18) and

RP sales19) expanded the rate of total asset

growth showed the highest level among all

non-bank financial institution sectors. The

rate of total asset growth at credit-special-

ized financial companies accelerated greatly

(5.0% → 10.2%), on increased credit card

use amounts, expansions in loans extended

and so on. Savings banks’ total assets sus-

tained their pace of increase, in line with

their normalizations of business since under-

going restructuring (Figure II-19).

Non-bank financial institutions’ leverage

ratio rose to a small extent, to 9.3 times as

of the end of September 2015 compared to

9.2 times at the end of March, but is at a

low level compared to the 12.3 times at

banks (Table II-1).

Looking at non-bank financial institutions’

management of their assets, their proportion

of securities investment has decreased slight-

ly and that of loans has increased. This is

because of the acceleration (end-March 2015

8.1% → end-September 2015 9.5%) in the

rate of growth (year-on-year) in loans on the

one hand, centering around savings banks

and mutual credit cooperatives, while the

rate of growth in securities investment has

on the other hand fallen (16.4% → 13.3%).

The share of card, installment and lease

assets has meanwhile risen slightly (5.7% →

5.8%) (Figure II-20).

71

II. Finan

cial System Stab

ility 2. Non-bank Financial Institutions

Ko

rea’s Finan

cial Stability Situ

ation

s

18) The amount of investor fund deposits received by securities companies related to financial investment product sales stood at 35.6 trillion won

as of end-September 2015, higher by 25.2% than at end-March.

19) The RP sales amount (balance basis) increased by 2.1% compared to end-March 2015 to stand at 98.6 trillion won as of end-September.

Note: 1) Year-on-year, excluding increases due to newmarket entries (NongHyup Life Insurance,NongHyup Property & Casualty Insurance, KBKookmin Card, Woori Card and Hana Card) andaccounts receivable of securities companies


20

15

10

5

0

20

15

10

5

0

30

15

0

-15

-30

30

15

0

-15

-30

<Figure II-19> Non-bank financial institution rates1) of total asset growth, by financial sector

2011.3 2013.3 2015.9 2011.3 2013.3 2015.9

(%) (%) (%)(%)

Insurance cos.Mutual credit cooperativesCredit-specialized financial cos.

Securities cos.Savings banks

<Table II-1> Leverage ratios1) of domestic banks and non-bank financial institutions

Domestic banks 12.2 12.1 12.0 12.2 12.2 12.3

Non-bank financial 9.8 9.3 9.1 9.2 9.4 9.3

institutions

2014 2015

Q2 Q3 Q4 Q1 Q2 Q3

Note: 1) Leverage ratio = Total assets / Equity capital (domestic banktotal assets based on their banking accounts)



100

75

50

25

0

100

75

50

25

0

<Figure II-20> Non-bank financial institution compositions of managed assets, by asset type

2011.12 2012.12 2013.12 2014.12 2015.3 6 9

(%) (%)

Cash and deposits

Loans

Others

Securities

Card, installment and lease assets

*금안2015(Dec)04-2장56~97 2016.2.18 11:25 AM 페이지71

Continued trend of asset qualityimprovement

Non-bank financial institution asset quality

has improved in most sectors, with delin-

quency rates and substandard-or-below loan

ratios falling for example. Insurance compa-

nies’ delinquency rate and substandard-or-

below loan ratio were 0.6% and 0.3%

respectively as of the end of September

2015, having maintained levels similar to

those at the end of March (0.6% and 0.4%

respectively). At mutual credit cooperatives

the delinquency rate (2.8% → 2.1%) and

the substandard-or-below loan ratio (2.4%

→ 2.0%) both fell, owing to federations’

continued strengthening of delinquency rate

management at individual cooperatives, to

disposals of bad loans and resolutions of

troubled cooperatives, etc. At credit-special-

ized financial companies the delinquency

rate (2.4% → 2.2%) and the substandard-or-

below loan ratio (2.1% → 1.9%) fell as well,

due for example to withdrawals of bad

loans. The savings bank delinquency rate

(13.5% → 11.2%) and substandard-or-below

loan ratio (14.5% → 11.6%) also fell, thanks

among other things to the supervisory

authorities’ efforts for bad loan disposal20)

(Figures II-21, II-22).

72

20) To improve savings banks’ asset quality, the supervisory authorities decided to lower the non-performing loan ratios for general loans and PF

loans to 9.9% and 48.5% respectively by the end of 2016.

Notes: 1) Based on delinquencies of one month orlonger (one day or longer for mutual creditcooperatives and savings banks)

2) Excluding insurance policy loans3) Including card (excluding credit sales),

installment and lease assetsSources: Financial institutions’ business reports

9

6

3

0

30

20

10

0

<Figure II-21> Non-bank financial institution delinquency rates1), by financial sector

2011.3 2012.3 2013.3 2014.3 2015.3 9

(%) (%)Insurance cos. (LHS)2) Mutual credit cooperatives (LHS)Credit-specialized financial cos. (LHS)3) Savings banks (RHS)


4

3

2

1

0

28

21

14

7

0

<Figure II-22> Non-bank financial institution substandard-or-below loan ratios, by financial sector

2011.3 2012.3 2013.3 2014.3 2015.3 9

(%) (%)Insurance cos. (LHS) Mutual credit cooperatives (LHS)Credit-specialized financial cos. (LHS) Savings banks (RHS)

*금안2015(Dec)04-2장56~97 2016.2.18 11:25 AM 페이지72

Improved profitability

Profitability21) has improved on the whole,

thanks to expansions in fee income, to

declines in interest and loan loss expenses,

and so on. This improvement in non-bank

financial institution profitability is however a

result of factors such as the fall in market

interest rates and contractions in loan loss

expenses, and so the volatility of profits can

expand in line with any changes in the

financial market environment going forward.

At insurance companies, as the extents of

their insurance operation deficits narrowed22)

their net income increased to a small extent,

and at 0.72% at the end of September 2015

their ROA had maintained the same level as

at the end of March. At mutual credit coop-

eratives net income increased slightly, on a

reduction in loan loss expenses in line with

improvements in asset quality, and ROA

rose as well (0.42% → 0.43%). Securities

companies’ ROA also increased (0.80% →

1.01%), on an expansion in brokerage com-

mission earnings and a decline in interest

expenses. ROA at credit-specialized financial

companies meanwhile fell (1.77% →

1.57%), owing to increased card expenses23),

to declines in gains on sales of stocks, etc. At

savings banks, net income increased (0.3 tril-

lion won → 0.6 trillion won), on expanded

interest earnings stemming from growth in

lending and on a contraction in loan loss

expenses due to a reduction in bad loans24),

while ROA also rose (0.83% → 1.66%)

(Figures II-23, II-24).

73

II. Finan

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Ko

rea’s Finan

cial Stability Situ

ation

s

21) The net income and ROA figures for the October 2014~September 2015 period are compared with those for the period from April 2014 to

March 2015.

22) Insurance operating losses (policy reserves deducted) declined from 21.1 trillion won during the April 2014~March 2015 period to 20.7 trillion

won between October 2014 and September 2015, while investment operating profits narrowed from 22.1 trillion to 21.8 trillion won over the

same time span.

23) Card expenses (credit card member recruitment expenses, etc.) rose by 0.6 trillion won (6.0%), from 10.2 trillion won during the April

2014~March 2015 period to 10.8 trillion won between October 2014 and September 2015.

24) Net interest income expanded from 2.1 trillion won during the April 2014~March 2015 period to 2.3 trillion won in the October

2014~September 2015 period, while loan loss expenses declined from 0.7 trillion to 0.6 trillion won over the same period.


6

5

4

3

2

1

0

-5

6

5

4

3

2

1

0

-5

<Figure II-23> Non-bank financial institution net incomes

Q1 2011 Q1 2012 Q1 2013 Q1 2014 Q1 2015 Q3


Insurance cos. Mutual credit cooperativesSecurities cos. Credit-specialized financial cos.Savings banks All sectors


3

2

1

0

-10

3

2

1

0

-10

<Figure II-24> Non-bank financial institution ROAs

Q1 2011 Q1 2012 Q1 2013 Q1 2014 Q1 2015 Q3

(%) (%)

Insurance cos.Mutual credit cooperativesSecurities cos.Credit-specialized financial cos.Savings banks

*금안2015(Dec)04-2장56~97 2016.2.18 11:25 AM 페이지73

Favorable capital adequacy

Non-bank financial institutions’ capital

adequacy maintained favorable levels greatly

exceeding the financial regulatory standards

in all sectors, although capital adequacy

ratios did decline slightly in some sectors.

Affected by the supervisory authorities’ mea-

sures to strengthen risk management25),

insurance companies’ risk-based capital

(RBC) ratio26) fell (end-March 2015 302.0%

→ end-September 2015 284.8%), despite

the accumulation of earned surpluses and

the occurrence of bond valuation gains due

to the declines in market interest rates.

Mutual credit cooperatives’ net capital

ratio27) rose slightly (8.0% → 8.1%), on

improvements in asset quality and in prof-

itability for example. At securities companies

the net operating capital ratio (NCR)28) fell

(414.2% → 405.4%), in line with the

increased total risk amount due to an expan-

sion in guarantee of debt.29) Credit-special-

ized financial companies enlarged their equi-

ty30), through capital increases for example,

in preparation for the implementation of

leverage ratio regulations31), but as their total

assets grew rapidly their adjusted capital

ratio decreased slightly (21.4% → 21.3%).

Savings banks’ risk-weighted assets grew in

line with their expansions in lending, but

their BIS capital ratio maintained the same

level (14.3%) as of the end of March 2015

owing to their accumulations of earned sur-

pluses (Figure II-25).

74

25) The supervisory authorities on July 2014 raised the statistical confidence level applied when measuring interest risk (95% → 99%), and

decided to also raise the confidence level related to credit risk (95% → 99%) by 2016. If confidence levels related to risk are adjusted upward,

then since a greater amount of capital related to risk is demanded the RBC ratio declines.

26) RBC (Risk-Based Capital Ratio) = Total available capital (Equity) / RBC-required capital (required capital calculated through measurement

of the amounts of insurance, interest rate, credit, market and operational risks)

27) To expand capital at large-scale (total assets of 500 billion won or more) mutual credit cooperatives, the government plans to push ahead with

introduction into the capital requirement ratio regulation of a capital buffer 1%p higher from 2016.

28) NCR (Net operating Capital Ratio) = Net operating capital (Net capital ± Adjustments) / Total Risk (Market risk + Credit risk +

Operational risk)

29) The amount of securities companies’ guarantee of debt increased by 21.7% compared to end-March 2015 (19.8 trillion won) to stand at 24.1

trillion won as of end-September 2015, and the majority of this was related to real estate PF transactions (ABCP purchase guarantee

contracts, etc.).

30) Through capital increases (Hana Capital 50 billion won), hybrid bond issuance (Lotte Capital 101 billion won, JB Woori Capital 100 billion

won), etc.

31) From December 2015 the total assets of credit card companies and other credit-specialized financial companies were limited to within six

times and 10 times equity respectively.

Notes: 1) mutual credit cooperatives’ net capital ratio (2%;community credit cooperatives 4%; agriculturalcooperatives 5%), credit-specialized financialcompanies’ adjusted-capital ratio (7%; credit cardcompanies 8%), savings banks’ BIS capital ratio(6%; companies with assets over 2 trillion won7%), Insurance companies’ risk-based capitalratio (supervisory standard 100%), securitiescompanies’ net operating capital ratio (150%)

2) Dotted lines indicate the relevant supervisorycapital adequacy standards.


25

20

15

10

5

0

600

400

200

0

<Figure II-25> Non-bank financial institution capital adequacy ratios1)2)

Mutual credit Credit-specialized Savings Insurance cos. Securities cos. cooperatives (LHS) financial cos. (LHS) banks (LHS) (RHS) (RHS)

(%) (%)

2013.12

2014.12

2015.3

2015.6

2015.9

*금안2015(Dec)04-2장56~97 2016.2.18 11:25 AM 페이지74

OTC derivatives transactions have a positive aspect,

in that they can be used as a tool for reducing the

risks of financial institutions and corporations. However,

they can also give rise to financial system risk in the case

where a financial shock occurs due to factors such as

leverage and counterparty risks.

The volume of OTC derivatives transactions by secu-

rities companies has continued to grow since 2011.

Using the business reports of securities companies we

take a look here at the present situation of OTC deriva-

tives transactions in Korea, and analyze their potential

risks.

( Present Situation of OTC DerivativesTransactions )

The notional amount outstanding of OTC derivatives

transactions by securities companies increased from

358.7 trillion won at the end of 2011 to 842.6 trillion

won as of the end of June 2015. Their share in the mar-

ket as a whole meanwhile grew from 5.2% to 10.7%

during the same period.

In terms of the underlying assets, interest rate deriva-

tive transactions took up the largest portion of this at

590.8 trillion won (70.1%), followed by foreign exchange

derivative transactions at 104.4 trillion won (12.4%),

equity-linked derivative transactions at 93.0 trillion won

(11.0%) and credit derivative transactions at 49.2 trillion

won (5.8%).

The increase in OTC derivatives transactions of securi-

ties companies has been due mainly to a growing

demand for hedging against risk of loss, as dealing in

financial investment products (structured notes, RPs,

etc.) and the amount of bond investment have increased.

As investor incentives to search for yield have intensified

due to continued low interest rates, the amount of struc-

tured note issuance by securities companies has expanded

75

II. Finan

cial System Stab


Ko

rea’s Finan

cial Stability Situ

ation

s

II-3BOX

OTC Derivatives Transactions by Securities Companies,and Assessment of Potential Risks

Note: 1) End-period basisSources: Financial institutions’ business reports

1,200

900

600

300

0

15

12

9

6

3

0

Notional amounts outstanding1) of OTC derivatives transactions, by the underlying assets

2011 2012 2013 2014 2015.6

(trillion won) (%)

Others (LHS) Credit derivatives (LHS)Equity-linked derivatives (LHS) Foreign exchange derivatives (LHS) Interest rate derivatives (LHS)Proportion of securities company notional transaction amount outstanding (RHS)

*금안2015(Dec)04-2장56~97 2016.2.18 11:25 AM 페이지75

– from 39.2 trillion won as of the end of 2011 to 94.8 tril-

lion won at the end of June 2015 (+55.6 trillion won). The

share in total debt of the issuance outstanding of struc-

tured notes rose from 21.4% to 29.9% over the same peri-

od. The ratio of structured note issuance outstanding to

equity capital meanwhile jumped from 1.0 time at the end

of 2011 to 2.3 times at the end of June 2015.

This increase in structured note issuance has caused

an expansion in securities companies’ demand for hedg-

ing against risk of loss. And this has in turn led to

increased OTC derivatives transactions, such as swap

and option transactions linked to equity, foreign

exchange, interest rates and credit.

As funding through the issuance of structured notes

and RP sales has increased, the volume of bond invest-

ment by securities companies has expanded greatly from

102.2 trillion won at the end of 2011 to 166.6 trillion

won as of the end of June 2015. And as demand for

hedging against price risks on bond holdings due to

interest rate changes has grown, it has worked as a fac-

tor causing interest rate swap transactions to increase.

There has been an increase in foreign exchange for-

ward and cross-currency swap transactions, for hedging

against the exchange rate risks posed by investment1) in

foreign currency assets (deposits, bonds, etc.) by securi-

ties companies and by customers (specific money in

trust, individuals, etc.)

( Potential risks )

The potential risks related to OTC derivatives transac-

tions by securities companies appear to be small for

now. In terms of Korean won interest rate swap con-

tracts, which make up the largest part of these compa-

nies’ OTC derivatives transactions, the related counter-

party risk has shrunken as clearing through the CCP has

become mandatory (effective June 2014). The notional

amount outstanding of securities companies’ Korean

won interest rate swap transactions cleared through the

CCP stood at 250.4 trillion won at the end of June 2015.

This was 43.1% of the notional amount outstanding of

all interest rate swap transactions of securities compa-

nies.

Considering that securities companies’ OTC deriva-

tives transactions are related mainly to hedging stem-

ming from expansions in dealing financial investment

products and bond holdings, the risk of loss from these

transactions is judged to be limited. This is because prof-

its and losses from hedging transactions are largely off-

set by profits and losses from changes in the prices of

financial investment products and bond holdings.

However, attention needs to be paid to market risk

due to changes in market prices (interest rates, stock

prices, etc.), liquidity risk stemming from transfers of col-

lateral and the possibility of a rise in counterparty risk.

Amid the expanded market risk due to increased bond

holdings and structured note issuance by securities com-

panies, there is a risk of loss being generated in any case

76

1) The outstanding issuance of foreign currency deposit ABCP collateralized by a beneficial interest in specific money in trust investing in a

foreign currency deposit increased from 3.6 trillion won at end-2013 to 29.9 trillion won at end-June 2015, while the volume of investment in

foreign currency bonds by securities companies expanded from 1.6 trillion won at end-2011 to 7.7 trillion won at end-June 2015.

Note : 1) End-period basisSources: Financial institutions’ business reports

180

120

60

0

180

120

60

0

Outstanding1) of bond holdings and structured note issuance by securities companies

2011 2012 2013 2014 2015.6


Bond holdings Structured note

*금안2015(Dec)04-2장56~97 2016.2.18 11:25 AM 페이지76

of drastic financial market change. In particular, in cases

of securities companies’ autonomous hedging of struc-

tured notes, they could experience increased profit and

loss volatility as they directly trade stocks, bonds and

derivatives in order to redeem their structured notes. The

amount of autonomous hedging of structured notes

increased from 11.9 trillion won at the end of 2011 to

45.1 trillion won as of the end of June 2015 (+33.2 tril-

lion won).

Securities companies can in addition experience liq-

uidity burdens2) from collateral transfers in cases of OTC

derivatives transactions. The collateral eligible for trans-

fer in these transactions is limited to prime assets such

as U.S. Treasuries and Korean government bonds. There

are concerns that, when trading with financial institu-

tions overseas, collateral burdens may increase due to

needs to provide additional collateral in line with rising

exchange rates, and to the setting of Korean won collat-

eral caps.

Moreover, in the case of OTC derivatives transactions

not cleared through the CCP, it is necessary to bear in

mind the possibility of expanded credit risk due to trad-

ing with non-prime customers or to counterparty concen-

tration.

77

II. Finan

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Ko

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cial Stability Situ

ation

s

2) When signing the CSA (Credit Support Annex) agreement, established by the International Swaps and Derivatives Association (ISDA) to

mitigate counterparty risks in OTC derivatives transactions, the parties concerned set the threshold amount in line with the agreement , and if

the market value of the derivatives exceeds that threshold they receive or transfer collateral in the amount of that excess.

*금안2015(Dec)04-2장56~97 2016.2.18 11:25 AM 페이지77

3. Financial Markets

Slight decline in stability

Influenced by the global financial markets,

stock price and exchange rate volatility in the

domestic financial markets have expanded. In

the corporate bond market the trend of sta-

bility has shown a picture of slight worsening

overall, with credit wariness rising due for

example to the slumps in business conditions

of domestic enterprises and to the highlight-

ing of risks in vulnerable industries (Figure II-

26). Going forward there are concerns that

market instabilities will grow in line with fac-

tors such as the ECB’s reduction of its policy

rate and expectations related to policy rate

hikes by the U.S. Federal Reserve.

Expansion in stock price andexchange rate volatility

In the global financial markets, as con-

cerns about economic unrest in China and

other EMEs spread following the August

2015 devaluation of the Chinese yuan32),

investment sentiment related to risky assets

and to EMEs shrank precipitously. Entering

October it showed a picture of regaining

stability, however, in response to the

People’s Bank of China’s monetary easing

measures33) for example (Figure II-27).

In the domestic financial markets, stock

price and exchange rate volatility expanded

greatly from June 2015, on the unrest in the

Chinese stock market together with concerns

about a global economic slowdown. Interest

78

<Figure II-26> Financial market stability map1)

Notes: 1) Extents of change in June~November 2015 periodcompared to December 2014~May 2015 period indexed

2) Daily volatility calculated using exponential weightedmoving average (EWMA) method

3) Corporate bond (BBB-) yield - Treasury bond (3-yr) yieldSource: The Bank of Korea

Baseline

2015.6~11

Interest rate (3-yr Treasurybond yield) volatility2)

Stock price(KOSPI)

volatility2)

Corporatebond (BBB-)

credit spreads3)

Deterioration

Improvement

Exchange rate (won / USD) volatility2)

32) The People’s Bank of China changed the method for fixing the reference yuan exchange rate, and between August 11 and 13, 2015 devalued

the reference rate by a total 4.5% (1.8% on the 11th, 1.6% on the 12th and 1.1% on the 13th), in consequence of which the market

exchange rate rose from 6.2 yuan to 6.4 yuan to the U.S. dollar.

33) On October 23 the People’s Bank of China announced monetary easing policies of reducing the benchmark interest rate by 25bp and the

reserve requirement ratio by 50bp.

Notes: 1) Volatility index calculated with prices for optionson S&P500 index

2) Spread between yields on emerging countrysovereign bonds and on U.S. Treasury bonds

Source: Bloomberg

50

40

30

20

10

0

500

400

300

200

100

0

<Figure II-27> VIX1) and EMBI+ spread2)

2013.1 7 2014.1 7 2015.1 7 11

(bp)

VIX (LHS)

EMBI+ spread (RHS)

*금안2015(Dec)04-2장56~97 2016.2.18 11:25 AM 페이지78

rate volatility meanwhile contracted consid-

erably after the Bank of Korea Base Rate

cut in June (1.75% → 1.50%, June 11), but

then expanded again after the November

FOMC meeting as the likelihood of a policy

rate hike by the U.S. Federal Reserve rose

(Figure II-28).

The Treasury bond (3-year) yield reversed

to a downward trend from July 2015, as

economic unrest in China and EMEs

spread, and recorded an all-time low of

1.57% on September 30. From October it

shifted back to an increase, however, as

expectations of a domestic economic recov-

ery and the likelihood of a policy rate hike

by the U.S. Federal Reserve within the year

rose, and stood at 1.79% as of November 30

(Figure II-29).

