Reserves jacked up to bolster banks

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Reserves jacked up to bolster banks

As risks in the euro zone escalate, financial authorities are prompting Korea’s banks to drastically increase their buffers against a liquidity crunch.

With a downturn in the Korean economy expected by analysts and government officials, local regulators have intensified reserve requirements for the banking sector despite several measures already in place to stave off a shortage of foreign currency and local banks’ limited exposure to beleaguered European banks.

Meanwhile, the price of insuring Korea’s government debt against the risk of default was on the rebound again as investor perception soured last week against strong European economies such as Germany.

The Financial Supervisory Service has recently advised local commercial banks to greatly expand their loan-loss reserves for bad debt.

An earlier requirement to increase reserves by an extra 300 billion won ($262 million) per bank to protect against debt write-offs has been increased to a whopping 1.8 trillion won at maximum, some six times the previous level.

“We are preparing for full-blown contagion from the European crisis by having banks pile up more loan-loss reserves for bad debt than was previously required,” said an FSS official.

More defaults are expected next year if Korea’s economy hits a wall in terms of growth due to a global slowdown.

“Looking at the default rates of household or small business loans, the ratio of bad debt is expected to increase by a considerable margin next year compared to this year,” Han Dong-woo, chairman of banking group Shinhan Financial Group, recently said. “As the global economy will likely undergo difficulties for the next two years, there must be larger loan-loss reserves for bad debts.”

In fact, the third-quarter net profits of four major banking groups’ holding companies - KB Financial, Woori Finance, Shinhan Financial and Hana Financial - have shrunk by more than 200 billion won collectively from the previous quarter, with even worse showings expected in the fourth quarter and throughout next year.

Although Korea has reduced its borrowing from shaky European banks to $180 billion as of June, down from $240 billion in early 2008, the nation’s overall cost of borrowing is on the rebound as investor confidence deteriorates.

According to the Korea Center for International Finance, the spread on credit-default swaps (CDS) for Korean government bonds closed at 177 basis points on Friday’s market close in New York.

The CDS spread, which tracks investors’ perceived costs of insuring Korea’s government bonds against default, had reached 229 basis points on Oct. 4 during increased financial volatility, and then bottomed out at 127 basis points on Oct. 28 before rising again to its current levels.

Analysts attribute the change to the euro zone crisis.

Days after even Germany, one of the strongest economies in Europe, had trouble selling government debt, government debt on sale last week from both Spain and Italy faced high interest rates and lackluster demand. Global credit ratings agencies also cut the sovereign ratings of both Hungary and Belgium.

By Lee Jung-yoon []

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