"Persuaded by Government"... Bank of Korea Considers Direct Loans to SPV

Government: "KDB's Burden Is Too Heavy... Direct Loans Are Better for Liquidity Supply Efficiency"
Government Guarantee Scale Is Key... Announcement Coming Soon

[Image source=Yonhap News]

[Asia Economy Reporters Eunbyeol Kim and Sehee Jang] The Bank of Korea is once again gaining momentum for a plan to directly lend to a special purpose vehicle (SPV) that purchases low-credit-rated corporate bonds and commercial papers (CP). This approach is essentially the same as that of the U.S. Federal Reserve (Fed). Initially, within the Bank of Korea, there was a preference for an 'indirect lending SPV' method, where the state-run Korea Development Bank (KDB) would lend most of the SPV’s funds, and KDB would use the money borrowed from the Bank of Korea to purchase corporate bonds and CP. However, as KDB’s financial burden has increased due to its participation in various government support programs responding to COVID-19, the government has shifted its stance toward having the Bank of Korea directly lend to the SPV.

According to Bank of Korea and government officials on the 15th, government representatives have recently been persuading the Bank of Korea to 'directly lend to the SPV.' A government official said, "It is too burdensome for KDB to handle the entire 20 trillion won SPV scale," adding, "It is more efficient for the central bank to supply liquidity in cooperation with the government." The Bank of Korea also holds the view that direct lending is not impossible. In recent meetings regarding the establishment of the SPV, the Bank of Korea conveyed to the government that "the establishment of an SPV with a direct lending method is possible on the premise that a 'payment guarantee' is firmly secured." The government and the Bank of Korea are currently finalizing details and plan to announce the SPV establishment plan soon.

The key issue is the payment guarantee that the Bank of Korea requires as a premise. The payment guarantee can be understood as the amount that the government will cover first in case of losses on corporate bonds or CP purchased by the SPV. For example, assuming an SPV scale of 20 trillion won, if the government provides a payment guarantee of about 20%, the government would cover 4 trillion won, and the Bank of Korea would bear 16 trillion won using its issuance power. If losses occur, the first 4 trillion won would be absorbed by the government. If losses exceed 4 trillion won, the Bank of Korea would bear the excess. Although the probability is low, the Bank of Korea could potentially incur losses by purchasing poor-quality corporate bonds and CP with money it issued.

A Bank of Korea official said, "In accordance with the principle of minimizing losses, the Bank of Korea must request an appropriate scale of payment guarantee," adding, "The government also agrees on the necessity of the payment guarantee and is currently discussing the specific required scale." If the payment guarantee amount the government can bear is less than expected, the proportion of low-credit-rated corporate bonds that the SPV can purchase must be reduced. Reducing the overall SPV scale could also be an alternative.

If KDB acts as the conduit bank (a pipeline role supplying funds), the Bank of Korea can bear up to 90% of the loan amount (indirect lending). Assuming a 20 trillion won SPV, the Bank of Korea would lend 18 trillion won to KDB. The government’s equity contribution would decrease from 4 trillion won to 2 trillion won. Since losses would be transferred to KDB, the logic is that the loan amount backed by issuance power can be increased.

KDB’s Basel III ratio last year was 14.05%, and lending to companies affected by COVID-19 could further lower this ratio. This is why the government is considering capital reinforcement for KDB.

Ultimately, the direction will be finalized depending on how the government judges the SPV payment guarantee amount. The government plans to announce the third supplementary budget bill in early June, which will include the SPV payment guarantee (or equity contribution) amount and KDB’s capital reinforcement amount. There is also a possibility that the SPV structure will be announced before the supplementary budget bill is finalized.

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