Foreigners’ securities investment funds began

to contract from June 2015, on the trend of

U.S. dollar strengthening due to expectations

of a rate hike by the Fed, on the worsening of

foreign currency liquidity conditions in EMEs,

etc., and between June and September shrank

by 4.1 trillion won. By investor type, funds

from banks contracted on a reduction in inter-

est rate arbitrage transaction incentives34), and

those from global funds under the influence of

a decline in funds in trust. Funds from emerg-

ing economy central banks decreased in line

with their objectives of securing foreign curren-

cy liquidity35), in distinct contrast to the past.

From October, however, as investment senti-

ment related to EMEs improved somewhat

and funds from central banks flowed back in

again, foreigners’ securities investment reversed

to a small increase (October~November +0.2

trillion won) (Figure II-30).

79

II. Finan

cial System Stab

ility 3. Financial Markets

Ko

rea’s Finan

cial Stability Situ

ation

s

Note: 1) Daily volatility calculated using exponentialweighted moving average (EWMA) method


3

2

1

0

3

2

1

0

<Figure II-28> Interest rate, stock price and FX volatilities1)

2013.1 7 2014.1 7 2015.1 7 11

(%) (%)

Interest rate (3-yr Treasury bond yield)

Stock price (KOSPI)

Exchange rate (won / USD)


4

3

2

1

4

3

2

1

<Figure II-29> BOK Base Rate, Korea and U.S. Treasury bond yields

2013.1 7 2014.1 7 2015.1 7 11

(%) (%)

U.S. Treasury (10-yr) yield

Korea Treasury (3-yr) yield

BOK Base Rate

34) As the swap rate [the cost of borrowing Korean won using dollars; (Future exchange rate – Spot exchange rate)/Spot exchange rate] rose

between June and September 2015, the arbitrage transaction incentive (Domestic-to-overseas interest rate differential – Swap rate) continually

declined.

35) Owing to the trend of U.S. dollar strengthening, to the collapses in international raw material prices, to concerns about the Chinese economic

slowdown, etc., capital outflows from some vulnerable EMEs expanded and their foreign exchange reserve holdings decreased.

*금안2015(Dec)04-2장56~97 2016.2.18 11:25 AM 페이지79

The Korean won/U.S. dollar exchange

rate reversed to a trend of increase, on

the effects for example of growing expec-

tations of a policy rate hike by the U.S.

Federal Reserve following the favorable

U.S. economic indicators from May 2015,

and of the Base Rate cut by the Bank of

Korea in June. From late June, as factors

such as strengthening risk aversion due to

difficulties in the Greece debt negotiations

and to worries about the economic slow-

down in China appeared, as well as out-

flows of foreigners’ securities funds, the

rate climbed and reached 1,203.7 won to

the dollar (on September 7). After that it

fluctuated, influenced by changes in

expectations related to the Fed rate hike,

and as of November 30 showed 1,158.1

won. The Korean won/Japanese yen (100

yen) rate meanwhile rose to a consider-

able extent from late June, as the yen

showed a trend of strengthening on rising

preferences for safe assets, but its extent

of increase then narrowed from October

as the won strengthened due to improve-

ments in global risk sentiment. The

won/100 yen rate weakened by 5.2%

between the end of May and November

30 – rising from 894.6 won to 943.5 won

(Figure II-31).

Decline in stock prices

Stock prices (KOSPI) showed a continu-

ing trend of decline from June 2015, on a

succession of worsening external conditions

such as concerns about a debt default by

Greece and expanded uncertainties related

to the Chinese economy, as well as the

MERS outbreak and concerns about

slumps in performances at domestic enter-

prises due to the trend of Japanese yen

weakening, and on August 24 recorded

their lowest figure for the year of 1,829.8.

From September they then rebounded to a

substantial extent, on the U.S. Fed’s contin-

ued holding of its policy rate steady, on the

upward adjustment of Korea’s sovereign

80


4

2

0

-2

-4

110

90

70

50

30

<Figure II-30> Bond investment by foreigners

2013.1 7 2014.1 7 2015.1 7 11


Changes in holdings (LHS)

Bond holdings (RHS)


1,400

1,200

1,000

800

1,400

1,200

1,000

800

<Figure II-31> Won / USD and won / yen exchange rates

2013.1 7 2014.1 7 2015.1 7 11

(won / USD, won / 100 yen) (won / USD, won / 100 yen)

Won / USD Won / 100 yen

*금안2015(Dec)04-2장56~97 2016.2.18 11:25 AM 페이지80

credit rating36), on the implementation of

additional easing policies in China, and so

on. Entering November it fluctuated, how-

ever, influenced greatly by global stock

price trends in line with issues related to

major countries’ monetary policies37), and as

of November 30 stood at 1,992. Major

country stock prices, meanwhile, in both

advanced countries and EMEs, after show-

ing large extents of decline in the

June~September period rebounded to con-

siderable extents in October, before then

falling again in November (Figure II-32).38)

Between June and September 2015 for-

eign investors recorded net sales of domestic

stocks of 9.2 trillion won39), owing to factors

such as expanded external risks including

the unrest in the Chinese stock market and

concerns about foreign exchange losses due

to the depreciation of the Korean won. In

October foreigners net purchased 0.6 trillion

won, on China’s interest rate cuts and

expectations of additional easing by the

ECB for instance, but in November they

reversed back to 1.7 trillion won of net sales,

in line for example with the trend of U.S.

dollar strengthening and with portfolio

adjustments by global funds40) (Figure II-33).

81

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cial Stability Situ

ation

s

36) On September 15, 2015 S&P adjusted Korea’s sovereign credit rating upward from A+ to AA-.

37) In the first half of November forecasts of a December interest rate hike by the U.S. Federal Reserve strengthened, but in the second half, as

amid emerging forecasts of gradual Fed rate hikes, expectations of additional easing by the ECB grew.

38) Between June and September 2015 the advanced country MSCI and EME MSCI indexes fell by 11.1% and 21.1% respectively, and after

reversing to increases of 7.8% and 7.0% in October they fell again by 0.7% and 3.8% respectively in November.

39) Based on the sum of the KOSPI and the KOSDAQ markets

40) This was a result of Korea’s share in the MSCI emerging markets index falling due to the inclusion of Chinese ADRs (American Depositary

Receipts) in the index (from close of business November 30).

Source: Bloomberg

2,200

2,100

2,000

1,900

1,800

1,700

210

180

150

120

90

60

<Figure II-32> KOSPI and global stock prices

2013.1 7 2014.1 7 2015.1 7 11

(1980.1.4 = 100) (2010.1.4 = 100)MSCI World (RHS)MSCI Emerging markets (RHS)Dow Jones (RHS)KOSPI (LHS)

Note: 1) Share of foreigner stock holdings in total KOSPImarket capitalization

Source: KOSCOM

39

37

35

33

31

8

4

0

-4

-8

<Figure II-33> Foreigner net stock purchases, and holding share1)

2013.1 7 2014.1 7 2015.1 7 11

(%) (trillion won)

Foreigner net purchases, by month (RHS)

Foreigner holding share (LHS)

*금안2015(Dec)04-2장56~97 2016.2.18 11:25 AM 페이지81

Expansion of credit wariness incorporate bond market

The corporate bond market showed a rel-

atively stable picture until August 2015, but

as credit wariness expanded from

September, in line with the highlighting of

risks in vulnerable industries following the

event at Daewoo Shipbuilding & Marine

Engineering, the continuation of companies’

sluggish business conditions, etc., credit

spreads for both prime (AA grade and

above) and sub-prime (A grade and below)

bonds widened sharply (Figure II-34).

In the primary market, entering the third

quarter of 2015 credit concerns showed a

picture of spreading to prime corporate

bonds. A look at the net issuance amounts,

which consider redemptions at maturity,

finds that in the case of prime bonds their

net issuance amount shrank greatly to 0.8

trillion won in the third quarter, from 3.0

trillion won and 3.6 trillion won respectively

in the first and second quarters. With regard

to net sub-prime bond issuance, the amount

of net redemption declined from 3.6 trillion

won in the first quarter of 2015 to 0.7 tril-

lion won in the second quarter and 1.2 tril-

lion won in the third. Meanwhile, the pro-

portion in total corporate bond issuance

accounted for by prime bonds fell to a large

extent after recording 79.6% in the first

quarter of 2015, to maintain levels of

around 70% in the second and third quar-

ters (Figure II-35).

In the secondary market, meanwhile,

investment demand for sub-prime corporate

bonds sustained a trend of decline from the

first quarter of 2015. The share of sub-

prime bonds in the total transaction amount

fell from 25.2% in the first quarter to 22.6%

in the second quarter and 19.0% in the

third quarter (Figure II-36).

82

Note: 1) 3-year maturity basisSource: Korea Financial Investment Association

100

80

60

40

20

0

160

140

120

100

80

60

<Figure II-34> Corporate bond credit spreads1), and spread across credit ratings

2013.1 7 2014.1 7 2015.1 7 11

(bp) (bp)

Corporate bonds (A-) - Corporate bonds (AA-) (RHS)

Corporate bonds (A-) - Treasury bonds (RHS)

Corporate bonds (AA-) - Treasury bonds (LHS)

Notes: 1) Excluding issuance by financial holdingcompanies

2) Based on monthly averagesSources: Korea Securities Depository, The Bank of Korea

2

1

0

-1

-2

90

75

60

45

30

<Figure II-35> Current status of corporate bond1) netissuance2), and proportion of prime bond issuance

2011 2012 2013 Q1 2014 Q3 Q1 2015 Q3

(trillion won) (%)AA and above (LHS) A (LHS)

BBB and below (LHS) Proportion of AA and above (RHS)

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83

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Note: 1) Excluding ungraded bondsSource: KOSCOM

100

80

60

40

20

0

100

80

60

40

20

0

<Figure II-36> Proportions in total corporate bond1)

transactions, by credit rating

2011 2012 2013 Q1 2014 Q3 Q1 2015 Q3

(%) (%)AA and above A BBB and below

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4. Foreign exchangesoundness

Satisfactory foreign exchangesoundness

Foreign exchange soundness has shown a

satisfactory picture overall, with the volatility

of the won/dollar exchange rate having

risen to a small extent but the current

account surplus continuing and the CDS

premium recovering a stable trend. The

external payment capacity is also solid, with

most of the main soundness indicators this

sector, including net external assets in debt

instruments and the current account-to-

nominal GDP ratio41), having improved.

Concerns regarding the adverse impacts on

Korea’s external soundness are however ris-

ing, as international financial market volatili-

ty expands in line with the monetary policies

of the ECB, the U.S. Federal Reserve, and

other central banks (Figure II-37).

Decline in net foreign exchangeinflows

Looking at foreign exchange supply and

demand conditions, a trend of a declining

amount of overall net inflows has been seen

as, after showing a trend of net inflows

entering 2015, foreign exchange reversed to

net outflows from the third quarter. This is

because the net outflows in the financial

account (excluding reserve assets and finan-

cial derivative assets) have increased, owing

for example to a reversal to net outflows of

foreigners’ securities investment funds even

despite the continuing large-scale current

account surplus (Figure II-38).

84

Notes: 1) Extents of change in April 2015~September 2015 comparedto October 2014~March 2015 indexed

2) Foreign exchange stabilization bond (5-yr) basis3) Short-term external debt / Foreign exchange reserves4) External assets in debt instrument – External debt


<Figure II-37> Foreign exchange soundness map1)

Baseline

2015.4~9

FX volatility

CDS premium2)Net external

assets4)

Current account /Nominal GDP

Short-term external debt ratio3)

Deterioration

Improvement

41) The current account-to-nominal GDP ratio is an indicator showing foreign exchange supply and demand conditions due to the results of

external trade, and is also useful for judging a country’s basic economic fundamentals.

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Looking at the financial account by indi-

vidual item, the net inflows of foreigners’

domestic investment (liabilities) increased in

the second quarter of 2015, as inflows of

foreigners’ securities investment funds grew,

but in the third quarter foreigners’ securities

investment funds reversed to net outflows

and banks’ short-term borrowings also

reversed to a large-scale net outflow as

banks redeemed them (Figure II-39).

The net outflows of external investment

by residents (assets) meanwhile expanded

greatly in the second quarter of 2015, on an

increase in overseas securities investment by

institutional investors for example, but in the

third quarter they decreased to a large

extent as the amount of investment declined

again (Figure II-40).

Continuing trend of growth in netexternal assets

Korea’s net external assets (external assets

in debt instruments - external debts) sus-

tained their trend of increase even after the

second quarter of 2015. They grew by 29.4

billion dollars in the second quarter and by

19.6 billion dollars in the third quarter also,

and as of the end of September recorded

312.9 billion dollars (Figure II-41).

85

II. Finan

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ility 4. Foreign exchange soundness

Ko

rea’s Finan

cial Stability Situ

ation

s

Note: 1) Excluding reserve assets and derivativesSource: The Bank of Korea

400

200

0

-200

-400

400

200

0

-200

-400

<Figure II-38> Balance of payments1)

Q1 2011 Q1 2012 Q1 2013 Q1 2014 Q1 2015 Q3


Current account Capital account

Financial account Balance of payments

Note: 1) A ”-” means net outflows and a ”+” net inflows;excluding financial derivative assets


300

150

0

-150

-300

300

150

0

-150

-300

<Figure II-39> Foreigners’ domestic investment1)

Q1 2011 Q1 2012 Q1 2013 Q1 2014 Q1 2015 Q3


Direct investment


Other investment

Note: 1) A ”-“ means net outflows and a “+“ net inflows;excluding changes in reserve assets and financialderivative assets


100

0

-100

-200

-300

-400

100

0

-100

-200

-300

-400

<Figure II-40> Residents’ overseas investment1)

Q1 2011 Q1 2012 Q1 2013 Q1 2014 Q1 2015 Q3


Direct investment


Other investment

*금안2015(Dec)04-2장56~97 2016.2.18 11:25 AM 페이지85

External assets in debt instruments

expanded to a considerable extent (33.8 bil-

lion dollars) in the second quarter, and grew

by 5.1 billion dollars in the third quarter as

well to stand at 722.0 billion dollars as of

the end of September. By individual sector,

the external assets in debt instruments of

the general government declined by 0.7 bil-

lion dollars during the second to third quar-

ters period, but the foreign exchange

reserves of the central bank increased by 5

billion dollars. External assets in debt

instruments of deposit-taking institutions

increased by a substantial amount of 22.0

billion dollars, centering around their man-

agement of foreign currency loans and for-

eign currency deposits, while those of the

other sectors grew by 12.6 billion dollars

during this same period on international

debt securities investment by institutional

investors (Figures II-42, II-43).

External debt meanwhile increased tem-

porarily in the second quarter of 2015 (+4.4

billion dollars), but entering the third quar-

ter fell substantially again (-14.6 billion dol-

lars) and as of the end of September stood

at 409.1 billion dollars. By individual sector,

between the second and third quarters exter-

nal debt of the general government and the

central bank contracted by 9.8 billion dol-

86


200

100

0

-100

200

100

0

-100

<Figure II-42> Changes in external assets in debt instruments, by sector

General Central Deposit-taking Other government bank institutions sectors


Q4 2014 Q1 2015

Q2 2015 Q3 2015


3,800

3,400

3,000

2,600

200

100

0

-100

<Figure II-43> Foreign exchange reserves

Q1 2011 Q1 2012 Q1 2013 Q1 2014 Q1 2015 Q3


Changes in foreign exchange reserves (RHS)

Foreign exchange reserves (LHS)


4,000

3,000

2,000

1,000

0

8,000

6,000

4,000

2,000

<Figure II-41> Net external assets

Q1 2011 Q1 2012 Q1 2013 Q1 2014 Q1 2015 Q3


Net external assets (LHS)

External assets in debt instruments (RHS)

External debts (RHS)

*금안2015(Dec)04-2장56~97 2016.2.18 11:25 AM 페이지86

lars, owing mainly to a decline in the bal-

ance of foreigners’ debt securities invest-

ment, while the external debt of deposit-tak-

ing institutions also fell by 1.2 billion dollars.

External debt of the other sectors in contrast

showed an increase of 0.8 billion dollars

(Figure II-44).

Satisfactory external paymentcapacity

The external payment capacity has sus-

tained its favorable level. The short-term

external debt-to-foreign exchange reserves

ratio and the proportion of short-term in

total external debt had increased temporari-

ly at the end of June 2015, but afterwards

showed declining trends and sustained good

conditions. As of the end of September the

short-term external debt-to-foreign

exchange reserves ratio stood at 32.5% and

the proportion of short-term in total exter-

nal debt at 29.2% – both satisfactory levels.

The ratio of total external debt to nominal

GDP as well, at 29.6% as of the end of

September, had also continued its trend of

decline (Figure II-45).

Favorable domestic bank foreigncurrency funding conditions

Domestic banks’ foreign currency funding

conditions did worsen temporarily in the sec-

ond half of 2015, as concerns arose about

the likelihood of a policy rate hike by the

U.S. Federal Reserve and about the econom-

ic slowdown in China, but they have shown

a generally favorable picture. The spread on

long-term foreign currency borrowings

showed a somewhat worsening picture, in

rising to 79bp in September 2015 for

instance, but since October has shown slight

fluctuations at around the 60bp level, on

favorable foreign currency liquidity condi-

tions due to the continuing current account

surplus. The rollover ratio (amount of newly

extended loans / amount of loans maturing)

has on the other hand shown a stable pic-

ture, exceeding 100% on average in the July

to November 2015 period (Figure II-46).

87

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ation

s


100

50

0

-50

-100

100

50

0

-50

-100

<Figure II-44> Changes in external debt, by sector

General Central Deposit-taking Other government bank institutions sectors

(100 million dollars)

Q4 2014 Q1 2015

Q2 2015 Q3 2015

(100 million dollars)


1,600

1,400

1,200

1,000

60

50

40

30

20

<Figure II-45> External payment capacity and liquidity indicators

Q1 2011 Q1 2012 Q1 2013 Q1 2014 Q1 2015 Q3


Short-term external debt (LHS)Short-term external debt / Foreign exchange reserves (RHS)Total external debt / GDP (RHS)Short-term external debt / Total external debt (RHS)

*금안2015(Dec)04-2장56~97 2016.2.18 11:25 AM 페이지87

Domestic banks’ CDS premium has also

shown a satisfactory level. It reversed to an

upward trend from June 2015, on the effects

of the difficulties in the Greek debt negotia-

tions, the economic unrest in China and

other EMEs, etc., and rose to 96bp by the

end of September, but then fell from

October, all the way to 81bp as of the end

of November, on the delay in its policy rate

hike by the Fed, the reduction in interest

rates in China, etc. The FX swap rate (3-

month) showed a declining trend during the

first half of 2015, due to a narrowing of the

domestic-to-foreign interest rate differential

in line with the monetary policy divergences

between Korea and the U.S. to the expan-

sion in overseas securities investment by resi-

dents, and so on, but in the second half it

rebounded, as non-resident net purchases of

forward exchange increased on expectations

of Korean won weakening due to worries

about the economic slowdown in China, and

has since then shown small-scale fluctuations

(Figure II-47).

Net outflows of foreigners’securities investment funds

Since June 2015 global investment funds

have shown large-scale changes in their in-

and outflows, but a general pattern of

inflows to advanced countries and outflows

from emerging market economies has

appeared. Outflows have been seen as

investor risk aversion has intensified - owing

to concerns about a Grexit in the May to

June 2015 period, to worries about econom-

ic unrest in EMEs following the slowdown

in economic activities in China from August,

and so on. In particular, the amount of

global investment funds that flowed out from

EMEs in August (37.2 billion dollars) was

the largest since the 32.2 billion dollar out-

88

Notes: 1) Simple average of CDS premiums of KookminBank, Industrial Bank of Korea, Shinhan Bank,Woori Bank and KEB Hana Bank; foreign exchangestabilization bonds based on 5-year maturity

2) 3-month maturity basisSources: The Bank of Korea, Bloomberg

250

200

150

100

50

0

3.0

2.5

2.0

1.5

1.0

0.5

0

<Figure II-47> CDS premium1) and foreign exchange swap rate2)

2013.1 7 2014.1 7 2015.1 7 11

(bp) (%)Domestic bank CDS premium (LHS)Foreign exchange stabilization bond CDS premium (LHS)Foreign exchange swap rate (RHS)

Notes: 1) Total amount of newly extended loans during period/ Total amount of loans maturing during period

2) Borrowing spreads based on LIBOR (based onnine domestic banks); rates calculated byamount-weighted averaging


120

80

40

0

300

200

100

0

<Figure II-46> Domestic banks’ foreign currency borrowing rollover ratio1), and spreads2) on

short- and long-term borrowings

2013.1 7 2014.1 7 2015.1 7 11

(bp) (%)

Rollover ratio (RHS)Spread on short-term borrowings (LHS)Spread on long-term borrowings (LHS)

*금안2015(Dec)04-2장56~97 2016.2.18 11:25 AM 페이지88

flow recorded in June 2013. In October, as

expectations of a U.S. interest rate hike

within this year weakened temporarily, glob-

al investment funds did reverse to inflows,

but since November they are showing pic-

tures of turning around to outflows as the

likelihood of an interest rate hike by the

U.S. Fed has emerged again (Figure II-48).

Foreigners’ securities investment funds in

Korea have also been influenced by these

changes in global funds flows, and shown a

picture of expanding in- and outflow volatili-

ty. Foreigners’ securities investment funds

notably showed outflows from June 2015,

due to the international financial market

unrest resulting from factors such as con-

cerns about a Grexit and about a policy rate

hike by the U.S. Federal Reserve and eco-

nomic instabilities in EMEs. In October for-

eigners’ securities investment funds did show

a net inflow as global investment sentiment

improved, but in November they reversed

again to outflows as the likelihood of a poli-

cy rate hike in the U.S. grew (Figure II-49).

