[Column] Preemptive measures to stop a financial crisis

2023. 3. 20. 20:17
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We need a contingency plan to prepare for a scenario in which the current crisis turns into a global crisis and affects the Korean financial market.

Shyn Yong-sang

The author is the director of the Financial Risk Research Center at the Korea Institute of Finance. The bankruptcy of Silicon Valley Bank (SVB) of the United States and the crisis of Credit Suisse (CS) of Switzerland have thrown the global financial market into chaos. To stop the spread of risks and resolve market unrest, central banks of the two countries are making every effort possible. They are doing so because if the situation is not resolved early, the crisis can spread to other major financial markets, prompting a global crisis and the countries’ reputations as financial hubs will collapse. Financial markets appeared to be stabilized, but concerns of a liquidity crunch and additional insolvencies still linger for smaller banks with low credit ratings. Although Korean financial market had few direct transactions with the banks, it had also temporarily experienced an alarming fluctuation.

The SVB crisis took place when a bank run was triggered by its massive loss from Treasury bonds due to a rapid rise of the benchmark rates. It was a liquidity crisis triggered by a specialized banking business model. On the other hands, the case of CS was caused by the loss of investments accumulated over several years, in addition to the largest shareholder’s decision to stop investment. Furthermore, trust issues contributed to the crisis.

The speedy responses of the two countries’ governments apparently contained the crises of the two banks. The situation had a limited impact on the Korean financial market. As Korean banks have different asset and debt structures from the two banks and their liquidity and soundness situations are healthy, they have the ability to respond to shocks.

And yet, it is extremely important to stress that we should be ready for a possible emergency. It is especially true because inflation has not stabilized as soon as expected and high interest rates are likely to remain for some time. The government and financial authorities are mulling preemptive measures to stabilize the financial market in preparation for a possible crisis.

We need a contingency plan to prepare for a scenario in which the current crisis turns into a global crisis and affects the Korean financial market. We also need a macroprudential plan so that a similar crisis will not take place in Korea. For an immediate response, the top priority will be strengthening the crisis response abilities of domestic banks. Along with efforts to increase capital to counter an abrupt credit crisis, we need to think about introducing a special reserve system to counter bad loans. Furthermore, we need to increase the ceiling limit for depositor protection in proportion to the growth of economy and financial assets.

It is also necessary to prepare for possible instability in the foreign exchange market. The market has contracted due to the expansion of the current account deficit and higher interest rates. In this circumstance, we need to strengthen monitoring over the Korean financial institutions’ foreign currency reserves and their ability to supply U.S. dollars and strengthen global cooperation to stabilize the financial market to prevent the global financial instability from causing a supply crunch of foreign currencies and disrupting foreign exchange rates.

Regarding the real estate project financing (PF) market — the weak link of the Korean economy — we need to think about securing additional channels for liquidity and properly manage regional savings bank, real estate trust companies and asset management companies that have largely invested in low-credit constructors and high-risk projects in order to prevent recurrence of a liquidity crisis. We also must think about plans to boost the venture capital ecosystem to support new industries and start-ups, which will likely suffer from funding shortages. We also need to offer customized support plans for each growth stage so that efforts to expand growth engines for innovative finance based on data and platforms will not be discouraged.

From a mid- to long-term perspective, a macroprudential measure is necessary to prevent a similar crisis from taking place in Korea. First, banks must secure multiple fund supply channels and introduce their business models to diversify their operation and profit structures in order to spread the risks. They also need to put efforts to improve their structures of loan products by increasing the ratio of fixed-rate loans.

Furthermore, banks need to strengthen the internal control system. SVB and CS both had suffered a serious lack of internal control and moral hazard. To restore public trust, bank must make efforts to establish strict internal control systems and enforce stronger rules for prior disclosure of internal trades.

Translation by the Korea JoongAng Daily staff.

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