Foreign Bank Branches Increase Short-Term Borrowing to Purchase Bonds

March Other Investment Borrowing $15.1 Billion... Record High
Foreign Bank Branches Invest in Bonds and Lend to Securities Firms with Cheap Foreign Currency Funding
Some Induced by Regulatory Easing... Impact on Increasing Dollar Supply

[Image source=Yonhap News]

[Asia Economy Reporter Kim Eunbyeol] In March, when the financial market was shaken by the aftermath of the novel coronavirus infection (COVID-19), it has been revealed that foreign bank branches in Seoul significantly increased short-term borrowing to purchase bonds.

According to the provisional balance of payments for March 2020 announced by the Bank of Korea on the 7th, borrowing under other investment liabilities increased by $15.1 billion in March. This is one of the largest monthly borrowing amounts ever recorded, with borrowing increasing nearly 20 times compared to February. Among these, the increase in short-term borrowing maturing within one year reached $14.14 billion. Even during the foreign exchange crisis, short-term borrowing did not increase to this extent.

The Bank of Korea estimates that a significant portion of this was used for domestic bond investments or securities company loans through foreign bank branches. Lee Hyunjin, head of the international balance of payments team at the Bank of Korea's Economic Statistics Bureau, said, "Based on internal analysis, it was found that foreign bank branches mainly borrowed rather than domestic banks," adding, "They covered foreign currency demand through short-term borrowing." This means that it was not domestic banks increasing leverage that borrowed, but foreign bank branches engaging in arbitrage by purchasing bonds through foreign currency borrowing.

Foreign bank branches have historically earned profits through arbitrage in Korea during crises. This is because they can generate arbitrage profits by exploiting the difference between spot and forward exchange rates (swap rates) and the interest rate differential between domestic and foreign rates. Foreign bank branches procure dollars and convert them into Korean won in the swap market to invest in domestic bonds. By purchasing government bonds using the interest rate differential and swap rate difference, they can conduct risk-free arbitrage that guarantees minimum profits, thus generating risk-free net income. In particular, March saw a significant widening of swap rates, creating favorable conditions for arbitrage.

An official from a foreign bank explained, "When there is a dollar shortage, it is common business practice to bring in dollars from overseas more easily and invest in bonds through arbitrage," adding, "This is a typical business that appears when dollars are scarce." During the 2008 financial crisis, foreign bank branches in Korea also earned high profits.

Although foreign bank branches tend to make money during crises, this time the Bank of Korea also encouraged this. If even foreign bank branches, which have the capacity to supply foreign currency, did not bring in dollars, the exchange rate could have completely skyrocketed.

In fact, in March, the government expanded the forward exchange position limits for banks by 25%. The forward exchange position limit for domestic banks was raised from 40% to 50%, and for foreign bank branches from 200% to 250%. Choi Heegwon, head of the Bank of Korea's International General Team, said, "Because dollar supply was very important, regulations were relaxed, and it can be interpreted that foreign bank branches increased borrowing according to this intention." He added, "Regulations may be further relaxed or reversed depending on market conditions, but it is still too early to talk about reversing the regulations."

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