Looking at the in- and outflows of foreign-

ers’ securities investment funds across the

different investor types, public funds includ-

ing central banks and sovereign wealth funds

have shown trends of stability, while private

funds have shown large-scale net outflows

since June 2015, centering around hedge

funds and securities companies. Since

October small-scale net inflows and net out-

flows have appeared, depending for example

on expectations related to the policy rate

hike by the Fed (Figure II-50). Meanwhile,

investors from oil-producing countries have

since August 2015 shown trends of with-

drawing their investment funds, especially

stock funds, in line with their deteriorating

government finances due to the on-going

low oil prices. As suggested by the recent

tendencies of the major investors who have

withdrawn their domestic securities invest-

ments, foreigners’ securities investment funds

are expected to be influenced greatly for the

time being by changes in external condi-

tions. Especially, short-term investors like

89

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ation

s

Source: EPFR

900

600

300

0

-300

-600

-900

900

600

300

0

-300

-600

-900

<Figure II-48> Global securities investment fund flows

2013.1 7 2014.1 7 2015.1 7 11


Advanced countries

Emerging markets

Note: 1) Cumulative sums of monthly net inflows sinceJanuary 2013


300

200

100

0

-100

300

200

100

0

-100

<Figure II-49> Net foreign investor securities fund inflows1)

2013.1 7 2014.1 7 2015.1 7 11


Stock funds

Bond funds

*금안2015(Dec)04-2장56~97 2016.2.18 11:25 AM 페이지89

hedge funds can respond sensitively to major

economies’ monetary policy stances, and

there is a large possibility of raw material-

exporting countries withdrawing for now

their funds invested in domestic securities,

owing to deteriorations in their fiscal sound-

ness stemming from the international raw

material price declines.

90


80

60

40

20

0

-20

-40

400

300

200

100

0

-100

-200

<Figure II-50> Foreign investor securities fund flows

2013.1 7 2014.1 7 2015.1 7 11


Public funds (LHS) Private funds (LHS)

Public funds (accumulated, RHS)

Private funds (accumulated, RHS)

*금안2015(Dec)04-2장56~97 2016.2.18 11:25 AM 페이지90

5. Financial MarketInfrastructure

Satisfactory payment andsettlement system stability

The settlement risks of BOK-Wire+ and

other major payment and settlement systems

have been managed stably. The over-the-

counter and exchange-traded markets of the

large-value payment system and the securi-

ties settlement system have been operated

smoothly, with indicators of risk improving

for example. The foreign exchange and

retail payment systems have also shown gen-

erally stable pictures (Figure II-51).

Favorable large-value settlementsystem stability

In line with increases in securities transac-

tions, for example in institutional RPs, the

average daily amount of settlement over

BOK-Wire+, which provides final settlement

services for settlement of call, retail, securi-

ties and foreign exchange transactions

between financial institutions, increased by

9.5% – from 256.0 trillion won in the first

quarter of 2015 to 280.2 trillion won in the

third quarter.

Among settlements made through BOK-

Wire+, the proportion (value basis) carried

out near the closing time (16:00~17:30) fell

slightly, in line for example with a change

in the CLS (continuous linked settlement)

settlement hours (4~6 p.m. → 3~5 p.m.)

during the summertime period (end-March

to end-October). The maximum intraday

overdraft cap exhaustion rate and the pro-

portion of payment orders in queue for set-

tlement, which reveal the levels of secured

settlement liquidity of BOK-Wire+ partici-

pant institutions, have shown generally

favorable pictures (Figure II-52). Since the

second quarter of 2015 there have been

zero cases of BOK-Wire+ operating hours

extension for reasons such as computer sys-

tem failures at participant institutions

(Figure II-53).

91

II. Finan

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ility 5. Financial Market Infrastructure

Ko

rea’s Finan

cial Stability Situ

ation

s

<Figure II-51> Major financial market infrastructure stability map1)

Baseline

2015.4~9Large-value settlement

system2)

Securities settlement system,over-the-counter market5)

Securities settlement system,exchange-traded market6)

Foreignexchangesettlement

system3)

Retailpaymentsystems4)

Deterioration

Improvement

Notes: 1) Extents of change during April ~ September 2015 periodcompared to October 2014 ~ March 2015 period indexed

2) Proportion of settlements carried out near closing time,number of closing time extensions, proportion of paymentorders in queue for settlement, and rate of maximumintraday overdraft cap exhaustion standardized

3) Proportion of settlement through CLS system and financialliabilities to financial assets

4) Frequency of net debit cap utilization rate exceeding 70%,amount of collateral securities to sum of obligations of withlargest settlement obligations

5) Proportion of free-of-payment (FOP) settlement of OTC bondsand institutional Repos free-of-payment (FOP) settlement

6) Proportion of exchange-traded government bond and stockpayments made after settlement deadline

Sources: The Bank of Korea, KFTC, Korea Exchange, Korea SecuritiesDepository

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Generally stable retail settlementsystem operation

The average daily amount of settlement in

the retail payment systems operated by the

Korea Financial Telecommunications &

Clearings Institute increased by 7.7%, from

57.3 trillion won in the first quarter of 2015 to

61.7 trillion won in the third, owing to a steady

expansion in electronic funds transfers through

Internet and firm banking42) for example.

The number of cases of net settlement par-

ticipants’net debit cap43) utilization rates

exceeding the warning level (70%) rose from

the second quarter of 2015, in line with factors

such as temporary large-scale fund transfers

due to some companies’ subscriptions to public

offerings and the related refunds. The average

maximum net debit cap utilization rate

showed a similar trend as well (Figure II-54).

92

Notes: 1) Amount of settlement processed after 16:00 /Total settlement amount

2) Daily average rate of maximum exhaustion ofparticipants’ intraday overdraft caps

3) Amount of payment orders in queue for settlement/ Total amount of funds transfers (excludingpayment orders in queue for liquidity savings)


70

60

50

40

30

20

15

10

5

0

<Figure II-52> Ratio1) of settlement concentration at around closing time, maximum intraday overdraft cap exhaustion rate2)

and proportion3) of payment orders in queue for settlement

Q1 2012 Q1 2013 Q1 2014 Q1 2015 Q3

(%) (%)Ratio of settlement concentration at around closing time(LHS)Maximum intraday overdraft cap exhaustion rate (LHS)2)

Proportion of payment orders in queue for settlement(RHS)

Note: 1) Total extension duration / Number of extensionsSource: The Bank of Korea

4

3

2

1

0

250

200

150

100

50

0

<Figure II-53> Extensions of BOK-Wire+ operating hours

Q1 2012 Q1 2013 Q1 2014 Q1 2015 Q3

(Times) (Mins)

Number of extensions(LHS)

Average extension duration(RHS)1)

1Times 1Times1Times

1Times

3Times

42) Firm banking is a financial transaction system for corporate use provided through their computer systems by financial institutions, in which

they supply firms services such as settlement of the prices of goods and management of funds.

43) In the case of the retail payment systems, including the ATM network system, the interbank remittance system and the electronic banking

system, the payees are paid immediately but the subsequent credits and debits across financial institutions are netted and settled on the

following business days at the designated time (11:00) through BOK-Wire+, with the result that credit is provided between financial

institutions. To control net settlement-related risks in the retail payment systems, the Bank of Korea requires participants to independently

establish ceilings (net debit caps) on their unsettled net debit positions, and provide collateral securities worth at least 30% of these ceilings.

Note: 1) Average daily maximum net debit caputilization rate (unsettled net debits / net debitcap) of participants during quarter


56

52

48

44

40

25

20

15

10

5

0

<Figure II-54> Maximum net debit cap utilization rate

Q1 2012 Q1 2013 Q1 2014 Q1 2015 Q3

(%) (Times)

Number of occurrences of net debit positions exceeding 70% (RHS)

Average maximum net debit cap utilization rate (LHS)1)

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The amount of collateral securities provid-

ed by participant institutions to guarantee

fulfillment of net settlement is exceeding the

level required44) by the 「Core Principles for

Systemically Important Payment Systems」

(Figure II-55).45)

Smooth securities settlementsystem management

The daily average amount of settlement in

the securities settlement systems operated by

the Korea Exchange and the Korea

Securities Depository increased by 19.2%

between the first and the third quarters of

2015 – from 76.8 trillion to 91.5 trillion won,

centering around institutional RPs. The pro-

portions of payments for settlement of

exchange-traded and over-the-counter stock

and government bond transactions made

after the settlement deadlines have declined

since the second quarter of 2015 (Table II-2).

The proportions of free-of-payment (FOP)

settlement of over-the-counter bonds and

institutional RPs have maintained stable

trends since 2014 (Figure II-56).

93

II. Finan

cial System Stab

ility 5. Financial Market Infrastructure

Ko

rea’s Finan

cial Stability Situ

ation

s

Notes: 1) Total settlement obligation of two participantswith largest individual net payments on day oflargest net payment during the quarter

2) Total assessed value of collateral on day of largestnet payment during the quarter


25

20

15

10

5

0

25

20

15

10

5

0

<Figure II-55> Adequacy of collateral securities

Q1 2012 Q1 2013 Q1 2014 Q1 2015 Q3


Sum1) of obligations of two participants with largest settlement obligations

Amount2) of collateral securities paid

44) Principle V of the 「Core Principles for Systemically Important Payment Systems」, announced by the Committee on Payments and Market

Infrastructures (CPMI) in January 2001, recommends that a system in which multilateral netting takes place be capable of ensuring the timely

completion of daily settlements even in the event of inabilities to settle by the two participants with the largest individual settlement obligations.

45) In the 「Principles for Financial Market Infrastructure (PFMIs)」, newly established in 2012, it is required that a DNS payment system that

explicitly guarantees settlement, whether that guarantee is from the FMI itself or from its participants, should maintain sufficient financial

resources to fully cover current and potential future exposures using collateral and other equivalent financial resources. The Bank of Korea is

thus now undertaking an initiative to overhaul the collateral arrangements in order to satisfy these new requirements.

<Table II- 2> Proportions of payments made after settlement delay penalty deadlines

Exchange-traded stocks 16:00 16:00 – – – – –

Exchange-traded 16:00 17:00 0.11 – 0.04 – –government bonds

OTC stocks3) 16:50 16:50 – 0.08 0.01 0.001 –

Proportion of paymentsPayment Penalty 2014 2015deadline1) deadline2) Q1 Q2 Q1 Q2 Q3

(%)

Notes: 1) Settlement deadline under system operating rules 2) Deadline after which settlement delay penalty assessed 3) Stock-trading institutional investors


Note: 1) Proportion in total settlement value (OTC bondsand institutional RPs) of settlements notprocessed through DvP system

Sources: The Bank of Korea, Korea Securities Depository

25

20

15

10

5

0

5

4

3

2

1

0

<Figure II-56> Shares1) of FOP settlement

Q1 2012 Q1 2013 Q1 2014 Q1 2015 Q3

(%) (%)

OTC bonds (RHS)

Institutional Repos (LHS)

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Maintenance of stable foreignexchange settlement risk

Foreign exchange settlement is carried out

through the interbank foreign exchange

transaction network, the CLS payment-ver-

sus-payment (PVP) system46), and the domes-

tic foreign currency funds transfer system47).

Among this, the daily average amount of

foreign exchange settlement through the

CLS PVP system rose by 0.6% between the

first and the third quarters of 2015, from

56.7 billion to 57.0 billion dollars.

The proportion of foreign currency settle-

ments carried out through PVP system has

fallen since the first quarter of 2015, owing

for example to an increase in transactions

involving the Chinese yuan, a non-CLS set-

tlement currency, but has still maintained a

high level in the 70% range (Figure II-57).

In the case of the domestic foreign currency

funds transfer system, the amount of foreign

currency overdraft use48) relative to the total

foreign currency funds transfer value showed

a stable picture as well during that same

period (Figure II-58).

94

46) To address time differences between countries, which are a fundamental cause of foreign exchange settlement risk, CLS (Continuous Linked

Settlement) Bank settles most transactions during a designated settlement period (07:00~12:00 CET). CLS means that the actual funds

transfers are continuously linked and processed within this settlement period between the accounts of settlement member banks and CLS

Bank held with the central banks handling the currencies concerned. At present the CLS PVP system is connected to the large-value payment

systems (including BOK-Wire+) run by the central banks issuing the 17 CLS settlement currencies.

47) This is a system by which many domestic banks handle their foreign currency funds transfers through foreign currency deposit accounts in the

U.S. dollar, the euro and the Japanese yen opened at domestic operating institutions (KEB Hana Bank, Kookmin Bank, Shinhan Bank and

Woori Bank), making possible the simultaneous transfer of funds. Regarding the system for foreign currency funds transfers related to the

Chinese yuan, the Seoul branch of China’s Bank of Communications has been designated by the People’s Bank of China as the yuan

currency clearing bank in Korea, and began the related operations from November 2014.

48) These overdrafts are temporary funds provided without any interest charges by the institutions operating the foreign currency funds transfer

system, for example for corporations’ large-value foreign currency deposit withdrawals and im-/exports companies’ urgent foreign exchange

settlement. From the time it provides an overdraft up until the time when it is notified of the completion of final settlement by the overseas

foreign exchange bank concerned, the operating institution providing this temporary settlement liquidity is exposed to foreign exchange risk

stemming from domestic-overseas time differences.

Note: 1) Proportion in total CLS eligible FX transactionsof those settled through CLS system


100

80

60

40

20

0

80

70

60

50

<Figure II-57> CLS system use

Q1 2012 Q1 2013 Q1 2014 Q1 2015 Q3

(billion dollars) (%)

Settlement value (LHS)

Proportion of CLS settlement (RHS)1)

Note: 1) For 2012~2013 based on time series beforerevision of statistics

Source: KEB Hana bank

50

40

30

20

10

0

50

40

30

20

10

0

<Figure II-58> Foreign currency overdraft use-to-total foreign currency funds transfer ratio1)

Q1 2012 Q1 2013 Q1 2014 Q1 2015 Q3

(%) (%)

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In the retail payment systems operated by the Korea

Financial Telecommunications and Clearings Institute

(KFTC), including for example the Electronic Banking

System and the Interbank Remittance System, a transfer

from a payer is immediately deposited into the beneficia-

ry’s account for withdrawal. The subsequent interbank

settlement is however only completed at a designated

time (11:00) on the following business day, based on the

Deferred Net Settlement (DNS) arrangements employed

by these systems.

This fast payment scheme is very convenient from the

customers’ perspective, in that it allows a beneficiary to

withdraw funds immediately. The beneficiary’s bank is

however exposed to credit risk due to its inability to

recover from the payer’s bank the funds paid out until

net settlement has been completed. The Bank of Korea

has since 1997 therefore been operating a risk manage-

ment arrangement involving the establishment of net

funds transfer limits (net sender caps) for individual

banks, a requirement that they provide collateral suffi-

cient to cover these caps, and the sharing of losses

among banks in events of collateral deficiency. In consid-

eration however of the recommendation in the 2001

CPMI standards1), that a payment system maintain collat-

eral sufficient to cover the default of the one participant

that would cause the largest aggregate credit exposure

to the system, as well as the collateral burdens on banks,

the Bank of Korea obliges banks to post collateral equiv-

alent to 30 percent of their net sender caps.2)

However, it has been noted that not only the current

retail payment systems have a fundamental limit in that

it provides only incomplete coverage of credit risk, but it

has also worked as a factor discouraging active risk man-

agement by system participants through means such as

reducing their net sender caps. That is, when participants

need to process large-value payments they prefer using

the Electronic Banking System rather than BOK-Wire+,

which entails no settlement risk stemming from time dif-

ferences between payment and settlement, since the col-

lateral burden of the Electronic Banking System is not so

high and there are minimal immediate funding liquidity

burdens. Consequently, the relevant risk is embedded in

95

II. Finan

cial System Stab

ility 1. Banks

Ko

rea’s Finan

cial Stability Situ

ation

s

II-4BOX

Reform of Net Settlement Risk ManagementSystem

1) The Core Principles for Systemically Important Payment Systems (Committee on Payment and Settlement Systems BIS, 2001). These standards

have since been replaced by the Principles for Financial Market Infrastructures (CPMI-IOSCO, 2012), the new international standards.

2) The ratio was originally set at 10% in 1997, and subsequently raised to 20% in 2001 and 30% in 2002.

Procedure1) for dealing with settlement defaults in DNS systems

Occurrence ofsettlement

default

Receipt ofdefault amount

Loss-sharingamong surviving

participants

YES

NO

Completion ofnet settlement

Disposal of collateraldeposited by defaulting

participant

Note: 1) Excluding note-exchange System: note-exchnage systemcomplete settlement using re-exchanging procedure whenparticipants don’t fulfill net-settlement

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the current system. With regard to the net settlement

systems, however, the PFMIs published in April 2012

have significantly raised the credit and liquidity risk man-

agement requirements, obliging FMIs to cover their cur-

rent and (where they exist) potential future exposures to

each participant fully with a high degree of confidence

using collateral and other equivalent financial resources.

For implementation of the increasingly stringent

international standards related to payment and settle-

ment systems, the Bank of Korea is pursuing reforms of

the relevant arrangements to encourage more active risk

management by participants and to enhance their credit

and liquidity risk management. First, the Bank plans to

revise upward the ratio of collateral to the net sender

cap, from the current 30% to 50% in 2016, and to grad-

ually increase the ratio up to 100% in consideration of

financial market conditions each year.

Given the possibility of increased collateral demands

on financial institutions due to the global financial

reform initiatives, raising the collateral-to-net sender cap

ratio while keeping the current settlement arrangements

in place would put banks under considerable pressures.

The Bank of Korea is thus pursuing a measure to reduce

participants’ credit risk by linking the Electronic Banking

System to BOK-Wire+.

After establishment of the new system directly linking

these two systems, batch processing of large-value funds

transfers exceeding one billion won, requested by cus-

tomers via Internet banking for example, will be auto-

matically carried out through the linked system.

Use of this new system will reduce financial institu-

tions’ exposures to credit risks stemming from net settle-

ment of funds transfers made via the Electronic Banking

System, and thus further reduce the collateral require-

ments stemming from such exposures. The system will in

addition allow customers to make large-value funds

transfers exceeding one billion won at one time via

Internet banking, thus greatly improving their conve-

nience.3)

96

3) In view of financial institutions’ credit risks arising from net settlements, the Electronic Banking System currently places a limit of one billion

won for each fund transfer processed through it, large value funds transfers are accordingly divided up into one billion won units, and

transferred as such through the system.

Procedures for Funds Transfers via Linkage of BOK-Wire+ and Electronic Banking System

② Withdrawal ⑧ Deposit

① Payment order Internet

Payer Beneficiary

⑩ Account inquiryand withdrawal

Internet

③Withdrawal details ⑦ Deposit order

⑨ Deposit details④ Request for settlement

(for funds transfers exceeding 1 bn won)

⑥ Settlementdetails

⑨ Deposit details

⑤ Funds transfer

Payer’sfinancial

institution (A)

A B

Beneficiary’sfinancial

institution (B) KFTC

BOK

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Analysis of FinancialStability Issues

I. Effects of Population Aging on Household Debt,

and Potential Risks········································································101

II. Status of Chronically Marginal Firms, and Assessment··················114

III. Effects of Economic Unrest in EMEs on Korean

External Soundness········································································126

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*금안2015(Dec)05-이슈98~137 2016.2.18 11:25 AM 페이지100

I. Effects of PopulationAging on Household Debt,and Potential Risks

1. Background2. Effects of Population Aging on

Household Debt3. Potential Risks4. Implications

1. Background

Population aging is progressing rapidly in

Korea1), as the productive population (ages

15 to 64) declines and the elderly population

aged 65 and above expands greatly due to

factors such as the continuing low birthrate

and increasing longevity.2) In line with this,

the asset accumulating age cohort (ages 35

to 59), the core group with high demand for

debt, is also expected to shift to a decline

from 2018. It is predicted that population

aging will not only cause a drop in vitality

in the economy as a whole, but have a con-

siderable effect on household debt as well

through diverse channels such as a contrac-

tion in the core group of household loan

borrowers and reductions in debt by the

retired elderly group. Asset market shocks

can occur in the process of the retired elder-

ly responding to their declines in income by

deleveraging their debts, and risks can arise

such as an increasing number of elderly vul-

nerable households that are unable to repay

their debts smoothly. In particular, since the

Korean Baby Boomer generation (born

between 1955 and 1963) is approaching

large-scale retirements within the next 10

years, substantial changes in the overall

household financial structure are expected.

Against this background, for this article we

have examined the effects of population

aging on household debt as well as the

potential risks in the process of debt delever-

aging, through comparison with cases in

major countries and analysis of fluctuations

in the debts, incomes and assets of house-

holds in the various different age groups,

utilizing micro data3), and then presented

some policy implications.

101

I. Effects of Po

pu

lation

Ag

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on

Ho

useh

old

Deb

t, and

Poten

tial Risks

An

alysis of Fin

ancial Stab

ility Issues

1) According to the U.N., countries’ stages of population aging are classified depending upon the proportions of their populations aged 65 years

and above, into “aging societies” (7% to less than 14% of population aged 65 or above), “aged societies” (14% to less than 20%), and “hyper-

aged societies” (20% and more). Korea, after having become an aging society in 2000, is expected to become an aged society in 2018 (14.5%)

and a hyper-aged society in 2026 (20.8%).

2)

3) For the micro data on liabilities, assets and incomes of individual households the Survey of Household Finances and Living Conditions (2010 to

2014), the Korean Labor & Income Panel Study (KLIPS) (1999 to 2012) and data from credit rating agencies could all be used, but because

the KLIPS sample size is small and its data extends only until 2012 so that it is not reflecting recent conditions, and in the credit rating

agencies’ data the statistics on household assets and incomes are insufficient, the data used was that from the Survey of Household Finances

and Living Conditions, whose sample size is relatively large and which provides the recent statistics on household liabilities, assets and incomes.

Note: 1) Period averages Source: Statistics Korea

Birthrate and life expectancy1)

Birthrate 1.95 1.59 1.21 1.23Life expectancy 68.2 73.4 78.3 81.2

1980~89 1990~99 2000~09 2010~14

(%, age)

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2. Effects of Population Agingon Household Debt

Financial liability holding behaviors, byage group

According to the Life-Cyle Model (Franco

Modigliani, 1954), in evening out their con-

sumptions over their entire lives households

manage consumption by accumulating assets

until their middle ages when their incomes

are increasing, and then using the assets that

they have accumulated in their elderly years.

