Different Ministries and Supervisory Systems: "Same Function, Same Regulation" Principle Needed [Mutual Finance Hindered by Regulation] ④

From Repayment Reserves to Net Capital Ratios,
Prudential Regulations Differ by Institution
Supervisory Authority Also Varies by Ministry
Financial Consumer Protection Act Applies Only to Credit Unions
"Balloon Effect and Increased Ris

Mutual financial institutions perform the same roles in providing community-based and inclusive financial services, but their supervisory frameworks are mixed, resulting in inconsistent application of regulations. For example, the Financial Consumer Protection Act, which is designed to protect financial consumers, applies only to credit unions. If the principle of "same function, same regulation" is not observed, regulatory arbitrage can occur, and as a result, certain assets may flow disproportionately into mutual financial institutions with looser regulations due to the so-called balloon effect.

Different Prudential Regulations and Supervisory Systems... Financial Consumer Protection Act Applies Only to Credit Unions

According to the financial sector on September 12, prudential regulation systems and supervisory frameworks applied to mutual financial institutions vary by institution. First, the mandatory reserve ratio for redemption reserves-funds set aside at the central association to prepare for customer withdrawal demands in the event of liquidity issues-differs by institution. Credit unions and community credit cooperatives are required to hold at least 10% of their deposit and installment savings balances as redemption reserves, with at least 80% of these reserves mandatorily deposited with the central association. Agricultural cooperatives, fisheries cooperatives, and forestry cooperatives must deposit 100% of their redemption reserves with the central association.

For the loan-to-deposit ratio (the ratio of loans to deposits), credit unions, agricultural cooperatives, fisheries cooperatives, and forestry cooperatives must maintain a ratio between 80% and 100%, depending on the proportion of amortized mortgage loans. Community credit cooperatives also have an 80% to 100% range, but those with total loans of less than 20 billion won at the end of the previous quarter are exempt.

The calculation methods for net capital ratio also differ among the five mutual financial institutions, and the standards for accumulating at least 10% of profits as statutory reserves until a certain level relative to equity capital is reached also vary by institution.

Regulations regarding executives, such as auditor qualifications and the term of office for cooperative heads, also differ. The asset requirements for cooperatives subject to external audits range from 30 billion won to over 50 billion won, depending on the institution. Audit cycles also vary: for credit unions and community credit cooperatives (limited to those with assets over 300 billion won), audits are conducted annually; for fisheries and forestry cooperatives, every two years; and for agricultural cooperatives, every four years. The term and reappointment rules for cooperative heads or chairpersons are the same for full-time positions (four years, up to two terms), but for part-time positions, credit unions and community credit cooperatives have a four-year term with up to two reappointments, agricultural and forestry cooperatives have a four-year term with no limit on reappointments, and fisheries cooperatives have a four-year term with one reappointment. The minimum requirements for appointing full-time directors also differ among institutions.

Supervisory authority is also dispersed among various government ministries. Broadly, agricultural cooperatives, fisheries cooperatives, forestry cooperatives, credit unions, and community credit cooperatives are governed by different laws. For community credit cooperatives, a separate supervisory framework has been in place since the enactment of the Community Credit Cooperative Act, distinct from the Credit Union Act. Specifically, for credit unions, the Financial Services Commission is responsible for supervising all business activities and granting establishment approvals, with the Financial Supervisory Service conducting inspections. For agricultural, fisheries, and forestry cooperatives, the Financial Services Commission supervises credit business, but economic business is overseen by the relevant ministries, and establishment approvals are handled by the respective ministries or provincial governors. For community credit cooperatives, the Ministry of the Interior and Safety mainly oversees business supervision, and establishment approvals are handled by local government heads.

This issue is also evident in the application of the Financial Consumer Protection Act, which protects consumers during the sale of financial products. Enacted in 2021, the law guarantees consumers a certain period of withdrawal rights and the right to terminate contracts in case of illegal acts by financial product sellers. Among mutual financial institutions, only credit unions are subject to this law. Other institutions are excluded because the Financial Services Commission does not have the legal authority to supervise their business activities under current law.

"Legal Amendments Needed to Prevent Risk Transfer"

Experts warn that if the same regulations are not applied to mutual financial institutions performing the same functions, there is a risk that certain institutions may face heightened risks.

Koo Junghan, Senior Research Fellow at the Korea Institute of Finance, stated in his report "Establishing the Identity of Mutual Finance and Directions for Reforming the Supervisory System," "There are almost no differences in the credit business among mutual financial institutions," and pointed out, "If the principle of same function, same regulation is not observed in this situation, regulatory arbitrage may occur, causing certain assets to flow disproportionately into mutual financial institutions with relatively looser regulations." This means that if risky assets become concentrated in certain institutions, the risk could rise sharply. Because risk transmission in the financial market tends to occur rapidly, if the asset soundness of a particular institution deteriorates quickly, it would be difficult for supervisory authorities to respond promptly.

As a solution, he suggested enacting new legislation or establishing a dedicated supervisory body. One representative option is to consider enacting a Mutual Finance Basic Act or to establish a Cooperative Agency to unify supervisory authorities, taking into account the characteristics and uniqueness of cooperatives. However, this approach has the disadvantage of requiring a legislative process. Therefore, Koo recommended, "The most practical solution is to amend the Credit Union Act and the Community Credit Cooperative Act so that Article 95 of the Credit Union Act or the 'Mutual Finance Business Supervisory Regulation' also applies to community credit cooperatives."