BOK "Direct Purchase of Corporate Bonds and CP Difficult to Implement Without Information Department Approval" (Comprehensive)

"Central Bank Should Not Bear Loss Risks That Burden the People"

[Image source=Yonhap News]

[Asia Economy Reporter Kim Eun-byeol] Despite growing concerns over credit crunches among companies due to the impact of the novel coronavirus disease (COVID-19), the Bank of Korea (BOK) has ultimately determined that it is difficult to directly purchase risky assets such as commercial papers (CP) or corporate bonds. The BOK maintains that indirect financial support, as done in the past, is fully possible, but it is unreasonable for the central bank to directly bear the risk burden.

On the 23rd, the BOK stated, "As a central bank exercising the issuing authority granted by the people, it must operate under the fundamental principle that it should not bear loss risks that become a burden to the people during policy implementation," adding, "It is difficult to view the designation of corporate bonds and CPs that do not meet liquidity and safety requirements as securities eligible for open market operations as consistent with the purpose of the Bank of Korea Act."

It also emphasized, "Direct purchase of corporate bonds or CPs by the BOK is difficult to implement without government guarantees due to the provisions of Article 79 of the Bank of Korea Act, which prohibits the purchase of bonds issued by the private sector," and noted, "Even the U.S. Federal Reserve (Fed) purchases CPs under government payment guarantees."

Recently, as the bond market showed signs of instability, BOK officials re-examined whether the purchase of CPs or corporate bonds is legally possible under the Bank of Korea Act. According to Article 68, Paragraph 1 of the Act, the assets that the BOK can purchase are government bonds, government-guaranteed bonds, and securities designated by the Monetary Policy Committee. Therefore, it was interpreted that with only the Monetary Policy Committee's resolution, the BOK could purchase risky assets such as CPs and money market funds (MMFs), which raised market expectations. Especially, given that the damage caused by COVID-19 is more severe than during the 2008 financial crisis, there was a sentiment that the BOK should take a magnanimous stance.

However, issues of stability and liquidity ultimately held back such moves. Article 68, Paragraph 2 of the Bank of Korea Act stipulates that "each security must be freely tradable and fully comply with issuance conditions." A BOK official explained, "Paragraph 2 is interpreted to mean 'securities with absolutely no risk,'" and the review concluded that due to Paragraph 2, it is difficult for the BOK to directly purchase CPs or corporate bonds. The official added, "This is similar to the requirement for eligible collateral when lending to financial institutions (Article 64)."

Therefore, the market is left waiting for the decision on the target assets for the Corporate Bond Stabilization Fund (Cha-an Fund). The size of the Cha-an Fund is reported to be at least 10 trillion won plus alpha (α), but experts agree that this amount is insufficient. Yoon Won-tae, a researcher at SK Securities, said, "The amount of corporate bonds maturing before June is 2.5 trillion won, and CPs and short-term notes total about 25 trillion won, reaching a total of 28 trillion won," adding, "Even conservatively assuming a 50% default rate, the Cha-an Fund should be at least about 15 trillion won for the market to feel secure."

The BOK's position is that additional support is possible as long as it does not involve direct funding to companies. This is similar to the situation in 2016 when the government and the BOK prepared funds for industrial restructuring in sectors such as shipbuilding. At that time, although the political circles demanded that the BOK directly provide financial support, the BOK insisted that fund formation was only possible with government guarantees. An industry insider said, "Ultimately, the issue is who will bear the losses if the worst-case scenario occurs."

Meanwhile, at the emergency economic meeting chaired by President Moon Jae-in on the 24th, financial market stabilization measures such as the Corporate Bond Stabilization Fund and the Securities Market Stabilization Fund (Jeung-an Fund) are expected to be announced. Specifically, measures under consideration include the establishment of the Cha-an Fund and the Securities Market Stabilization Fund (up to 10 trillion won), and the preparation of a program for bond-backed securities (P-CBO) worth 6.7 trillion won.

This content was produced with the assistance of AI translation services.