In line with the heightened access to finance

with the development of the financial indus-

try since the 1990s, the household behavior

of expanding debt greatly until before retire-

ment, for consumption and asset accumula-

tion, and after that then redeeming debt

through disposing of assets following retire-

ment, has intensified. Noting this point, the

results of dynamic analysis4) of changes in the

financial debts, assets and incomes of Korean

households, by age, showed that households

expand their financial debts5) (excluding rental

guarantee deposits, the same hereafter) until

the age of 57, after which they are reducing

them from age 58, just after their first round

of retirement. In particular, compared to the

time between the ages of 58 and 64, just after

their first rounds of retirement, households

were found to be reducing their financial lia-

bilities most greatly during the period of their

second rounds of retirement between the ages

of 65 and 70, just after their children are

leaving home (Figure I-2).

102

Note: 1) Estimation basisSource: Statistics Korea

6

4

2

0

-2

6

4

2

0

-2

<Figure I- 1> Rates1) of population increase, by economic activities age group

2000 2005 2010 2015 2020 2025

(%) (%)

Working age population

Asset accumulating age population

Population 65 and older

4) Due to data limitations the same households’ entire lifetimes cannot be studied when analyzing the dynamic changes in household financial

liabilities, assets and incomes, and so we must rely on the average household data for the different age groups. There is thus a limitation in that

the amounts of dynamic changes in financial liabilities, assets and incomes of individual households can differ across generations, but from the

aspect of the trend flows this is judged to be no big problem.

5) Household debt in the household credit statistics and the flow of funds statistics, which are macroeconomic indicators, is based on financial

debt, while in the Survey of Household Finances and Living Conditions it is divided into financial debt and total debt with rental deposit funds

included in financial debt. In consideration of the point that rental deposit funds, being mutual transactions among households, are not

included in the financial debt in the macroeconomic indicators, they are also excluded here.

Note: 1) Based on average yearly changes in debt by agegroup, between 2010 and 2014


600

400

200

0

-200

-400

-600

600

400

200

0

-200

-400

-600

<Figure I- 2> Changes in financial debt1), by age group

30~39 40~49 50~57 58~64 65~70 71~79


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When the changes in households’ debts

due to aging were compared with those in

their incomes and assets, financial debts

appeared to be moving in the same direc-

tion as incomes and real assets. Until retire-

ment the extent of increase in financial lia-

bilities exceeded that in income, and after

retirement the extent of decline in financial

liabilities exceeded that in income (Figure I-

3). This suggests that households are

expanding their financial debts more than

the increases in their incomes until before

retirement, and using them for consumption

or asset accumulation. In the case of real

assets, they increase to a greater extent than

financial liabilities until retirement, then

decline to a larger extent than financial lia-

bilities after retirement – a phenomenon

judged to be because real assets are being

disposed of after retirement and used for the

repayment of financial debts. Notably,

between 65 and 70 the scales of reduction in

financial liabilities and real assets are large,

which appears to be because, after second

round retirements and children’s moving

out, there are many cases of large-scale

housing disposal and repayment of financial

liabilities followed by moving into smaller

housing.6) Financial assets increase even after

retirement, albeit to a small extent – due

apparently to the residuals after repayment

of financial debts through real asset disposals

being held in financial assets, as well as to

increasing receipts of severance payments

and public pensions (Figure I-4).

103

I. Effects of Po

pu

lation

Ag

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on

Ho

useh

old

Deb

t, and

Poten

tial Risks

An

alysis of Fin

ancial Stab

ility Issues

6) This is also supported by the results of the Korea Housing Survey (Ministry of Land, Infrastructure and Transport, 2014), showing that, in the

cases of debt holding families with plans to move, they are moving to housing of higher prices than that they are moving from until their 50s,

while in their 60s and above they are moving from higher to lower priced housing.

Current residential housing price 19,627 24,193 25,508 33,264 33,931Planned price of housing moved to 25,492 28,275 30,123 19,508 19,704

30s 40s 50s 60s 70s and above

(10 thousand won)

Note: 1) Based on average yearly changes in households’debts and incomes by age group, between2010 and 2014


600

400

200

0

-200

-400

-600

600

400

200

0

-200

-400

-600

<Figure I- 3> Changes1) in financial debt and income, by age group

30~39 40~49 50~57 58~64 65~70 71~79


Financial debt Ordinary income

Note: 1) Based on average yearly changes in debts andassets by age group, between 2010 and 2014


2,000

1,500

1,000

500

0

-500

-1,000

2,000

1,500

1,000

500

0

-500

-1,000

<Figure I- 4> Changes1) in financial debt and assets, by age group

30~39 40~49 50~57 58~64 65~70 71~79


Real assets Financial assets Financial debt

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The results of dynamic analysis of changes

in households’ financial liabilities, assets and

incomes are reflected in the cross-sectional

data for the different age groups. A look at

the average per-household amounts of finan-

cial liabilities held in the different age

cohorts, as of the end of March 2014, shows

that they increase until the householders are

in their 50s then shows a picture of declin-

ing when they reach their 60s. The propor-

tions of households holding financial liabili-

ties also fall sharply, from 65.1% of house-

holds in their 50s to 48.2% of those in their

60s and 20.8% of those aged 70 and above,

which shows that households are repaying

their debts as they age (Figure I-5).

From the aspect as well of the financial

debt-to-disposable income ratio (the financial

debt ratio hereafter) and the financial debt-

to-financial assets ratio7), the rapid adjust-

ment of debt by households after they reach

their 60s can be confirmed. The financial

debt ratio falls sharply from 109.8% for

households in their 50s to 107.4% for those

in their 60s and 91.7% among those aged

70 and above, and the financial debt-to-

financial assets ratio from 46.8% for the 50s

age cohort to 43.3% for households in their

60s and 32.5% for those 70 years old or

more (Figure I-6). This is because the extent

of decline in financial debt after retirement

greatly exceeds that in income, while finan-

cial assets show a picture of increasing even

after retirement.

104

Note: 1) End-March 2014 basisSources: The Bank of Korea, Statistics Korea (Survey of


6,000

4,000

2,000

0

80

60

40

20

0

<Figure I- 5> Amounts of financial debt1) per household, and proportions of households with

financial debt by age group

30~39 40~49 50~59 60~69 70 and older

(10 thousand won) (%)

Per-household average (LHS)

Proportions of households with financial debt (RHS)

7) The household debt ratio (household debt to household disposable income, household credit statistics and national accounts basis) and the

financial liabilities-to-financial assets ratio (flow of funds basis), both of which are macroeconomic indicators, stood at 137.6% and 44.9%

respectively as of 2014, and there are thus differences with the micro data of the Survey of Household Finances and Living Conditions

compiled based on questionnaire-type surveys.



80

60

40

20

0

160

120

80

40

0

<Figure I- 6> Financial debt-to-financial assets and financial debt-to-disposable income ratios1),

by age group

30~39 40~49 50~59 60~69 70 and older

(%) (%)

Financial debt-to-financial assets ratio (LHS)

Financial debt-to-disposable income ratio (RHS)

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Total household debt amount

Since as aging advances the population age

group whose assets and liabilities are increas-

ing declines and that whose liabilities and

assets are contracting grows, population aging

is expected to work as a factor causing a

slowdown in the pace of increase in the over-

all household debt amount. In particular,

those who are currently in their 50s and 60s,

who are expected to reduce their financial

debts in the future, now hold 44.8% of the

total financial debt of Korean households.8) In

addition, as these families reduce their finan-

cial liabilities more than the declines in their

incomes, it is predicted that the rise in the

household financial debt ratio will also be

restrained. The relationship between popula-

tion aging and the total household debt vol-

ume analyzed through micro data is showing

a similar picture in the macroeconomic indi-

cators as well. The rate of increase in house-

hold debt and the debt ratio (household debt

to disposable income) are showing move-

ments very close to those of the asset accu-

mulating population. Until the mid-2000s the

rate of household debt growth and the debt

ratio both rose to large extents, along with

the high rate of growth in the asset accumu-

lating population, before their extents of

increase then began slowing with the slow-

down as well in growth of the asset accumu-

lating population. When this is considered,

the decline in the asset accumulating popula-

tion from 2018 is seen as likely to work as a

factor causing the rate of household debt

expansion to slow (Figure I-7, I-8).

In the instances of major countries as well,

population aging is analyzed as having

worked as a factor causing reductions in the

rates of household debt increase and in debt

ratios. The results of panel model analysis

105

I. Effects of Po

pu

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Ag

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useh

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An

alysis of Fin

ancial Stab

ility Issues

Note: 1) Household credit statistics basisSources: The Bank of Korea, Statistics Korea

14

12

10

8

6

4

2

0

4

3

2

1

0

-1

-2

<Figure I- 7> Rates1) of increase in household debt and asset accumulating population

2004 2006 2008 2010 2012 2014 2016 2018 2020 2022 2025

(%) (%, %p)

Rate of household debt increase (LHS)

Rate of asset accumulating age population increase (RHS)

Change in proportion of asset accumulating age population (RHS)

Notes: 1) Household debt / Disposable income2) Household credit statistics basis

Sources: The Bank of Korea, Statistics Korea

8

6

4

2

0

-2

-4

3

2

1

0

-1

-2

<Figure I- 8> Household debt ratio1)2), and asset accumulating population

2004 2006 2008 2010 2012 2014 2016 2018 2020 2022 2025

(%p) (%, %p)

Change in household debt ratio (LHS)

Change in asset accumulating age population proportion (RHS)

Rate of increase in asset accumulating age population (RHS)

Asset accumulatingage group starts todecrease (2018)

←

Asset accumulatingage group starts todecrease (2018)

←

8) As of end-March 2014 the proportions in total household financial liabilities accounted for by the different age groups were 18.5% by

households in their 30s, 32.9% by those in their 40s, 32.5% by those in their 50s, 12.3% for the population in their 60s, and 3.8% by those in

their 70s and above.

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carried out on 19 OECD countries including

Korea9) analyzed that both household debt

growth rates and debt ratios have positive (+)

correlations with the asset accumulating pop-

ulation. This means that, where other macro-

economic conditions such as economic

growth and housing prices are the same, a

decline in the asset accumulating age group

can work as a factor restraining increases in

the rate of household debt growth and in the

debt ratio. It was found as well that, in major

countries such as the U.S. and the U.K., at

around the times when their asset accumulat-

ing populations peaked the rates of increase

in their household debt and their debt ratios

either slowed or declined (Figure I-9, I-10).

Household debt distribution

Households do not liquidate all of their

financial liabilities at once but are holding

them for considerable times, and so as the

proportion of the elderly population grows

in line with population aging the share in

total financial debt taken up by the elderly

age cohort is forecast to rise. If we consider

only the changes in the population structure

and calculate the future changes in the

financial debt distribution by age group

compared to the end of March 2014, the

proportion of debt held by households in

106

9) Panel model analysis was conducted of the age effects between 1995 and 2012 in 19 among the OECD member countries for which use of

their statistics was possible (Korea, the U.S., the U.K., Germany, Japan, France, Australia, Canada, Austria, Belgium, Denmark, Finland, Italy,

Netherlands, Norway, Portugal, Spain, Sweden, Switzerland). At the time of estimation the nominal variables were converted to real variables

using comsumer prices, real GDP, real housing prices and the asset accumulating population were changed to their logarithms, and the

employment rate and long-term real interest rates were used as is.

Real GDP 0.86*** (1.08)*** 0.34*** (0.54)***Real house price 0.47*** (0.52)*** 0.40*** (0.42)***Asset accumulating population 1.12*** (0.88)*** 0.97*** (1.25)***Employment rate 0.007*** (0.012)*** 0.008*** (0.013)***Long-term real interest rate -0.007*** (-0.007)*** -0.002*** (-0.003)***Constant term -6.74*** (-6.91)*** -3.32*** (-5.65)***R2 0.57*** (0.57)*** 0.30*** (0.30)***

Household debt amount Household debt ratio

Note: 1) ***, ** and * indicate statistical significances at the levels of 1%, 5% and 10% respectively, while figures in ( ) are estimations using theproportions of the asset accumulating populations rather than their actual numbers

Note: 1) T is the year when the proportion of the assetaccumulating age group is the highest

Source: OECD

16

12

8

4

0

-4

16

12

8

4

0

-4

16

12

8

4

0

16

12

8

4

0

20

15

10

5

0

20

15

10

5

0

12

8

4

0

12

8

4

0

<Figure I- 9> Major country rates of increase inhousehold debt and asset accumulating populations1)

(%) (%) (%) (%)<U.S.> <U.K.>

(%) (%) (%) (%)<Australia> <France>

T-5 T-4 T-3 T-2 T-1 T T+1 T+2 T+3 T+4 T+5 T-5 T-4 T-3 T-2 T-1 T T+1 T+2 T+3 T+4 T+5


Note: 1) T is the year when the proportion of the assetaccumulating age group is the highest

Source: OECD

12

6

0

-6

-12

12

6

0

-6

-12

16

8

0

-8

-16

16

8

0

-8

-16

15

10

5

0

-5

-10

15

10

5

0

-5

-10

8

4

0

-4

8

4

0

-4

<Figure I-10> Major country changes in household debt ratios and asset accumulating populations1)

(%p) (%p) (%p) (%p)<U.S.> <U.K.>

(%p) (%p) (%p) (%p)<Australia> <France>



*금안2015(Dec)05-이슈98~137 2016.2.18 11:25 AM 페이지106

their 60s and 70s shows a rise from 17.3%

to 21.8% after five years and to 26.7% after

10 years (Figure I-11). In the case where the

cohort effect10) on the change in population

structure is also considered, however, the

proportion of financial liabilities held by the

elderly group appears to rise further. The

cohort effect appears in the phenomenon, as

can be seen in the U.S., of the average

amount of debt of elderly families growing

in accordance with aging. This is because (in

Korea’s case as well), with the aging of the

Baby Boomer generation, which holds much

debt on average, these families’ financial lia-

bilities are expected to be transferred11) to

the elderly group in their 60s and above

(Figure I-12).

Meanwhile, in the cases as well of

advanced countries such as the U.S. and

Canada, the shares in their total financial

liabilities held by elderly households have

increased greatly in accord with population

aging (Figure I-13).

107

I. Effects of Po

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An

alysis of Fin

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ility Issues

10) Individual households are adjusting their financial debts as they move into higher age groups (aging affect), but the amounts of financial debt

adjustment can differ across the different generations depending upon their economic environments and systems, and this is what is called the

cohort effect.

11) In the 2000s, as the Korean macroeconomic situation worked in a direction leading to greatly increased household debt, the Baby Boomer

generation’s average financial debt amount (50s age group: 48.89 million won in 2012, KLIPS) showed an extremely large level compared to

the previous generation (50s age group: 20.46 million won in 2002, KLIPS). If this is considered, then when the Baby Boomer generation is

in their 60s and 70s in the future, their average financial debt amount is expected to be large compared to that of families in their 60s and

70s at present.

Note: 1) Change in population composition is applied tofinancial debt distribution in 2014


30

25

20

15

10

5

0

30

25

20

15

10

5

0

40

35

30

25

20

15

10

5

0

40

35

30

25

20

15

10

5

0

<Figure I-11> Forecasts for population and financial debt distributions1), by age group

<Change in population distribution> <Change in debt distribution>

30~39 40~49 50~59 60~69 70~79 30~39 40~49 50~59 60~69 70~79

(%) (%)(%) (%)

2014 After 5 years After 10 years

Note: 1) Average debt by age group-to-average debt of allhousehold

Source: FRB

2.0

1.5

1.0

0.5

0.0

2.0

1.5

1.0

0.5

0.0

<Figure I-12> Changes1) in distribution of average debts of U.S. households

under 35 35~44 45~54 55~64 65~74 75 and older

(times) (times)

1989 2013

*금안2015(Dec)05-이슈98~137 2016.2.18 11:25 AM 페이지107

3. Potential Risks

Factors burdening the real estate market

here are worries that, if together with pop-

ulation aging the Baby Boomer generation

engage actively in financial debt deleverag-

ing after their retirements, this could work

as a factor burdening the real estate market.

Compared to the U.S. the proportion of real

assets held by households in Korea is

extremely high, and differently from the

U.S., where the share of financial assets held

relative to real assets rises the higher the age

group, the degree of real asset concentration

is deepening further. The proportion of real

assets of Korean families in the 55~74 age

group is not only greatly exceeding that in

the U.S. at about 80%, but their financial

liabilities-to-financial assets ratio is also at a

level of two to three times that of U.S. fami-

lies (Figure I-14). Notably, in the case of

families aged 55~74 who hold financial lia-

bilities, their financial liabilities-to-financial

assets ratios range from 85 to 115%, and

there can be families which in order to

repay their financial debts cannot help but

to dispose of their real assets (Figure I-15).

Meanwhile, as supply-demand imbalances in

the real estate market occur in line with the

decline from 2018 in the asset accumulating

population, the core group with demand for

real estate, downward pressures on real

estate prices can grow.

108

Note: 1) Occupation share basisSources: FRB, Statistics Canada, Australian Bureau of

Statistics

40

30

20

10

0

40

30

20

10

0

<Figure I-13> Major country changes1) in financial debt distributions, by age group

~34 ~44 ~54 ~64 65~ ~34 ~44 ~54 ~64 65~ ~34 ~44 ~54 ~64 65~

(%) (%)

(세)

2001

2013

20122010

19992004

<U.S.> <Canada> <Australia>

Note: 1) 2013 basis (U.S.), 2014 basis (Korea) Sources: The Bank of Korea, Statistics Korea (Survey of

Household Finances and Living Conditions), FRB

100

80

60

40

20

0

100

80

60

40

20

0

<Figure I-14> Asset compositions1) in Korea and the U.S., by age group

35~44 ~54 ~64 ~74 75~ 35~44 ~54 ~64 ~74 75~

(%) (%)Financial assets Real assets

<U.S.> <Korea>

(세)

*금안2015(Dec)05-이슈98~137 2016.2.18 11:25 AM 페이지108

Further, the decrease in the asset accu-

mulating population as well as the speed of

aging in Korea are faster than those in

advanced countries, and there are fears

that households’ financial debt deleveraging

will be concentrated over a short period of

time. The projected extent of decline in the

share of the asset accumulating age group

in the 10 years after its peak (40.4%, in

2016), at 3.8% points, is about two times

the major country average (2.0% points),

and it is expected that the time required

for moving from an aged society (2018) to

become a hyper-aged society (2026) will be

eight years – about four times faster than

the major country average (31 years)

(Figures I-16, I-17).

Looking at the time periods concerned, as

debt deleveraging in line with population

aging increases during the 2020~2024 peri-

od, when the amount of decline in the asset

accumulating population and the amount of

increase in the elderly population 60 years

old and above are the greatest, the effects

stemming from this are also expected to be

large (Figure I-18).

109

I. Effects of Po

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alysis of Fin

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Note: 1) 2013 basis (U.S.), 2014 basis (Korea) Sources: The Bank of Korea, Statistics Korea (Survey of

Household Finances and Living Conditions), FRB

250

200

150

100

50

0

250

200

150

100

50

0

<Figure I-15> Financial debt-to-financial assets ratios1)

of Korea and the U.S., by age group

35~44 45~54 55~64 65~74 75~

(%) (%)

(세)

U.S. (all households)

Korea (all households)

Korea (households with financial debt)

Note: 1) Decrease during 10 years following peakSources: Statistics Korea, OECD

5

4

3

2

1

0

5

4

3

2

1

0

<Figure I-16> Paces1) of decrease in proportions of asset accumulating populations

(%p) (%p)

3.8

Average : 2.0%p

Kore

aSp

ainNe

ther

lands

U.S.

U.K.

Cana

daFr

ance

Swed

enAu

strali

aGe

rman

yBe

lgiu

mJa

pan

Denm

ark

Norw

aySw

itzer

land

Austr

ia18

8

Sources: Statistics Korea, OECD

160

120

80

40

0

160

120

80

40

0

<Figure I-17> Paces of population aging

(years) (years)

Aging society → Aged society (time required)

Aged society → Hyper-aged society (time required)

Avg : 56 years

Avg : 31 years

Fran

ce

Swed

en

Austr

alia

U.S.

Cana

da

Neth

erlan

ds

Denm

ark

Norw

ay

U.K.

Spain

Germ

any

Austr

ia

Japa

n

Kore

a

*금안2015(Dec)05-이슈98~137 2016.2.18 11:25 AM 페이지109

Increase in aging families with weakfinancial soundness

In conditions of increasing debt deleverag-

ing by the retiring age cohort in line with

the advance of population aging, the num-

ber of elderly families with weak financial

soundness can increase greatly in a case

where, owing to real estate market shocks

due to destabilizing factors domestically or

abroad, together with the household income

shocks, financial debt deleveraging by the

elderly class cannot proceed smoothly.

Among all marginal households12) (those vul-

nerable to drops in real estate prices and

declines in income), 42.1% are in the 50~60

year age group, and it can be seen that the

potential risks related to future financial debt

deleveraging by these households are not

small (Figure I-19).

If financial debt deleveraging after retire-

ment is not accomplished sufficiently, there

is a possibility of these elderly families’

financial soundness deteriorating. In the

case of the elderly families 60 years old and

above holding financial liabilities, as of

2014 their financial debt ratios were

exceeding 200% and their debt service

ratio was also at a level greatly exceeding

30% (Figure I-20).

110


80

60

40

20

0

-20

-40

80

60

40

20

0

-20

-40

<Figure I-18> Change in asset accumulating population and population 60 and older

2015 2017 2019 2021 2023 2025 2027 2030

(10 thousand people) (10 thousand people)

Asset accumulating population 60 and older population60 and older population: 538 thousand persons increase

each year between 2020 and 2024

Asset accumulating population: 216 thousand personsdecrease each year between 2020 and 2024

12) Marginal households are those with DSRs above 40% and net financial assets below 0%. For details refer to the June 2015 Financial Stability

Report <Box I-2> 「Current Status of Marginal Households」.

