FSS takes on swings in FX

Korean banks will be required to allocate at least 2 percent of their foreign currency assets in safer investments like U.S. Treasuries and make more investments easily convertible to cash to improve their liquidity in a funding crunch.

The Financial Supervisory Service yesterday laid out the new rules, which take effect in July 2010, and also put more restrictions on local exporters trying to hedge against future currency swings through currency forward contracts.

According to the new rules, the banks will be required to invest at least 2 percent of their foreign currency assets in what are considered the safest investments, including government bonds rated A or higher and corporate bonds rated A or higher.

“Many financial companies responded to the latest foreign liquidity crisis by largely relying on government assistance,” the agency said in a statement. “The minimum requirement will help make sure the financial companies can respond on their own in times of a liquidity crunch in the future.”

Concerns over Korean lenders’ ability to pay back foreign currency debts were a major culprit behind the Korean won’s massive loss against major currencies earlier this year. Korean exporters’ heavy exposure to risky currency forward contracts - agreements to buy or sell assets at current prices for delivery at a specified future time - later went sour and further fanned market uncertainties.

Seoul regulators, in order to fend off such turbulence that may arise in the future, said they also want to ban local exporters from making currency forward contracts worth more than 125 percent of their actual trading amount. For instance, a shipbuilding company that exports about $100 million in goods every year will be allowed to make the forward contracts worth only up to $125 million a year to hedge against possible losses due to currency swings.

The FSS also said it would require banks to secure more sources for long-term financing, as lenders have often borrowed extremely short-term loans from third parties or issued equally short-term bonds to finance their own lending operations for customers. Exposure to such short-term obligations was also said to have worsened turbulence in the financial market earlier this year.

The banks will also be required to gauge the liquidity of foreign currencies in their asset portfolio more rigorously. For instance, foreign currency-denominated assets in the form of B-rated corporate bonds will be given less liquidity weight than A-rated Treasuries, while stocks of listed companies will be given more liquidity weight than unlisted stocks.

By Jung Ha-won [hawon@joongang.co.kr]