Bank Says Rush To Government Bonds Is Risky

The head of Korea's central bank warned Friday that there are signs of overheating in the government-bond market due to excessive demand for the risk-free assets from local institutional investors.

Chon Chol-hwan, governor of the Bank of Korea, said in a luncheon meeting with local bankers that institutional investors are flocking to the government-bond market in search of smaller investment risks compared with corporate bonds, pushing the long-term bond yields below one-day call rates. In addition, some other investors, with abundant liquidity, are engaged in arbitrage trading for short-term profits.

The craze for the risk-free assets, which shrinks corporations' capital supply, could negatively affect the Korean economy and hurt restructuring efforts, Mr. Chon said.

"The overheated government bond market will eventually correct, and the resulting capital losses will add burdens on financial institutions," he warned.

The governor urged banks to expand corporate lending and manage their loan and deposit rates in a "rational" way.

The benchmark state-bond yield soared after Mr. Chon's remarks. The yield on three-year government bonds jumped by as much as 29 basis points to 5.43 percent in early trading Friday. It stabilized in the afternoon, closing at 5.32 percent, up 18 basis points from Thursday.

"The market reacted sensitively to the governor's comment," said Kim Byung-chul, head of the bond management at Tong Yang Securities Co. "The yield is expected to stay around that level."

by Kim Hyun-chul