Notes: 1) End-March 2014 basis2) Based on households with financial debt


40

30

20

10

0

40

30

20

10

0

30

20

10

0

30

20

10

0

<Figure I-19> Distributions1) of marginal household numbers and financial debts, by age group<Occupation share> <Share2) in age group>

30~39 40~49 50~59 60~69 70 and 30~39 40~49 50~59 60~69 70 and older older

(%) (%)(%) (%)

Number of households

Financial debts

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In the case of elderly households, the

qualitative structure of their debts as well as

their employment conditions are also rela-

tively fragile. From the aspect of qualitative

debt structure, the proportions of bullet

repayment loans and loans from non-bank

financial institutions held by elderly families

aged 60 and above are relatively high in

comparison with those of families in their

30s and 40s (Figure I-21). From the aspect

of employment conditions, meanwhile, as

elderly families age the proportion of finan-

cially indebted families with regular employ-

ment becomes very low, while the propor-

tions of self-employed business operators and

the unemployed become high (Figure I-22).

If we look at the composition of incomes

of elderly families aged 65 years and above,

the proportion accounted for by stable trans-

fer incomes such as pensions is 34.3%, while

on the other hand the share of business

income, wage income and property income,

which are all sensitive to economic fluctua-

tions, is 65.7%, and Korean households’

111

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ility Issues

Note: 1) End-March 2014 average basis Sources: The Bank of Korea, Statistics Korea (Survey of


60

40

20

0

400

300

200

100

0

<Figure I-20> Financial debt ratio1) and debt service ratio(DSR) of households with financial debt, by age group

30~39 40~49 50~59 60~69 70 and older

(%) (%)

Debt service ratio (LHS)

Financial debt-to-disposable income ratio (RHS)



60

40

20

0

60

40

20

0

<Figure I-21> Proportions of bullet repayment and non-bank loans, by age group

30~39 40~49 50~59 60~69 70 and older

(%) (%)

Bullet repayment loans Non-bank loans



80

60

40

20

0

80

60

40

20

0

<Figure I-22> Proportions1) of households with financialdebt, by work status

30~39 40~49 50~59 60~69 70 and older

(%) (%)

Regular employees

Temporary daily workers

Self-employed business operators

Unemployed, etc.

*금안2015(Dec)05-이슈98~137 2016.2.18 11:25 AM 페이지111

elderly income foundation is thus in a weak

situation compared to foreign countries

(Figure I-23).

4. Implications

There is seen to be a high possibility of

the effects of population aging on household

debt becoming full-scale from 2018, through

a decline in the asset accumulating popula-

tion and an increase in the elderly popula-

tion aged 60 years and above. It is expected

that the pace of increase in household debt

will slow due to population aging, but there

is a need to bear in mind the point that this

is a result of factors such as households’ eco-

nomic activity declining and financial debt

deleveraging by elderly families, more than

households’ income growth. Moreover, real

estate prices can fall in the process of house-

hold repayments of debt after retirement,

and if financial debt deleveraging is not

smooth then elderly families’ financial

soundness can weaken. The potential risk

factors stemming from full-scale population

aging will thus have to be responded to pre-

emptively.

First, if real estate prices increase exces-

sively and the high pace of expansion in

household liabilities continues, then inas-

much as the negative effects of population

aging can grow in the future, efforts for real

estate market stability and household debt

management will have to be sustained.

Second, diverse efforts will have to be

made to seek measures for minimizing

shocks to the real estate market that can

occur due to disposals of real assets for pur-

poses of debt repayment. To this end, there

is a need first of all to revitalize the system

of reverse mortgages, through for example

an expansion in the number of institutions

dealing with them.13) At present the reverse

mortgage system has a structure in which

financial institutions’ reverse mortgage loans

are being implemented under payment guar-

antees by the Korea Housing Finance

Corporation, and not only will their use be

limited by the capacity for payment guaran-

tee of the KHFC, but the access to them is

declining somewhat. There is thus a need

for example for positively considering the

diversification of institutions providing the

112

Note: 1) 2014 basis (Korea), 2013 basis (U.S., Australia)Sources: The Bank of Korea, Statistics Korea, FRB,

Australian Bureau of Statistics

100

80

60

40

20

0

100

80

60

40

20

0

<Figure I-23> Major country 65 and older householdincome compositions1)

Korea U.S. Australia

(%) (%)Transfer income Property income Business income Earned income

13) With the number of marginal families in the 50~70 age range standing at 750,000, that of those who do not possess real estate except for

their own residential housing, and thus have large potential demand for a reverse mortgage system, totals about 300,000. As of year-end 2014,

however, the number of households that have used the reverse mortgage system was a mere 20,000.

*금안2015(Dec)05-이슈98~137 2016.2.18 11:25 AM 페이지112

payment guarantees, as well as measures

promoting financial institutions’ independent

provision of reverse mortgage loans. There

is a need as well for encouraging households

to change so as to view their housing not as

tools for possession or for inheritance but

instead as accumulated assets that can be

actively used for consumption through use of

the reverse mortgage system for example.

Together with revitalization of the reverse

mortgage system, a foundation must be built

for an industry in which houses are pur-

chased from elderly families and then rented

out. For example, measures can be consid-

ered to promote the use of real estate invest-

ment trusts (REITs), which would purchase

housing from elderly families for use in

operation of rental businesses, while also

establishing a related public real estate

investment organization if needed.

Third, the system will have to be

improved to ensure that households expand

their shares of financial assets relative to

their real assets. It is important to improve

the taxation system to ensure that the hold-

ing of financial assets is more advantageous

than that of real assets, and to guarantee a

stable residential environment through an

increase in the supply of public rental hous-

ing. There is a need as well for inducing an

expansion in subscriptions to private pen-

sions.14)

In addition, finally, in order to preserve

elderly families’ incomes, reemployment will

have to be induced through for example an

expansion in public work and the creation of

specially designed jobs for the elderly, while

monitoring of the financial soundness of

debt holding elderly households will also

have to be strengthened.

113

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14) As of the end of 2012 the income replacement rate of Korean private pensions (retirement pension + private pensions) was about 20% (Korea

Insurance Research Institute estimate), a level far short of the rate (40%) recommended by international institutions such as the OECD.

*금안2015(Dec)05-이슈98~137 2016.2.18 11:25 AM 페이지113

II. Status of ChronicallyMarginal Firms, andAssessment

1. Background2. Status of Chronically Marginal Firms3. Background to Increase in

Chronically Marginal Firms4. Related Potential Risks to the Real

Economy and Financial System5. Implications

1. Background

As the slump in Korean companies’ per-

formances since the global financial crisis

has continued, concerns about defaults on

corporate debt have been rising. In particu-

lar, marginal firms have seldom broken free

from marginal statuses, especially in the

shipbuilding, transportation and steel indus-

tries whose business conditions have deterio-

rated due to factors such as the slowdown in

global economic growth and intensified

competition with China. Against this back-

ground, for this article we have defined

firms that was marginal firms each year and

had also experienced marginal firm statuses

before then as well between 2005 and 2014,

as chronically marginal firms, and analyzed

their risks of default.1) First, we have looked

at the status of chronically marginal firms,

and the background to their increase, and

after examining the related potential risks to

the real economy and the financial system

we have presented some policy tasks for the

promotion of effective corporate restructur-

ing.

2. Status of ChronicallyMarginal Firms

Among companies subject to external

audits, the proportion of chronically mar-

ginal ones has risen from 8.2% (1,851 firms)

in 2009 to 10.6% (2,561 firms) in 2014 –

2.4% points more.2) As the number of com-

panies newly included among chronically

marginal firms exceeds that of those which

have been normalized or shut down3) (an

annual average 142), the number of chroni-

cally marginal firms has continually

increased (Figure II-1).

114

1) Analysis was done of 27,995 non-financial corporations required to receive external audits under the 「Act on External Audit of Stock

Companies」. Marginal firms are firms that have had interest coverage ratios (Operating income / Interest expenses) below 100% for three

consecutive years, and normal firms are defined as all those subject to analysis with marginal firms excluded.

2) Between 2009 and 2014 the proportion of marginal firms among all companies subject to external audits rose by 2.0% points (12.4% →14.4%), and among total marginal firms the share of chronically marginal ones rose by 8.1% points (65.7% → 73.8%).

3) Includes companies from which obtaining financial information is impossible, due to their shutdowns or absorptions or mergers, to auditors’

refusals to disclose their opinions, and so on.

Note: 1) Proportions in total companies subject to external auditsSource: KIS-Value

Status of marginal firms

Company numbers (proportions1)) 2,819(12.4) 2,899(12.5) 2,979(12.5) 3,058(12.6) 3,297(13.3) 3,471(14.4)2009 2010 2011 2012 2013 2014

(numbers, %)

*금안2015(Dec)05-이슈98~137 2016.2.18 11:25 AM 페이지114

Looking at chronically marginal firms in

line with the periods of their remaining in

that status, among all such firms the propor-

tions of those whose interest coverage ratios

have been below 100% for five straight

years and ten straight years are 64.4%

(1,650 firms) and 10.0% (257 firms) respec-

tively (Figure II-2).

In terms of the assets and liabilities4) held

by chronically marginal firms, and the num-

bers of their employees, as of the end of

2014 they stood at levels of 7.8% (239 tril-

lion won), 14.1% (borrowings, bonds and

trade credit, 228 trillion won) and 5.4%

(191,000 persons) respectively of those of all

companies subject to external audits.5) These

proportions had all risen compared to the

end of 2009, and the extents of increase in

their liabilities (4.8% points) in particular

were relatively large. This is because some

large enterprises having large amounts of

debt were newly included among chronically

marginal firms (Figure II-3).

115

II. Status o

f Ch

ron

ically Marg

inal Firm

s, and

Assessm

ent

An

alysis of Fin

ancial Stab

ility Issues

Notes : 1) Proportion among all corporations subject toexternal audits

2) Normalized from marginal firm status3) Corporations closed and merged, those for

which financial information is lacking, etc.Source: KIS-Value

3,000

2,500

2,000

1,500

1,000

500

0

12

11

10

9

8

7

6

1,200

1,000

800

600

400

200

0

1,200

1,000

800

600

400

200

0

<Figure II- 1> Status of chronically marginal firms<Number and proportion> <Amounts of increase>

2009 2011 2013 2014 2010 2012 2014

(companies) (companies)(%) (companies)

Number of firms (LHS)

Proportion (RHS)1)

New (A)

Normalized (B)2)

Closed, etc. (C)3)

Net increase (A-B-C)

4) Covering borrowings, corporate bonds, trade accounts payable (accounts payable, bills payable), other liabilities (advances received, accrued

charges, liability reserve), etc.

5) Marginal firms’ shares in total corporate assets, liabilities and employee numbers stood at 10.1% (312 trillion won), 17.4% (280 trillion won)

and 7.5% (265,000 persons) respectively as of year-end 2014.

Note: 1) Figures in ( ) are the proportions in the total figures for all firms subject to external auditsSource: KIS-Value

Marginal Firm Asset and Liability Volumes, and Employee Numbers

2009 2,210(100) 247(11.2) 127(5.8) 1,262(100) 188(14.9) 117( 9.3) 284.9(100) 18.6(6.5) 12.0(4.2)2014 3,082(100) 312(10.1) 239(7.8) 1,609(100) 280(17.4) 228(14.1) 352.7(100) 26.5(7.5) 19.1(5.4)

Asset amount Debt amount Employee numbersFirms subject to Marginal Chronically Firms subject to Marginal Chronically Firms subject to Marginal Chronicallyexternal audit firms marginal firms external audit firms marginal firms external audit firms marginal firms

(trillion won, 10,000 persons, %)

Notes: 1) End-2014 basis2) Numbers of firms by the periods of their remaining

in a state of interest coverage ratios below 100% /Numbers of all chronically marginal firms

3) Operating income / Interest expensesSource: KIS-Value

40

30

20

10

0

40

30

20

10

0

<Figure II- 2> Proportion1)2) of chronically marginal firms by the periods of their remaining in a state of

interest coverage ratios3) below 100%

3 years 4 years 5 years 6 years 7 years 8 years 9 years More than 10 years

(%) (%)

Firms with interest coverage ratios

below 100% for five consecutive

years → 64.4% (1,650 companies)

*금안2015(Dec)05-이슈98~137 2016.2.18 11:25 AM 페이지115

Looking at the situation based on compa-

ny size, the proportion of chronically mar-

ginal firms among large enterprises is

increasing rapidly compared to that among

small and medium-size enterprises. While

the share of chronically marginal firms

among total large enterprises jumped by

4.2% points (6.6% → 10.8%) during the

2009~2014 period, that among SMEs rose

by 2.1% points (8.5% → 10.6%) over the

same span of time (Figure II-4). By industry,

the extent of increase in the share of chroni-

cally marginal firms has been somewhat

larger in the non-manufacturing sector (2009

10.8% → 2014 13.6%) than in manufactur-

ing (5.2% → 7.2%). In the non-manufactur-

ing sector the proportions of chronically

marginal firms have increased most greatly

in the transportation and construction indus-

tries, while in manufacturing it has been the

shares of the shipbuilding and steel indus-

tries that have grown the most (Figure II-5).6)

116

Note: 1) Proportions among those of all corporationssubject to external audits

Source: KIS-Value

15

10

5

0

15

10

5

0

<Figure II- 3> Chronically marginal firms’ proportions1)

of assets, liabilities and numbers of employees

Assets Liabilities Numbers of employees

(%) (%)

2009

2014

6) Looking at the shares of chronically marginal firms in the various industries, those in the real estate (21.7%), wholesale & retail (9.1%) and

construction (7.5%) industries account for high proportions.

Notes: 1) Based on numbers of companies at the end of 2014 2) Per-industry numbers of chronically marginal firms / Total number of chronically marginal firms

Source: KIS-Value

Proportions1)2) of chronically marginal firms, by industry

21.7 9.1 7.5 6.8 6.2 3.5 2.8 42.4Real estate Wholesale & retail Construction Electronics Transportation Food services & accommodation Steel Others

(%)

Note: 1) Proportions among all corporations subject toexternal audits, by firm size

Source: KIS-Value

2,500

2,000

1,500

1,000

500

0

15

12

9

6

3

0

<Figure II- 4> Chronically marginal firms’ numbers and proportions1), by firm size

2009 2011 2014 2009 2011 2014

(companies) (%)

Numbers of firms (LHS) Proportions (RHS)

<Large enterprises> <SMEs>

Note: 1) Proportions among all corporations subject toexternal audit, by industry

Source: KIS-Value

30

20

10

0

-10

30

20

10

0

-10

<Figure II- 5> Chronically marginal firm proportions1), by industry

Shipb

uilding Ste

el

Textile

s&ap

parel

Electr

onics

Machi

nery

Oilref

ining&

chemi

cals

Autom

obiles

Foods

Transp

ortati

on

Const

ructio

n

Whole

sale&

retail

Reale

state

Foods

ervice

s&acc

ommo

datio

n

(%, %p) (%, %p)

Changes in proportion (B-A)

2009 proportions (A)

2014 proportions (B)

Manufacturing industry(5.2%→7.2%)

Non-manufacturing industry(10.8%→13.6%)

*금안2015(Dec)05-이슈98~137 2016.2.18 11:25 AM 페이지116

3. Background to Increase inChronically Marginal Firms

Continuing slumps in corporate performance

As the sluggishness of growth and prof-

itability since the global financial crisis has

persisted, companies’ debt repayment capaci-

ties have declined overall. After having

slowed from 2011, the pace of growth in

chronically marginal firms’ sales reversed to a

decline (-5.4%) in 2014, and their operating

income-to-sales ratio has also sustained minus

(-) figures as they have continually recorded

operating losses. Considering the recent cir-

cumstances of an ongoing slump in domestic

business activities while corporate perfor-

mances are not improving7), the trend of

growth in numbers of chronically marginal

firms seems likely to continue for the time

being (Figure II-6).

A look at the different industries finds

business performances to have deteriorated

greatly centering around the shipbuilding,

transportation, steel and construction indus-

tries, and due to this the extents of increase

in the shares of chronically marginal firms in

these industries (based on numbers of com-

panies) have exceeded the average for total

industry (Figure II-7).

In particular, from the perspective of prof-

itability chronically marginal firms are very

vulnerable. A considerable percentage

(71.2%) of chronically marginal firms have

shown negative (-) operating income-to-sales

ratios (2009~2014 averages), on top of

which the proportions of those that have

sustained situations of operating deficits or

capital impairment for six straight years

have also reached 23.7% and 14.6% respec-

117

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ically Marg

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Assessm

ent

An

alysis of Fin

ancial Stab

ility Issues

7) Looking at corporate growth and profitability (based on 1,552 listed and 279 unlisted companies representing the different industries) during

the first half of 2015, the rate of sales growth was -7.1%, as its pace of decline had accelerated greatly compared to the previous year (H1 2014

-1.1%), while the operating income-to-sales ratio had shown a slight improvement (4.7% → 5.6%).

Note: 1) Operating income / Sales Source: KIS-Value

30

20

10

0

-10

30

20

10

0

-10

20

10

0

-10

-20

20

10

0

-10

-20

<Figure II- 6> Rates of sales growth, and operating income-to-sales ratios1)

<Rates of sales growth> <Operating income-to-sales ratios>

2009 2011 2013 2014 2009 2011 2013 2014

(%) (%)(%) (%)

Normal firms


Normal firms


Notes: 1) Overall corporate average during 2009~20142) Change in proportions in 2014 compared to

those in 2009Source: KIS-Value

10

8

6

4

2

0

10

8

6

4

2

0

<Figure II- 7> Rates of sales growth and operating income-to-sales ratios1), and changes2) in proportions of chronically marginal firms

Shipbuilding Transportation Steel Construction Overall

(%, %p) (%, %p)

Sales growth rates

Operating income-to-sales ratios

Changes in proportions of chronically marginal firms

*금안2015(Dec)05-이슈98~137 2016.2.18 11:25 AM 페이지117

tively (Figure II-8).8)

Financial institution tendencies towardlending leniency

With the worsening of cash flows at

chronically marginal firms due to their

slumps in profitability, they are relying for

their operating funds9) mainly on external

borrowings. While normal firms’ debt ratios

have on the one hand fallen, those of chron-

ically marginal firms have continually risen

since 2011. In particular, as some large

enterprises with sizeable amounts of debt

have been included among chronically mar-

ginal firms recently, the chronically marginal

firm debt ratio rose to a large extent from

173.4% in 2013 to 260.2% in 2014.

Chronically marginal firms’ borrowings-to-

total assets ratio (2014 56.3%) has also been

at a level more than twice that (24.6%) of

normal enterprises (Figure II-9).

The fact that chronically marginal firms

have been able to continue their external

borrowings in this way appears to be a

result mainly of financial institutions’ for-

118

Note: 1) Averages during 2009~2014Source: KIS-Value

60

40

20

0

60

40

20

0

<Figure II- 8> Proportions of firms in different operating income-to-sales ratio1) ranges

Below -10 -5 0 5 10 15 20% or -10% ~-5% ~0% ~5% ~10% ~15% ~20% above

(%) (%)

Normal firms


71.2% of chronically marginal firms

23.3% of normal firms

8)

9)

Note: 1) (Liquid assets – Liquid liabilities) / Total assetsSource: KIS-Value

Net working capital ratios1)

Normal firms 6.6 6.2 6.4 7.4 9.1 8.7Chronically marginal firms -14.0 -14.0 -15.0 -17.2 -16.7 -20.8

2009 2010 2011 2012 2013 2014

(%)

Notes: 1) End-2014 basis 2) During 2009~2014Source: KIS-Value

Proportions of chronically marginal firms1) experiencing operating deficits and capital impairment, by frequency2)

Operating deficits 8.2 7.7 9.9 14.0 20.6 15.9 23.7 100.0Capital impairment 53.0 8.6 6.9 6.0 6.4 4.5 14.6 100.0

0 times 1 time 2 times 3 times 4 times 5 times 6 times Total

(%)

Notes: 1) Debt / Equity (excluding capital impaired firms)2) (Borrowings + Corporate bonds) / Total assets

Source: KIS-Value

300

200

100

0

300

200

100

0

100

80

60

40

20

0

100

80

60

40

20

0

<Figure II- 9> Firms’ financial structure stability<Debt ratios1)> <Borrowings-to-total assets ratios2)>

2009 2011 2013 2014 2009 2011 2013 2014

(%) (%)(%) (%)

Normal firms


Normal firms


*금안2015(Dec)05-이슈98~137 2016.2.18 11:25 AM 페이지118

bearance lending.10) In connection with this,

there is a likelihood that financial institu-

tions’ credit appraisals of companies and

their management of asset soundness are

being carried out leniently.11) Looking at

banks’ credit assessment grades and asset

soundness classifications (five domestic bank

basis) for firms with very weak financial con-

ditions even compared to other chronically

marginal firms (three consecutive years of

operating deficits as well as debt ratios

above 200%), the proportion of credit classi-

fied as B grade and above is 55.6%, while

that of credit classified as normal is reaching

63.7% (Figure II-10).

Delays in corporate restructuring

Due to limitations in corporate restructur-

ing in terms of the system and conditions,

chronically marginal firms’ management

normalizations or market exits cannot be

achieved smoothly. The number of firms

chosen by their creditor banks for restructur-

ing is steadily increasing, but the actual

pushing ahead with restructuring is slow.

Among companies that applied for workout

programs or rehabilitation proceedings

between 2009 and 2013, the proportion of

those that had not yet finished the restruc-

turing process by year-end 2014 came to

52%. In particular, the situation of progress

in workout programs of large enterprises is

very sluggish compared to that seen in reha-

bilitation proceedings.12) Moreover, even

when companies have been selected for

workout programs by their creditor banks,

situations are occurring of these companies

not applying for and evading these programs

(Figure II-11).13)

119

II. Status o

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ically Marg

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s, and

Assessm

ent

An

alysis of Fin

ancial Stab

ility Issues

10) Financial institutions have tendencies of helping to prolong lives of companies through extending their loan maturities even if their capacities

for principal repayment are insufficient (as long as they are not delinquent on their interest payments). This is because, if companies are

unable to repay the principal at the time of loan recovery then non-performing loans occur, and financial institution profitability deteriorates

due to burdens of loan loss reserve accumulation.

11) Banks set up and operate their own credit appraisal models for assessing companies’ debt repayment capacities, and these models have to be

properly linked with asset soundness classifications (Banking Supervision Regulations, Article 27).

12) Workout programs have the advantage that supporting firms with new capital is easy, but in the cases of large enterprises instances of

restructuring being delayed frequently occur due to conflicts of interest among the bond holding institutions in line with the complex

relationships between claims and obligations.

13) Among firms selected for workout programs resulting from their creditor institutions’ credit risk evaluations of large enterprises, the actual rate

of application for workout programs (2010 88.1% → 2012 54.6% → 2014 33.3%) has continually declined (Goo Jeong Han, Kim Dong

Hwan and Kim Seok Gi, “Plan for Regular Legislation of the Corporate Restructuring Promotion Act”, Korea Institute of Finance,

November 2014). This is judged to be a result in part of the decline in applications for workout programs by firms reluctant to replace their

management, as the agents applying for workout programs have been changed from the creditor institutions to the firms themselves with the

revision in 2011 of the Corporate Restructuring Promotion Act.

Notes: 1) Chronically marginal firms having had three consecutiveyears (2012~2014) of operating losses and debt ratiosabove 200% (capital impaired firms included)

2) Based on five major domestic banks (as of end-June2015)


<Figure II-10> Chronic marginal firm1) credit rating and asset soundness classification proportions2)

Substandard-or-below(32.8%)

No Grade↘

(0.6%)Grade A(1.4%)

Grade B(54.1%)

Grade C(10.9%)

Grade D(33.0%)

Normal(63.7%)Precautionary

(3.5%)

<Asset soundness classifications><Credit ratings>

*금안2015(Dec)05-이슈98~137 2016.2.18 11:25 AM 페이지119

Until now restructuring through the capital

markets, involving private equity funds (PEFs)

for example or the non-performing loan mar-

ket, has not been active. Inflows of funds to

PEFs are continuing, but the amount (new

contract basis) of corporate financial stabiliza-

tion PEF contracts for management normal-

ization of restructured enterprises is at a level

below one trillion won. Due to a shortage of

large-scale PEFs and professional operating

personnel, moreover, rather than strategic

investment for the purposes of corporate buy-

outs most PEF investment is financial invest-

ment, where after the acquisition of equity the

buyers just monitor the existing management

group.14) In the case of the non-performing

loan market as well, the quantity of supply is

limited, while transactions are also being car-

ried out with a priority put on small-scale real

estate collateralized bonds, and transactions in

large-scale bad loans of restructuring firms are

at a minimal level.15) The amount of domestic

banks’ sales of bad loans has been sustaining a

trend of decline since 2012 (Figure II-12).

There is a likelihood that the expanded

government policy support since the global

financial crisis may have caused delays in

corporate restructuring. The provision of

credit to chronically marginal firms by spe-

cialized banks and policy finance-related

institutions16) has increased greatly, from 22.8

120

Notes: 1) Based on creditor banks’ regular corporate creditrisk evaluations

2) Proportions of firms undergoing restructuring at end-2014 relative to those selected for workouts orrehabilitation between 2009 and 2013 (based onanalysis of 329 corporations subject to external audits)

Sources: Financial Supervisory Service, KIS-Value

600

400

200

0

600

400

200

0

80

60

40

20

80

60

40

20

<Figure II-11> Firms selected for restructuring, and their current situations

<Numbers1) of firms selected for restructuring> <Proportions2) of firms undergoing restructuring>

2009 2011 2013 2015 Overall Workouts Rehabilitation

(companies) (%)(companies) (%)

Workouts

Rehabilitation

Large enterprises

SMEs

14) During the 2005~2014 period the proportion of PEF investment made for purposes of corporate takeovers was 25.7% (177 out of 690 cases

of investment) (Financial Supervisory Service, March 2015).

15) Bad loans are sold mainly as NPL ABSs, and the majority of the assets underlying the ABSs comprise real estate-collateralized loans (2014

96.0%). During 2014 the bond value per bad loan (per borrower) sold through NPL ABSs was an average 240 million won (1.13 billion won).

16) Specialized banks include Korean Development Bank, Korea Eximbank, Industrial Bank of Korea, the National Agricultural Cooperative

Federation and the National Federation of Fisheries Cooperatives, while policy finance-related institutions include Korea Credit Guarantee

Fund, Korea Technology Finance Corporation, Korea Trade Insurance Corporation, Korea Finance Corporation, Small and medium

Business Corporation, the Korea Federation of SMEs, etc. .

Notes: 1) During the period2) Based on management participating private

collective investment schemes3) Domestic bank basis4) January~October 20155) January~September 2015

Source: Financial Supervisory Service

12

9

6

3

0

12

9

6

3

0

40

30

20

10

0

40

30

20

10

0

<Figure II-12> New contracts of PEFs, and amounts1)

of non-performing loan disposal<New contracts of PEFs2)> <Amounts3) of non-performing loan disposal>

2010 2012 2014 20154) 2010 2012 2014 20155)

(trillion won) (trillion won)(trillion won) (trillion won)

Corporate financial stabilization PEFs

PEFs

Write-offs SalesCollateral disposalsNormalizationsOthers

*금안2015(Dec)05-이슈98~137 2016.2.18 11:25 AM 페이지120

trillion won in 2011 to 43.7 trillion won as

of the end of June 2015. The majority of

this is concentrated on large enterprises,

while the amount supplied to SMEs has

declined somewhat even despite an increase

in the number of firms receiving policy

funds (Figure II-13).

4. Related Potential Risks to the RealEconomy and Financial System

Constraints on real economic growth

Compared to the case with normal firms

the rates of growth in tangible assets and

numbers of employees at chronically margin-

al firms are relatively low, and as the num-

ber of these firms increases they can have

negative impacts on facilities investment and

employment in the economy as a whole. The

rate of tangible asset growth at chronically

marginal firms has, with the exception of

2011, been sustaining a lower level than at

normal companies, and in 2014 reversed to a

minus figure (-4.3%). Employee numbers

also, while increasing at normal companies,

have sustained trends of decline at chronical-

ly marginal firms (Figure II-14).17)

121

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ically Marg

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alysis of Fin

ancial Stab

ility Issues

17) The higher an industry’s share of chronically marginal firms, the more it has seen limitations in investment and in its creation of jobs. By

industry (based on eight manufacturing industries), the coefficients of correlation between the proportions of chronically marginal firms (end-

2014 basis) and the rates of increase in tangible assets and in employee numbers (2010~2014 averages) are -0.73 and -0.84 respectively.

Notes: 1) End-period basis2) Korea Credit Guarantee Fund, Korea Technology

Finance Corporation, Korea Trade InsuranceCorporation, etc.

Sources: Korea Federation of Banks, KIS-Value

60

40

20

0

60

40

20

0

2,000

1,500

1,000

500

0

2,000

1,500

1,000

500

0

<Figure II-13> Credit supply1) to chronically marginal firms by specialized banks and policy

finance-related institutions2)

<Amounts of credit supplied> <Numbers of firms>

Overall Large enterprises SMEs Overall Large enterprises SMEs

(trillion won) (companies)(trillion won) (companies)

2011

2015.6

2011

2015.6

Note: 1) Year-on-yearSource: KIS-Value

30

20

10

0

-10

30

20

10

0

-10

15

10

5

0

-5

-10

15

10

5

0

-5

-10

<Figure II-14> Current situations of corporate investment and employment

<Rates1) of tangible asset growth> <Rates1) of increase in numbers of employees>

2010 2012 2014 2010 2012 2014

(%) (%)(%) (%)

Normal firms


Normal firms


*금안2015(Dec)05-이슈98~137 2016.2.18 11:25 AM 페이지121

Chronically marginal firms’ productivity is

low, and they are causing an inefficient dis-

tribution of resources and can work as a fac-

tor limiting economic growth. Chronically

marginal firms’ labor productivity (value

added per person) is at a level just 60% that

of normal enterprises, and the pace of its

improvement is also relatively inadequate.

These companies’ ratio of gross value added

to total assets is also running at a level less

than one-half that at normal firms.

Chronically marginal firms’ capacity for cre-

ation of value added is low, but as their

number increases like this the share18) of the

resources of the economy as a whole that

they take up is also rising (Figure II-15).

Decline in financial institutionmanagement soundness

At any time of occurrence of domestic or

external shocks, defaults on loans to chronically

marginal firms can spread and lead to financial

system instability as financial institutions’ asset

soundness worsens. As of the end of June 2015

the amount of credit supplied to chronically mar-

ginal firms (total financial institution basis) stood

at 101.5 trillion won, to account for 11.8% of

credit supplied to all companies subject to exter-

nal audits. Of this, the amount supplied to large

enterprises was 69.3 trillion won, more than

twice that to SMEs (32.2 trillion won), and the

proportion of credit supplied to the transporta-

tion, shipbuilding, real estate and construction

industries, where the shares of chronically mar-

ginal firms are high, was 64.0% (Figure II-16).19)

122

Notes: 1) Median value basis2) Value added / Number of employees3) Value added / Total assets

Source: KIS-Value

12

9

6

3

0

12

9

6

3

0

40

30

20

10

0

40

30

20

10

0

<Figure II-15> Changes1) in corporate productivity

<Labor productivity2)> < Total asset investment efficiency3)>

2009 2014 2009 2014

(10 million won) (%)(10 million won) (%)

Normal firms


Normal firms


18) The proportions (among those of all companies subject to external audits) of tangible assets and employee numbers of chronically marginal

firms increased from 6.4% and 4.2% respectively in 2009 to 9.4% and 5.4% respectively in 2014.

19) The amount of credit supplied to chronically marginal firms belonging to large corporate groups was 37.4 trillion won. By financial institution

type, specialized banks (63.2%) accounted for a high proportion of this, and by form of credit provision loans (61.3%) and payment

guarantees (30.7%) comprised the majority.

Note: 1) End-June 2015 basisSources: Korea Federation of Banks, KIS-Value

Proportions of credit supply to large corporate group-affiliated chronically marginal firms, by financial institution type and form of credit1)

26.2 63.2 9.9 0.7 61.3 30.7 4.5 3.5

By financial institution type By form of creditCommercial banks Specialized banks Non-banks Other Loans Payment guarantees Securities Other

(%)

Note: 1) End-June 2015 basisSources: Korea Federation of Banks, KIS-Value

120

100

80

60

40

20

0

120

100

80

60

40

20

0

<Figure II-16> Credit supply1) to chronically marginal firms

<Credit supplied, by company size> <Component ratios, by industry>

Overall Large enterprises SMEs


Others(21.3%)

Transportation(18.6%)

Shipbuilding (16.8%)

Real estate(15.1%)

Construction(13.5%)

Electronics (5.4%)

Wholesale & retail (5.1%)

Steel (4.2%)

*금안2015(Dec)05-이슈98~137 2016.2.18 11:25 AM 페이지122

The forms of the credit supplied and the

proportions of the types of financial institutions

supplying it differ depending upon the sizes of

the chronically marginal firms concerned.

Looking first at the proportions of credit sup-

plied by financial institution type20), in the case

of large enterprises, specialized banks (49.7%)

are accounting for a level of one-half of the

credit supplied, while for SMEs it is non-bank

financial institutions making up the highest

share (39.3%). By the form of credit supply,

for SMEs the majority is loans (88.2%), while

among large enterprises the proportion of pay-

ment guarantees (22.1%) has also been rela-

tively high (Figure II-17).

Chronically marginal firms’ default risks

are showing higher levels than the average

for corporations overall. At the end of June

2015 the chronically marginal firm delin-

quency rate (domestic bank basis) and sub-

standard-or-below loan ratio (five domestic

bank basis) were 1.8% and 16.3% respective-

ly, greatly exceeding the overall corporate

sector averages (0.8% and 1.9%). Since the

global financial crisis the delinquency rate

has been showing a general trend of decline,

while the substandard-or-below loan ratio

has been sustaining a high level since 2013

as defaults by large enterprises in vulnerable

industries have increased (Figure II-18).21)22)

123

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ically Marg

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alysis of Fin

ancial Stab

ility Issues

20) Financial institutions were broken down into commercial banks, specialized banks, non-bank financial institutions and other institutions, etc.

and analyzed. Here specialized banks include Korean Development Bank, Korea Eximbank, Industrial Bank of Korea, the National

Agricultural Cooperative Federation, the National Federation of Fisheries Cooperatives, etc., while non-bank financial institutions comprise

credit-specialized financial institutions, securities companies, savings banks, mutual credit cooperatives and insurance companies, and other

institutions Korea Credit Guarantee Fund, Korea Technology Finance Corporation, Korea Trade Insurance Corporation, Korea Finance

Corporation, Small and medium Business Corporation, the Korea Federation of SMEs, etc.

21) During 2013 there was a great expansion in defaults on credit to large enterprises in the shipbuilding and contruction industries (including

STX and Tongyang Group affiliates, Sungdong Shipbuilding & Marine Engineering, Ssangyong Engineering & Construction, etc.)

22) It is judged that the substandard-or-below loan ratio having remained at a high level even despite the decline in the delinquency rate is due to

an increase in credit classified as substandard-or-below for reasons other than delinquency. Of the amount of increase in domestic banks’

substandard-or-below loans, the proportion of delinquent loans has fallen (2012 32.2% → H1 2015 23.6%) while the shares of credit to

insolvent firms (15.4% →21.1%) and loans for which repayment capacities have weakened (16.0% → 24.3%) have both risen.

Notes: 1) End-June 2015 basis2) Securities include CP, corporate bonds, bills

bought, etc.Sources: Korea Federation of Banks, KIS-Value

100

80

60

40

20

0

100

80

60

40

20

0

100

80

60

40

20

0

100

80

60

40

20

0

<Figure II-17> Proportions1) of credit supplied to chronically marginal firms, by type2) of financial

institution and form of credit <By financial institution type> <By form of credit>

Total Large enterprises SMEs Total Large enterprises SMEs

(%) (%)(%) (%)

Commercial banks Specialized banks

Others Non-banks

Loans Guarantees

Securities Others

Notes: 1) Based on corporate loans of domestic banks2) Based on corporate credit supply ( loans,

guarantees, etc.) by five major domestic banks Sources: The Bank of Korea, Financial Supervisory Service,

Korea Federation of Banks

4

3

2

1

0

4

3

2

1

0

24

18

12

6

0

8

6

4

2

0

<Figure II-18> Corporate delinquency rates1)

and non-performing loan ratios2)

<Delinquency rate> <non-performing loan ratio>

2011 2013 2015.6 2011 2013 2015.6

(%) (%)(%) (%)


All corporations

Chronically marginal firms (LHS)

All corporations (RHS)

*금안2015(Dec)05-이슈98~137 2016.2.18 11:25 AM 페이지123

Going forward there is expected to be a

high possibility of firms with weak profitabil-

ities and high reliance on external borrow-

ings becoming insolvent first at any time of

occurrence of shocks from U.S. interest rate

hikes or the slowdown in economic activities

in China. In line with this we postulated a

case of chronically marginal firms in situa-

tions of deficit and with debt ratios exceed-

ing 200% (including those with impaired

capital) being unable to service their debts

due to deteriorations in business conditions

stemming from an external shock, and then

calculated the resulting changes that would

appear in soundness indicators at domestic

banks.

First, in the case of defaults by chronically

marginal firms that have experienced three

consecutive years (2012~2014) of operating

deficits and debt ratios above 200% (18.9%

of all chronically marginal firms; scenario

①), effects appeared of domestic banks’ cor-

porate loan delinquency rate rising by 0.9%

point (0.8% → 1.7%) compared to the fig-

ure in the end of June 2015 on the one

hand, and their total capital ratio falling by

0.9% point (14.1% → 13.2%). Next, in the

case of defaults by firms with operating

deficits and debt ratios above 200% in 2014

(41.7% of all chronically marginal firms; sce-

nario ②), the corporate loan delinquency

rate (4.4%) recorded its highest level since

2008 while the total capital ratio (11.2%)

approached its lowest level since then

(Figure II-19).

5. Implications

Considering recent economic conditions

domestically and overseass, it is expected that

the number of chronically marginal firms will

increase for some time to come. As chronical-

ly marginal firms increase, the negative

impacts that they have on investment and

employment expand, the efficiency of resource

distribution falls, and there is a possibility of

economic growth being constrained.

Moreover, as chronically marginal firms’

financial conditions are weak they can work

as factors destabilizing the financial system at

any time of domestic or external shock occur-

rence, as this leads to their large-scale defaults.

There is thus a need for efforts, through the

promotion of efficient corporate restructuring,

to ensure that firms for which there are con-

124

0.81.7

4.4

14.113.2

11.2

Notes: 1) Dotted lines indicate the highest (delinquency rate)or the lowest (total capital ratio) levels since 2008

2) Assumed taking into consideration changes in thedelinquency rate (domestic bank basis) and thenon-performing loan ratio (based on five majordomestic banks) under each scenario


20

15

10

5

0

20

15

10

5

0

<Figure II-19> Changes1) in domestic bank asset soundness and capital adequacy following

defaults by chronically marginal firms

Corporate loan delinquency rate Total capital ratio2)

(%) (%)

May 2009(2.0%)

Sep 2008(10.9%)

June 2015 Scenario 1 Scenario 2

*금안2015(Dec)05-이슈98~137 2016.2.18 11:25 AM 페이지124

cerns about defaults, including chronically

marginal firms, can either swiftly normalize

their managements or exit the market.

First, to encourage an expansion in corpo-

rate restructuring by creditor financial institu-

tions, a plan for improvement of the related

systems will have to be sought. Inasmuch as

financial institutions have not moved ahead

positively with restructuring, due to burdens

of bad loan occurrence and declines in prof-

itability stemming from the corporate restruc-

turing carried out to this time, there is a need

for provision of suitable incentive measures.

For example, a plan can be considered for

granting financial institutions specified addi-

tional points for results in restructuring, dur-

ing their management evaluations. Financial

institutions can on their own as well work to

strengthen their corporate assessments, and to

raise the effectiveness of their credit rating

and asset soundness classifications, and

through differentiation in lending interest

rates on this basis resolve and move on from

their practices of allowing chronically margin-

al companies to survive through collateral,

guaranteed loans and low interest rates.23)

Efficient operation of the current corporate

restructuring framework, which is

dichotimized into workout programs center-

ing around the creditor institutions and

court-ordered rehabilitation proceedings, will

have to be promoted. In the case of workout

programs, differently from their original

intention of swift implementation of restruc-

turing, efficiency is instead declining, with

restructuring being delayed due among other

factors to conflicts between the parties con-

cerned and to diversities in relationships

between claims and obligations. Considering

these changes in circumstances, there is a

need to implement workout programs on a

limited basis, at firms for which the propor-

tions of bank holdings of their bonds are

high, and for which the debt relationships

are simple. In the case meanwhile of rehabil-

itation proceedings, the role of the creditor

institutions, which is currently limited to

their suggesting of opinions, needs to be

strengthened, and in bankruptcy proceedings

rights to preferential payment should also be

granted to credit newly supplied by the cred-

itor institutions, so as to ensure that fund

support for firms undergoing rehabilitation

proceedings can be achieved smoothly.24)

In the medium to long term, it will be

important to foster the private sector

restructuring market and create conditions

under which regular restructuring in accor-

dance with market principles can be carried

out. There is a need to encourage expan-

sions in size of PEFs, through the cultivation

of professional investors, and to revitalize

investment in restructuring-related bad loans

and in corporate buyouts.25) It is expected

that bad loan disposals can be achieved

swiftly as a result of these measures, and

that this can also help to boost financial

institutions’ management soundness.

125

II. Status o

f Ch

ron

ically Marg

inal Firm

s, and

Assessm

ent

An

alysis of Fin

ancial Stab

ility Issues

23) While the proportion of chronically marginal firms’ collateralized and guaranteed loans increased by 11.9% points between year-end 2010

and the end of June 2015, from 37.0% to 48.9%, the average interest rates that they paid on their loans fell by 2.3% points (6.4% → 4.1%)

over the same period (five domestic bank basis).

24) In court-initiated rehabilitation proceedings all claim-obligation relationships are adjusted according to law, and compared to workout

programs they have the merit that fairness can be heightened although there are also problems such as moral hazard among management

and limitations on new fund support. The right to preferential payment related to new supply of credit is applied only in rehabilitation

proceedings, and financial institutions not granted this right in the bankruptcy process worry about losses occurring at the time of bankruptcy,

and so show tendencies of avoiding fund support.

25) Through its revision (effective October 25, 2015) of the 「Financial Investment Services and Capital Markets Act」, the Financial Services Commission

eased the regulations on investment related to PEFs, and is pushing ahead (under its “Measures for Establishment and Operation of Professional

Corporate Restructuring Companies,” October 22, 2015) with the establishment of private sector-led corporate restructuring companies.

*금안2015(Dec)05-이슈98~137 2016.2.18 11:25 AM 페이지125

III. Effects of EconomicUnrest in EMEs on KoreanExternal Soundness

1. Background2. Potential risks in EMEs3. Effects of economic unrest in EMEs

on the Korean economy 4. Implications

1. Background

Recently, as concerns grow related to the

prolonged slowdown in Chinese economic

growth, there has been persistent financial

unrest in emerging market economies, with

their currency values falling and capital

flowing continually from them. Concerns are

as a result also rising about the resulting

negative impacts on the Korean economy.

This is because of the possibility of Korea

being adversely affected even despite its

favorable fundamentals, as in every past

period of international financial market

unrest a pattern of withdrawals of global

investment funds from EMEs, due to safe

asset preference, has been repeated. In par-

ticular, with the real and financial sector

linkages between EMEs having deepened

since the global financial crisis, the possibili-

ty of financial unrest in EMEs spreading to

Korea through these channels has increased

even more.

In line with this, we examine in this article

the potential risks in major emerging market

economies1) due to factors such as concerns

about China’s slowdown in economic activi-

ties and financial unrest and the policy rate

hikes by the U.S. Federal Reserve, and then

look at the effects on the Korean economy

due to any occurrence of instability in

EMEs.

2. Potential risks in EMEs

China’s structural slowdown in economicactivities

As the Chinese economy has driven global

economic growth based on its own high rate

of growth to this time, its share in the world

economy has expanded. The interconnected-

ness among emerging market countries and

the Chinese economy has in addition soared

greatly compared to the past. Since the

global financial crisis the shares of major

EMEs’ exports to China have risen greatly,

and the coefficient of correlation in rates of

economic growth between China and EMEs

has risen further – from 0.878 in the 2000

to 2008 period, to 0.992 between 2010 and

2015 (Figures III-1, III-2).

126

1) In this article we have chosen as our subjects of analysis EMEs whose economic sizes are relatively large: China, India, Indonesia, Malaysia,

Thailand, Brazil, Turkey, Russia, the Republic of South Africa and the Middle East area countries.

*금안2015(Dec)05-이슈98~137 2016.2.18 11:25 AM 페이지126

In line with this, in cases when concerns

about the slowdown2) in the Chinese econo-

my have emerged financial unrest has even

shown signs of spreading, with EMEs’ cur-

rency values depreciating to large extents

and their stock prices falling. Notably, since

June 2015 when Chinese stock prices

plunged, propagations of financial unrest

have appeared, with stock prices and curren-

cy values in major EMEs also falling togeth-

er for example (Figures III-3, III-4).

127

III. Effects of Eco

no

mic U

nrest in

EMEs o

n K

orean

External So

un

dn

ess

An

alysis of Fin

ancial Stab

ility Issues

Note: 1) Based on India, Indonesia, Malaysia, Thailand, Brazil,Turkey, Russia, Republic of South Africa and Korea

Source: IMF Direction of Trade Statistics

4,000

3,000

2,000

1,000

0

15

12

9

6

3

0

<Figure III- 1> Major EME1) exports to China, and proportion in total exports

2000 2002 2004 2006 2008 2010 2012 2014


Exports to China (LHS)

Proportion in total exports (RHS)

Source: IMF World Economic Outlook (2015.10)

18

15

12

9

6

3

0

-3

-6

18

15

12

9

6

3

0

-3

-6

<Figure III- 2> Global economy growth rates

2000 2002 2004 2006 2008 2010 2012 2014

(%) (%)

World Advanced countries

EMEs China

2) Since China’s launch of reform and opening there have been four episodes of GDP growth running below 8% (in the 1979~81, 1989~90 and

1998~99 periods, as well as since 2012), and while the three episodes in the past were slowdowns in economic activities due to cyclical factors,

the episode this time is judged to be a period of structural transition due for example to a decline in the potential growth rate (“New Thinking

About the Chinese Economy in the Era of a New Normal”, The Bank of Korea Beijing Representative Office, August 2014).

Source: Bloomberg

160

140

120

100

80

60

160

140

120

100

80

60

<Figure III- 4> EME stock prices

2015.1 4 7 10 11

(2014.12.31 = 100) (2014.12.31 = 100)

Malaysia Russia

India China

Indonesia Brazil

Source: Bloomberg

160

140

120

100

80

160

140

120

100

80

<Figure III- 3> EME currency exchange rates against U.S. dollar

2015.1 4 7 10 11

(2014.12.31 = 100) (2014.12.31 = 100)

Malaysia Russia

India China

Indonesia Brazil

*금안2015(Dec)05-이슈98~137 2016.2.18 11:25 AM 페이지127

The slowdown in Chinese economic

growth has caused a weakening of global

demand for international raw materials, and

can lead to contractions in exports and dete-

riorations in current and fiscal accounts in

the economies of emerging market countries

that rely greatly on raw material exports.

Especially, for raw material exporters such

as Russia, Brazil and Malaysia, as their

paces of export growth have slowed greatly

since the second half of 2014, and their cur-

rent and fiscal accounts have worsened, their

international credit standings3) have fallen

greatly.

Moreover, as the sizes of crude oil export-

ing countries’ sovereign wealth funds4)

decrease, due to contractions in these coun-

tries’ crude oil sales revenues and the resul-

tant worsening of their finances, there is a

possibility as well of this working as a factor

causing EME financial market volatilities to

expand (Figures III-5, III-6).

External debt redemption burdens due toU.S. interest rate hikes

Against the backdrop of the abundant liq-

uidity due to the large-scale quantitative eas-

ing by the U.S. Federal Reserve, EMEs’ dol-

lar-denominated borrowings have expanded

greatly since the global financial crisis,

through the channels of borrowings in their

non-bank sectors and international bond

issuance by their corporations (Figures III-7,

III-8).

128

3) Russia credit rating (Moody’s): A2 → A3 (Oct. 2014) → Baa2 (Dec. 2014) → Baa3 (Jan. 2015) → Ba1 (Feb. 2015); Brazil credit rating (S&P):

BBB → BBB- (March 2014) → BB+ (Sep. 2015)

4) Since 2006 crude oil exporting countries have been managing close to 350 billion dollars in overseas investments (securities·direct·other

investment) each year (Korea Center for International Finance, December 2014).

Note: 1) 1962~2014 averageSource: IMF World Economic Outlook (2015.10)

100

80

60

40

20

0

100

80

60

40

20

0

<Figure III- 5> Proportions1) of raw material exports

Russia Brazil Malaysia Indonesia

(%) (%)

Grains Metals Energy Other raw materials

Notes: 1) Oil price levels enabling achievements of balancedfiscal and current accounts (3 grades of oil average)in the individual countries; dotted lines the yearlyaverage (January~September 2015, USD 53.6)

2) 2015 estimates Source: IMF Regional Economic Outlook (2015.1)

120

100

80

60

40

20

0

<Figure III- 6> Oil price levels1) required for balanced current . fiscal accounts2)

0 50 100 150 200

(dollars / barrel)

(dollars / barrel)

YemenLibya

Algeria

Oman

Iran

Bahrain

Saudi Arabia

UAE

Turkmenistan

Kuwait

Kazakhstan

Iraq

QatarAzerbaijan

(Oil price level for balanced fiscal account)(O

il pr

ice

leve

l for

bal

ance

d cu

rren

t acc

ount

)

*금안2015(Dec)05-이슈98~137 2016.2.18 11:25 AM 페이지128

Therefore, when the U.S. Federal

Reserve’s policy rate is raised in the future,

while economic growth in China is also

slowing, EMEs’ external debt repayment

burdens could become very heavy. This is

because the increase in U.S. interest rates

could lead to a decline5) in dollar liquidity

globally, and firms in EMEs including China

and Brazil could face substantial difficulties

in raising funds in the global capital mar-

kets. In addition, owing to the trend of U.S.

dollar strengthening these companies’ debts

in terms of their home country currencies

will grow, and there are concerns that, as

their external debt repayment burdens as a

result worsen, liquidity conditions will deteri-

orate sharply, centering around firms experi-

encing slumping business performances.6)

Expansion in capital flow volatility due toglobal risk

Capital flow volatility has expanded greatly

since the financial crisis, as inflows of global

investment funds to EMEs have increased

steadily while withdrawals of investment

funds have become easier due to the progress

of capital account liberalization in EMEs. In

line with this, during times of continuing

international financial market unease stem-

ming from global risk factors, such as the

recent Taper Tantrum and the collapse in

oil prices, large-scale capital outflows from

EMEs have appeared, centering around

129

III. Effects of Eco

no

mic U

nrest in

EMEs o

n K

orean

External So

un

dn

ess

An

alysis of Fin

ancial Stab

ility Issues

Note: 1) End-period basis Source: BIS Locational Banking Statistics

3,500

3,000

2,500

2,000

1,500

1,000

500

0

3,500

3,000

2,500

2,000

1,500

1,000

500

0

<Figure III- 7> Non-bank sector loan balances1)

of international commercial banks

China India Indonesia Malaysia Thailand Brazil Turkey Russia Republic of South Africa


2008

2015.3

Notes: 1) Nationality basis 2) End-period basisSource: BIS International Debt Securities Statistics

3,000

2,000

1,000

0

3,000

2,000

1,000

0

<Figure III- 8> Corporate sector international bond balances1)2)

China India Indonesia Malaysia Thailand Brazil Turkey Russia Republic of South Africa


2008

2015.9

5) During the period of U.S. policy rate hikes between 2004 and 2006 the extent of increase in long-term market interest rates was very limited,

due to the expansions in securities investment in the U.S. by trade surplus countries including EMEs (Greenspan’s Conundrum). However, in

conditions where factors causing instability in EMEs remain, differently from in the past, the future U.S. policy rate hikes could greatly affect

U.S. market interest rates, which have a large influence on capital outflows from EMEs.

6) Since the global financial crisis companies in EMEs have deposited their funds raised through borrowings overseas in their respective countries’

banks, and it is analyzed that, with banks having used these funds as resources for lending, their supplying of credit has expanded greatly

(Jhuvesh Sobrun and Philip Turner, “Bond markets and monetary policy dilemmas for the emerging markets”, BIS Working Paper No. 508,

BIS, August 2015).

*금안2015(Dec)05-이슈98~137 2016.2.18 11:25 AM 페이지129

securities investment funds (Figure III-9).

This suggests that, amid ongoing slow-

downs in economic activities in EMEs

including China, should negative shocks also

occur due for example to a contraction in

global liquidity following the policy rate

hikes by the U.S. Fed, there is then a possi-

bility7) of drastic outflows of investment funds

from emerging markets (Figure III-10).

There are also concerns that, as such capital

outflows from EMEs cause their interest

rates to rise and their stock prices to fall,

this could limit the effects of any macroeco-

nomic expansionary policies they attempt in

response to slumping economic activities

domestically.

3. Effects of economic unrest inEMEs on the Korean economy

Direct effects due to expansions in mutualexposure

It is assessed that, as the amounts of trade

and capital transactions between Korea and

EMEs have steadily expanded, the degrees

of these countries’ interconnectedness in the

real and financial sectors have risen greatly.

Looking at the amounts of their trade, dur-

ing 2014 the volume of Korea’s exports to

major EMEs stood at 211.8 billion dollars,

to account for 37.6% of its total export vol-

ume, while the volume of these countries’

exports to Korea, of 152.7 billion dollars,

comprised 8% of their total export volume

(Figure III-11).

130

7) The IIF (October 2015) has forecast that, as a result of risk factors in EMEs themselves, such as slowdowns in growth and the increased

uncertainties concerning the Chinese economy, capital will in 2015 show a net outflow from EMEs (of 540 billion dollars) for the first time

since 1988.

Note: 1) Yearly basisSource: IIF (Institute of International Finance)

15,000

10,000

5,000

0

-5,000

-10,000

-15,000

15,000

10,000

5,000

0

-5,000

-10,000

-15,000

<Figure III-10> Amounts1) of capital flows to EMEs

2003 2006 2009 2012 2015e 2016e


Capital inflows of non-residents

Capital outflows of residents

Net capital flows

<Expectation>

Note: 1) During the periodSource: IIF (Institute of International Finance)

500

400

300

200

100

0

-100

-200

-300

-400

500

400

300

200

100

0

-100

-200

-300

-400

<Figure III- 9> Amounts1) of securities investment fund flows to EMEs

2013.1 7 2014.1 7 2015.1 7 11


Taper Tantrum Oil price collapse,Russian financial crisis

*금안2015(Dec)05-이슈98~137 2016.2.18 11:25 AM 페이지130

In the case of capital transactions, as of the

end of 2014 Korea’s investment in EMEs

stood at 307.9 billion dollars, to account for

43.0% of its total external investment, while

the amount of these countries’ investment in

Korea, of 291.3 billion dollars, made up

29.2% of all investment in Korea by foreign-

ers. By investment type, in the case of

Korean investment in EMEs the share of

direct investment was the highest, and in the

case of EMEs’ investment in Korea portfolio

investment led the way (Figure III-12). In

line with this, at times of crisis such as eco-

nomic unease in EMEs Korea’s withdrawal

of capital from EMEs will be relatively diffi-

cult, while EMEs’ withdrawal of portfolio

investment from Korea will on the other

hand be easy, and it is assessed that the risk

of outflows of foreign capital domestically is

high. This is because, although EMEs’

domestic portfolio investment to Korea com-

prises mainly public funds financed by the

foreign exchange reserves of central banks,

sovereign wealth funds, etc., and by nature

the risk of sudden capital outflows is thus rel-

atively lower than in the case with private

funds, the likelihood does still also remain of

investment fund withdrawals depending upon

economic conditions in the individual coun-

tries concerned.

Indirect effects from synchronization withEMEs

Meanwhile, even besides the direct effects

stemming from these expansions in mutual

exposures, Korea’s main financial price vari-

ables, such as its CDS premiums, stock

prices and exchanges rates, are also influ-

enced by synchronization with China and

other EMEs. In particular, during times

when global investors’ tendency toward safe

asset preference intensifies, owing to global

financial market instabilities for example, the

extent of synchronization has appeared to

131

III. Effects of Eco

no

mic U

nrest in

EMEs o

n K

orean

External So

un

dn

ess

An

alysis of Fin

ancial Stab

ility Issues

Notes: 1) Based on China, India, Indonesia, Malaysia,Thailand, Brazil, Turkey, Russia, and theRepublic of South Africa

2) Proportion in total Korean exports to EMEs orEMEs’ share in total Korean exports

Source: IMF Direction of Trade Statistics

3,000

2,000

1,000

0

60

40

20

0

<Figure III-11> Amounts of exports between Korea and EMEs1), and proportion2) of Korean exports to EMEs

2003 2006 2009 2012 2014


EMEs → Korea (LHS)

Korea → EMEs (LHS)

Proportion in total Korean exports to EMEs or EMEs’ share in total Korean exports (RHS)

Note: 1) Sum of International Investment Positions (IIP)of China, Southeast Asia, Central and SouthAmerica, and the Middle East area; applicableyear accumulation basis


4,000

2,000

0

2,000

4,000

4,000

2,000

0

2,000

4,000

<Figure III-12> Investments1) between Korea and EMEs

2003 2006 2009 2012 2014


Korea → EMEs

Direct investment


Other investment

EMEs → Korea

*금안2015(Dec)05-이슈98~137 2016.2.18 11:25 AM 페이지131

increase greatly.

If we evaluate the degrees of synchroniza-

tion of Korea’s CDS premium with those of

China and other EMEs, using time-varying

coefficients of correlation8), they show very

high levels, with the coefficient of correlation

with China ranging from 0.8~0.9 and those

with other EMEs from 0.6~0.8. Notably,

the coefficient of correlation with EMEs did

show a temporary divergence, falling to 0.4

during the period of the Taper Tantrum

(May~November 2013) for example, but has

risen back to its previous level of around 0.7

(Figures III-13, III-14). This weakened dif-

ferentiation from other EMEs, even despite

Korea’s favorable external conditions includ-

ing its persistent current account surplus, is

because concerns about a materialization of

policy rate hikes by the U.S. Federal

Reserve, the slowdown in economic growth

in China, etc., can work as factors causing

international financial market instability to

increase greatly. In the past as well, in cases

where international financial market unrest

expanded to the global level and investor

risk aversion grew, the differentiation

between Korea and EMEs showed a tenden-

cy to weaken.

132

Note: 1) The shaded area indicates the period ofdifferentiation between Korea and EMEs(May~November 2013)

Sources: Bloomberg, The Bank of Korea

1,200

800

400

0

1.0

0.8

0.6

0.4

0.2

0

<Figure III-13> Time-varying correlation coefficient1)

between Korean CDS premium and EME interest rate spread

2003 2005 2007 2009 2011 2013 2015

(bp)

Korean CDS premium (A, LHS)

EMBI+ spread (B, LHS)

Time-varying correlation coefficient between A and B (RHS)

Note: 1) The shaded area indicates the period ofdifferentiation between Korea and China(November~December 2013)


800

600

400

200

0

1.0

0.8

0.6

0.4

0.2

0


of CDS premiums between Korea and China

2003 2005 2007 2009 2011 2013 2015

(bp)Korean CDS premium (A, LHS)

Chinese CDS premium (B, LHS)

Time-varying correlation coefficient between A and B (RHS)

8) In our time-varying correlation coefficient estimation for this article we use Dynamic Conditional Correlation (DCC) Models, which have the

flexibility of univariate GARCH without the complexity of conventional multivariate GARCH. These models, which parameterize the

conditional correlations directly, are naturally estimated in two steps – the first a series of univariate GARCH estimates and the second the

correlation estimate. These methods have clear computational advantages over multivariate GARCH models, in that the number of parameters

to be estimated in the correlation process is independent of the number of series to be correlated (Engle, 2002).

*금안2015(Dec)05-이슈98~137 2016.2.18 11:25 AM 페이지132

Meanwhile, the time-varying coefficients of

correlation between Korean and EME stock

prices, at 0.6~0.8 since the 2000s, have

shown higher levels than the correlations

with China (0.2~0.4) and the U.S. (0.1~0.3).

Moreover, the time-varying coefficient of

correlation between Korean and EME

exchange rates has also risen since 2006, and

been maintaining high levels ranging from

0.5 to 0.7 (Figures III-15, III-16).

In line with this trend of synchronization

of major financial price variables in Korea

with those in EMEs, it is judged that, in any

case of intensified economic unrest in China

or other EMEs, there would be a substantial

possibility of negative effects on Korea’s

external soundness despite its sound eco-

nomic fundamentals, with external borrow-

ing conditions worsening for example and

external debt repayment burdens growing

due to an increase in the won/dollar

exchange rate. In particular, the fact that

the CDS premium has not fallen greatly,

even despite the recent upward adjustments

of Korea’s credit rating by international

credit rating agencies, is appraised as sup-

porting this judgement.

133

III. Effects of Eco

no

mic U

nrest in

EMEs o

n K

orean

External So

un

dn

ess

An

alysis of Fin

ancial Stab

ility Issues

Note: 1) Using the KOSPI, the MSCI emerging marketindex, the S&P 500, and the Shanghai StockExchange for the stock prices of Korea, EMEs, theU.S. and China respectively


1.0

0.8

0.6

0.4

0.2

0

-0.2

-0.4

1.0

0.8

0.6

0.4

0.2

0

-0.2

-0.4


of price-earnings ratios between Korea and China

2000 2003 2006 2009 2012 2015

Korea and China

Korea and emerging countries

Korea and U.S.

Note: 1) JP Morgan Emerging Market Currency Index used Sources: Bloomberg, The Bank of Korea

1.0

0.8

0.6

0.4

0.2

0

1.0

0.8

0.6

0.4

0.2

0

<Figure III-16> Time-varying correlation coefficient1) of exchange rate fluctuations between Korea and EMEs

2003 2006 2009 2012 2015

*금안2015(Dec)05-이슈98~137 2016.2.18 11:25 AM 페이지133

Effects of EME financial unrest on Korea’sforeign currency funding conditions

To examine the effects on Korea’s foreign

currency funding conditions (CDS premium)

stemming from China’s economic slowdown

and the financial instabilities in EMEs for

example, we set up a logit probability

model9) and the results of empirical analysis

showed that international financial market

instability (e.g. a rise in won/dollar

exchange rate volatility), an increase in

international interest rates, unrest in EMEs,

and the Chinese economic slowdown all

have significant effects in causing the proba-

bility of Korean foreign currency funding

conditions worsening10) greatly to rise. The

expansion in Korea’s current account sur-

plus-to-nominal GDP ratio was on the other

hand found to cause that probability to

lessen, while EME stock prices and the

VIX11) were analyzed as not having signifi-

cant effects.

Meanwhile, calculation of the probability

of Korea’s foreign currency funding condi-

tions worsening greatly in the future, using

these results of estimation, found that rate of

probability standing at just 23.2% as of

September 2015. But in the case where eco-

nomic instabilities in EMEs are increasing12),

on top of a trend of economic slowdown in

China as at present, the probability of

Korea’s foreign currency funding conditions

deteriorating greatly was estimated to rise to

48%. Especially, in the case where upward

pressures13) on international interest rates fol-

lowing the rate hikes by the U.S. Fed occur,

in addition to the Chinese economic slow-

down and to instabilities in EMEs, then the

probability of foreign currency borrowing

conditions worsening was found to expand

greatly to 75% (Figure III-17).

134

9) The logit probability model was set up and analyzed as follows:

■ Dependent variable: Periods when the Korean CDS premium was 1.5 or more times its standard deviation (60bp) higher than the average

Korean premium (January 2003~August 2015 70bp, excluding the financial crisis period) were defined as periods of unrest and given

coefficients of 1, with other periods assigned coefficients of 0

■ Explanatory variables and results of estimation1)

10) The case of the CDS premium exceeding 130bp was chosen to indicate such a worsening.

11) The fact that the influence of the VIX is not statistically significant is judged to have resulted from its high correlation with won/dollar

exchange rate volatility.

12) The rate of increase in China’s industrial output has fallen recently from the 6% (August 2015 6.1%) to the 5% range, while EMEs’ average

CDS premium was assumed to be exceeding 383bp (January 2003~August 2015 average CDS premium (171bp) + 1.5 × standard deviation

(141)).

13) A case of international interest rates increasing by 50bp due to U.S. interest rate hikes was assumed, on top of the previously mentioned

decline in the rate of Chinese production growth and increase in EME CDS premiums.

Notes: 1) Estimates based on monthly data from January 2003 to August 2015, using maximum likely estimation (MLE) method2) ***, ** and * indicate statistical significances of 1%, 5% and 10% respectively

Sources: Bloomberg, IMF

Won/dollar exchange rate volatility Won / USD inherent volatility (3-month) 1.18*** ( 3.13)Degree of int’l financial market unrest VIX 0.09 ( 0.70)Int’l interest rates U.S. Libor (3-month) 16.49** ( 2.08)EME stock price volatility MSCI emerging markets index 0.03 ( 0.28)EME economic unrest 1 in periods when EME CDS premium standard deviation rose to 1.5 times its standard deviation higher than its average 6.60** ( 2.50)Chinese economic slowdown Industrial output growth rate (year-on-year) -0.85*** (-2.65)Korean current account Current account / Nominal GDP -4.70** (-2.17)Psuedo R2 0.75

Determinants Model explanatory variables Estimated coefficients

(Z-values)2)

*금안2015(Dec)05-이슈98~137 2016.2.18 11:25 AM 페이지134

4. Implications

Given the Korean economy’s steadily

improved external soundness thanks to its

sound fundamentals since the global finan-

cial crisis, it is assessed that until now the

possibility is not large of negative shocks due

to potential risks from EMEs including

China leading to any deterioration in its

external soundness (Figures III-18, III-19).

The fact that international credit rating

agencies have adjusted Korea’s sovereign

credit rating14) upward recently is evaluated

to have reflected Korea’s satisfactory exter-

nal soundness. However, in circumstances where the pos-

sibility is large of the hikes in U.S. interest

rates causing international financial market

volatility to expand, on top of the increased

direct interconnectedness of the Korean real

economy with China since the global finan-

135

III. Effects of Eco

no

mic U

nrest in

EMEs o

n K

orean

External So

un

dn

ess

An

alysis of Fin

ancial Stab

ility Issues

23.2


100

80

60

40

20

0

500

400

300

200

100

0

<Figure III-17> Probability of Korean foreign currency funding conditions weakening greatly

2007 2009 2011 2013 2015

(%) (bp)

Probability of foreign currency funding conditions weakening greatly (LHS)

CDS premium (RHS)

14) In September 2015 S&P adjusted Korea’s sovereign credit rating upward from A+ (positive) to AA- (stable).

Note: 1) January~August 2015Source: The Bank of Korea

1,000

800

600

400

200

0

7

6

5

4

3

2

1

0

<Figure III-18> Korean current account1), and current account / nominal GDP ratio

2003 2006 2009 2012 2015


Current account balance (LHS)

Current account / Nominal GDP (RHS)

Note: 1) Q3 2015 basisSource: The Bank of Korea

4,000

3,500

3,000

2,500

2,000

1,500

90

80

70

60

50

40

30

20

<Figure III-19> Korea’s foreign reserves and short-term foreign debt1)

2008 2010 2012 2014 2015


Foreign reserves (LHS)Short term foreign debt / Foreign reserves (RHS)

*금안2015(Dec)05-이슈98~137 2016.2.18 11:25 AM 페이지135

cial crisis, it is judged difficult, even despite

the Korean economy’s favorable fundamen-

tals, to rule out the risk of instabilities in

EMEs spreading domestically, due to deep-

ening risk aversion in the international

financial markets for example. In the results

of empirical analysis as well, Korea’s price

variables, such as its CDS premium, stock

prices and exchange rates, are analyzed as

having high degrees of synchronization with

those of EMEs, which on top of this have

been strengthening recently.

In consequence, in the case where not

only the economic slowdown in China and

interest rate hikes in the U.S., but also

unrest in EMEs coincide, there is a possibili-

ty of risk aversion in the international finan-

cial markets expanding, which could cause

negative shocks to the domestic financial

markets. There is thus a need to closely

examine response plans, and to devise coun-

termeasures.

136

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*금안2015(Dec)05-이슈98~137 2016.2.18 11:25 AM 페이지137

*금안2015(Dec)06-부록138~145 2016.2.18 11:26 AM 페이지138

[Annex 1]Monetary andMacroprudential PolicyOperational Framework1)

Mutual effects between monetary andmacroprudential policies

Monetary policy uses methods such as pol-

icy rate adjustment to promote the stability

of prices and employment as well as eco-

nomic growth. Macroprudential policy on

the other hand works to achieve financial

stability through policy measures such as

LTV and DTI regulations, by restraining

growth in systemic risks stemming for exam-

ple from excessive credit expansion. The two

types of policies differ in terms of their poli-

cy targets and instruments, but they have

mutual impacts on each other in the

processes of transmission of their respective

policy implementation effects through the

credit markets for instance. Monetary policy

can cause either an expansion or a decline

in financial imbalances, through changes in

the risk attitudes of economic actors includ-

ing households and corporations, in the asset

markets, and in the operating environments

of financial institutions. Macroprudential

policy can also show effects on the monetary

policy target variables of economic growth

and prices.

The real and financial cycles, and policyconduct

In the process of policy implementation,

the monetary policy stance is decided based

on a judgement related to the real economic

cycle, and the macroprudential policy stance

based on one related to the financial cycle.

Compared to the real cycle, the financial

cycle has the traits of involving a longer

span of time and a greater amplitude. Due

to this, cases can occur of the real and the

economic cycles either moving in the same

direction, or of their upward and downward

phases being estranged from each other. In

particular, in cases of increasing credit dri-

ven by mutual self-reinforcement2) between

credit and asset prices, situations do also

occur of the financial cycle expanding when

financial imbalances3) intensify, without any

connection to the real economy.

139

[An

nex 1]

1) For details refer for example to KIM YongMin, PARK JungPhil and JUNG YonSoo, “Unintended Consequences of Macroprudential Policy

Instruments” (BOK Economic Review, 2014), Kim YongMin and LEE JungYeoun, “Monetary and Macroprudential Policy Conduct in

Consideration of the Real and the Financial Cycles” (BOK Issue Review, 2014), LEE JungYeoun and Park YangSu, “Measurement of Korea’s

Financial Cycle” (BOK Issue Review, 2015), JUNG YonSoo, KANG SooYoun and NAH SungO, “Mutual Effects between the Countercyclical

Capital Buffer and Monetary Policy, and a Framework for Effective Policy Conduct” (BOK Economic Review, 2015), and PARK HyungGeun

and KIM YeJin, “Monetary and Macroprudential Policy Conduct in Response to Financial Imbalances” (BOK Issue Note, 2015).

2) Refers to the phenomenon of a repeating process of 「Asset price rise → Increase in asset demand → Creation of credit for asset purchases →Further asset price rise」.

3) There is no clear-cut definition of financial imbalances, but the term is generally used to designate a situation in which an excessive expansion

in credit and sharp rises in asset prices occur in the financial market, triggered by excessive risk-seeking behavior of economic agents.

*금안2015(Dec)06-부록138~145 2016.2.18 11:26 AM 페이지139

Because monetary and macroprudential

policies can exert mutual effects on each

other’s target variables as explained above,

depending upon which phases – of expan-

sion or of contraction – the real economic

and financial cycles are in, complementary

or conflicting, or even independent relation-

ships between the two policies can arise.

Especially, in a situation in which the phases

of the two cycles differ, a conflicting rela-

tionship between the policies occurs.

For example, in circumstances where busi-

ness activities are sluggish (with inflation

running below the target level) and financial

imbalances have intensified, if expansionary

economic policies are adopted then financial

unease can deepen, while if in contrast

macroprudential regulations are tightened a

situation of real economic activities contract-

ing even further can appear. Recent

research is analyzing that inflation is low in

many nations, and situations of deepening

financial imbalances are often occurring4),

while in Korea as well estrangements

between the two cycles have been appearing

since the global financial crisis.

Discussions of policy mixes, and casesof their operation

Due to the continuing low growth and low

interest rate stances in many nations since

the global financial crisis, the imbalances in

their financial sectors have widened. In line

with this the amount of consideration given

to financial stability in the process of mone-

tary policy conduct has grown, while discus-

sions of frameworks for operating suitable

mixes of macroprudential and monetary

policies have been progressing briskly.

One view in this regard is based on the

separation principle, claiming that monetary

policy should focus on the stability of prices

and real economic activities while macropru-

dential policy should concentrate on finan-

cial stability.5) Monetary policy is a blunt

tool, with wide-ranging effects on the econo-

my as a whole, and so when it is used for

the purpose of financial stability this can

give rise to considerable side effects.

140

Note: Reprinted from Kim, YongMin and Lee, JungYeoun (2014)

0.25

0.20

0.15

0.10

0.05

0.00

-0.05

-0.10

-0.15

-0.20

U.S. real and financial cycles

1976 1980 1990 2000 2012

NBER Recession Financial cycle Real cycle

4) Kim and Mehrotra (2015, “Managing Price and Financial Stability Objectives: What Can We Learn from the Asia-Pacific Region?”) analyzed

six nations in the Asia-Pacific region including Korea and Australia, and reported that, in conditions where inflation was running below the

target figures, cases had been observed 19 times since the 2000s of credit/nominal GDP gaps being positive (+, financial booms).

5) This view is advocated mainly by the U.S. Federal Reserve and the IMF, as well as by Keynesian scholars.

Relationship between monetary and macro-prudential policies

Financial overheating complementary independent conflicting

No financial unbalance independent independent independent

Financial contraction conflicting independent complementary

Above inflation Near inflation Below inflationtarget level target level target level

*금안2015(Dec)06-부록138~145 2016.2.18 11:26 AM 페이지140

Therefore, while monetary policy responses

are not ruled out, it is insisted that excessive

expansions in credit causing amplified sys-

tem risks should be responded to through

macroprudential policies.

The second opinion is that monetary poli-

cy should respond more actively to financial

imbalances.6) Advocates of this view insist

that monetary policy’s effects on the finan-

cial sector are expanding, and that a mone-

tary policy response is effective in restraining

economic agents’ risk-seeking behavior.

When signs of financial instability occur,

such as credit bubbles for example, then

operation of an excessively accommodative

monetary policy is thus undesirable even in

conditions of real cycle recession, and it is

warned that prolongation of such a stance

can bring about a new financial crisis.

Looking at the policy responses of major

countries that have experienced gaps

between their financial and real cycles since

the global financial crisis, Canada,

Switzerland and the United Kingdom,

among others, have operated accommoda-

tive monetary policies to boost their real

economic activities since the crises, and with

regard to rises in asset prices and increases

in private debt they have strengthened their

macroprudential regulations responding with

monetary policy. In contrast, Sweden,

Norway and others have responded actively

to financial unrest through monetary policy.

In the case of Sweden, notably, it has explic-

itly included risks related to financial imbal-

ances in the considerations of monetary poli-

cy, and in the past set its base rate at a level

higher than that corresponding to real eco-

nomic conditions.

Comparative analysis of the economic

results of these countries’ policy operations

finds that, in the cases of countries that have

responded to financial instability through

monetary policy, the adjustments of their

financial imbalances have generally been

temporary and limited, while the negative

side effects on their real economies have

been considerable. In the cases of countries

that have responded separately with macro-

prudential rather than monetary policies,

they appear to have been able to mitigate

their financial imbalances effectively. Until

now however the cases of such policy opera-

tions have been few, and considering that a

substantial number of countries are in the

early stages of macroprudential policy intro-

duction it is difficult to conclude which opin-

ion is superior.

Considerations in designing an optimaloperational framework

There are close interconnections between

monetary and macroprudential policies, in

terms of their transmission channels and

their policy target variables. And with con-

cerns rising recently about both slumps in

economic activities and financial imbalances

in major countries including Korea, the

designing of operational frameworks for

macroprudential policies and the role of the

central bank in this process are emerging as

very important issues.

In relation to this, in the building of policy

141

[An

nex 1]

6) This opinion is being asserted for example by the BIS and by Reserve Bank of India Governor Rajan.

*금안2015(Dec)06-부록138~145 2016.2.18 11:26 AM 페이지141

operation frameworks going forward the fol-

lowing points will have to be considered.

First, to effectively resolve the problem of

conflicts among policy goals stemming from

the gaps between the real and the financial

cycles, diverse macroprudential policy instru-

ments will have to be secured and put into

active use. Second, while macroprudential

policy can also have effects on the real econ-

omy, it has a more direct effect on credit

expansions for example, and in view of this

should be implemented with a priority put

on the financial stability objective. Third,

given monetary policy’s effects on the finan-

cial sector through the risk-seeking channel,

for example to the credit and asset markets,

it is necessary to consider monetary policy

from the aspect of financial stability as well,

and meticulous consideration as to how the

existing monetary policy framework must be

changed is thus needed. It is important final-

ly to promote harmonious conduct of these

two types of policies, when adjusting their

levels of intensity for example, through the

sharing of understandings of economic and

financial conditions between the monetary

and the macroprudential policy authorities,

and close consultation between them.

142

*금안2015(Dec)06-부록138~145 2016.2.18 11:26 AM 페이지142

Explanation of Terms

(Households)

Mortgage Refinance Program –

Conversion loan products introduced to

ensure that borrowers of home mortgage

loans having variable interest rates or requir-

ing payment of interest only can change

them to fixed interest rate, amortizing loans

Right of preferential payment – A credi-

tor’s right to receive repayment on bonds

prior to other creditors

Disposable income – Income that can be

used for private consumption or savings

Marginal households – Households with

DSRs in excess of 40% and negative (-) net

financial assets (Financial assets – Financial

liabilities)

(Corporations)

Interest coverage ratio – The ratio of

operating income divided by interest expens-

es, used as an indicator measuring capacity

for creation of the income necessary for pay-

ment of interest

Companies at-risk – Companies with

interest coverage ratios and liquidity ratios

(Short-term liquid assets / Short-term liabili-

ties) below 100% simultaneously

Borrowings-to-total assets ratio – Indicator

showing the proportion in total asset of

funding through external borrowings (corpo-

rate bonds included)

Cash flow coverage ratio – Ratio of the

sum of cash flows created through business

activities and interest expenses divided by

the sum of short-term borrowings plus inter-

est expenses

(Banks)

Structural profitability – The ratio of the

sum of interest income, fee income and trust

account income minus operating expenses,

divided by real total assets (average balance

basis), used as an indicator showing banks’

capacities for sustainable profit creation

Common equity capital – Capital that is

not redeemed except at times of bank liqui-

dation (capital, earned surplus, etc.)

Liquidity coverage ratio (LCR) - The ratio

of highly-liquid assets relative to the amount

of net cash outflows possible during 30 days,

indicating a bank’s capacity for autonomous

response to a sudden outflow of liquidity

over such a time frame

(Non-bank financial institutions)

Central counterparty (CCP) – An institu-

tion promoting the alleviation of transaction

counterparty credit risk, through netting the

volumes of settlement between parties con-

ducting over-the-counter derivative transac-

tions, guaranteeing settlement execution, etc.

Structured notes – Financial investment

products issued by securities companies,

which are linked to the price volatilities of

143

[An

nex 1]

*금안2015(Dec)06-부록138~145 2016.2.18 11:26 AM 페이지143

their underlying assets and on which the

investment gains are decided in accordance

with methods determined in advance

(Financial markets)

Global fund – A fund investing 25% or

more of its portfolio composition in securi-

ties overseas

Credit spread – Indicator showing differ-

ences in yields between Treasury bonds and

corporate bonds, in 0.01% units (bp),

through which the risk premiums recognized

by investors can be grasped arithmetically

Prime bonds – Corporate bonds appraised

at credit grades AA- or higher by credit rat-

ing agencies

(Foreign exchange soundness)

CDS (credit default swap) – A credit

derivative product for which the buyer pay

the seller a premium, but instead in the case

of occurrence of default on the underlying

assets or another credit event the buyer

receives from the seller the either amount of

the loss or a set amount of money

CDS premium – Commission paid on the

purchase of a CDS

(Financial market infrastructure)

Large-value payment system – A funds

transfer system that typically handles large-

value and high-priority payments

Retail payment systems – A funds transfer

system that typically handles a large volume

of relatively low-value payments in such

forms as cheques, credit transfers, direct

debits, and card payment transactions

Real-time gross settlement – The real-time

settlement of payments, transfer instructions,

or other obligations individually on a trans-

action-by-transaction basis.

Deferred net settlement – A net settlement

mechanism which settles on a net basis at

the end of a predefined settlement cycle

Continuous linked settlement (CLS) –

Settlement system carrying out simultaneous

settlement, through CLS Bank, of two differ-

ent international currencies exchanged in a

transaction, established to reduce foreign

exchange settlement risk in foreign exchange

transactions that can occur due to time dif-

ferences between countries

(Effects of Population Aging onHousehold Debt, and Potential Risks)

Cohort effect – Phenomenon in which

changes in amounts of financial debt are

similar within generations having similar

socio-economic environments, while showing

differences compared to generations whose

economic conditions and environments are

different

Deleveraging – Contractions in leverage

through reductions in their debts by house-

holds that had previously increased their

leverage (financial liabilities / net assets or

financial liabilities / income) through expan-

sions in their debts

144

*금안2015(Dec)06-부록138~145 2016.2.18 11:26 AM 페이지144

Aging effect – Effect in which the volume

of financial assets held by the same house-

holder changes in accordance with changes

in his/her age

Asset accumulating age population – The

population age bracket (35~59 years of age)

that is accumulating many assets while par-

ticipating actively in economic activities such

as production and consumption, whose lia-

bilities also expand in the process of this

asset accumulation

(Status of Chronically MarginalFirms, and Assessment)

Private equity fund – A private collective

investment scheme investing in and manag-

ing firms’ stocks, bonds, etc. for purposes of

participation in management rights, business

restructuring or improvement of manage-

ment structure, etc.

Chronically marginal firms – Firms that

were marginal firms each year and had also

experienced marginal firm statuses before

then as well since 2005.

Supply of credit – Financial institutions’

direct and indirect transactions accompany-

ing the credit risks on loans, payment guar-

antees and purchases of securities, and other

financial transactions

Marginal firms – Firms that have had

interest coverage ratios (Operating income /

Interest expenses) below 100% for three

consecutive years

Forbearance lending – Financial institu-

tions’ lending even to companies without

loan repayment capacities, achieved by

deferring debt repayment through changes

in contract conditions, extentions of new

loans, etc.

(Effects of Economic Unrest in EMEson Korean External Soundness)

Time-varying coefficient of correlation –

Coefficient of correlation between variables

that changes depending upon the point in

time considered

Taper tantrum - The sharp jumps in

interest rates, declines in stock prices and

other shocks that occurred in the interna-

tional financial markets following the sugges-

tion in May 2013, by U.S. Federal Reserve

Chairman Ben Bernanke, of a possibility of

the Fed’s tapering off its quantitative easing

145

[An

nex 1]

*금안2015(Dec)06-부록138~145 2016.2.18 11:26 AM 페이지145

Contributing Departments & Authors by Section

Section Author

Planning & Coordinating

[Financial Stability Overview]

Box 1

Box 2


I. Financial Soundness of Household and

Corporate Sectors

1. Households

Box I-1

Box I-2

Box I-3

2. Corporations

Box I-4

Box I-5

II. Financial System Stability

1. Banks

Box II-1

Box II-2

2. Non-Bank Financial Institutions

Box II-3

Financial Stability Dep. Byun, Seung Sik

Financial Stability Dep. Lee, Min Gyu

Lee, Kang One·Hong, Jin Shil

Bu, Sang Don·Lee, Ji Hyeon

Financial Stability Dep. Oh, kanghyun·Kim, Sol

Yoon, Hee Jin·Lee, Chae Ryoung

Oh, kanghyun·Lee, Chae Ryoung

Financial Stability Dep. Oh, kanghyun·Kim, Sol

Office of Bank Examination Lee, Ji Hyeon·Han, Kyung Cheol

Financial Stability Dep. Lee, Kang One·Jang, Ha Ju

Hong, Jin Shil

Financial Stability Dep. Lee, Min Gyu·Bu, Sang Don

Lee, Ji Hyeon·Jung, Seo Rim

Bu, Sang Don·Jung, Seo Rim

Lim, Jong Hyuck·Lee, Eun Kook

Financial Stability Dep. Kim, Min Woo·Park, Min Ryul

Kim, Eun Sun·Jin, Bo Bae

Kim, Min Woo·Lee, Chae Ryoung

Jung, Yon Soo·Kang, Soo Youn

Park, Sungmin

Financial Stability Dep. Kim Kyung Sup·Lee, Jang Wook

Lim, Young Ju·Jeong, Sang Beom

Park, Shin Young

*금안2015(Dec)집필진146~147 2016.2.18 12:2 PM 페이지146

Section Author

3. Financial Markets

4. Foreign Exchange Soundness

5. Financial Market Infrastructure

Box II-4


I. Effects of Population Aging on Household

Debt, and Potential Risks

II. Status of Chronically Marginal Firms, and

Assessment

III. Effects of Economic Unrest in EMEs on

Korean External Soundness

[Annex 1] Monetary and Macroprudential

Policy Operational Framework

Explanation of Terms

English editor Office of International Affairs Michael Marking

Advisors University of Pennsylvania Enrique G. Mendoza

University of Chicago Herald Uhlig

Financial Market Dep. Noh, Jin Young·Jeong Hyun Seok

Lee, Chang Min·Chu, Myeong sam

Hong, Jun Yu

International Dep. Baek, Bong Hyun·Jeon, Eun Hee

International Dep. Jung, Sun Young·Lee, Mee Hye

Baek, Yoonah·Kim, Da Ae

Bae, Suk Jin

Payment & Settlement Systems Dep. Son, Min Kun·Kim, Su Jin

Kim, Yong Gu·Choi, Min Woo

Financial Stability Dep. Lee, Bum Ho·Kim, Sol

Yoon, Hee Jin

Financial Stability Dep. Bu, Sang Don·Jung, Seo Rim

Jo, Sung Min

International Dep. Kim, Young Ju·Choi, Ji Eon

Financial Stability Dep. Park, Yang Su·Lee, Jung Yeoun

*금안2015(Dec)집필진146~147 2016.2.18 12:2 PM 페이지147

*금안2015(Dec)판권 2016.2.18 11:27 AM 페이지1

*금안2015(Dec)판권 2016.2.18 12:2 PM 페이지1


Publisher Lee, Juyeol

Editor CHO, Jeonghwan

Published by The Bank of Korea

39, Namdaemunno, Jung-Gu, Seoul, 04531, Korea

www.bok.or.kr

Published on February 23, 2016

Printed by Jeil Printech Co., Ltd.

■ This material is posted on the web-site of the Bank of Korea (http://www.bok.or.kr > Financial Stability > Financial Stability Reports)

■ Please contact Financial Stability Analysis Team, Financial Stability Department, the Bank of Korea (Tel: +82-2-750-6842, Email: [email protected])

■ This book is available at the price of 7,500 won at the book/souvenir shop (+82-2-759-4805) in the Bank of Korea Money Museum or at the Government Publication Center (+82-2-734-6818)

Copyright © THE BANK OF KOREA. All Rights Reserved

ISSN 1975-7042

*금안2015(Dec)판권 2016.2.18 12:2 PM 페이지2


FinancialStabilityR

eport

December 2015

ISSN 1975-7042

m.bok.or.kr

Decem

ber 2015

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Documents

Financial Stability Report · June 2015 to November 2015 as the objects of its analysis. It is hoped that this Financial Stability Report will help financial market participants,