[Square] Purpose of Introducing the Financial Group Supervision Act

Jaeyeon Lee, Deputy Director of Korea Institute of Finance

The Financial Group Supervision Act, which was automatically discarded with the end of the 20th National Assembly, has been resubmitted to the 21st National Assembly. It has been six years since the IMF pointed out the inadequacy of integrated risk management for financial groups in its 2014 Financial Sector Assessment Program (FSAP), but legislation has been slow. However, the introduction of the financial group supervision system, which began in earnest in 2015, has achieved some results and has been piloted using model guidelines since the fall of 2018, though it has limitations in effectiveness.

Financial companies provide financial services using customers' funds, so if they become insolvent, not only shareholders but also customers can suffer significant losses. Furthermore, if customer trust is lost, the intermediation function of funds may be interrupted, causing serious difficulties in economic activities. Accordingly, supervisory authorities have established a regulatory system stronger than that of other industries to protect financial consumers by preventing insolvency of financial companies and to ensure the stable development of the financial industry. Major financial regulations include financial soundness regulation, governance regulation, and disclosure regulation.

Financial soundness regulation requires financial companies to hold sufficient capital to absorb unexpected losses. By sector, banks and savings banks must maintain a capital adequacy ratio (BIS ratio) against risk-weighted assets, insurance companies must maintain a solvency margin ratio against net assets, and financial investment companies must maintain a net capital ratio (NCR) against total risk amount, each above a certain level.

Governance regulation requires financial companies to maintain fair and transparent governance to minimize conflicts of interest among stakeholders, thereby securing soundness and profitability. It also strengthens accountability to safely manage customers' assets and secure customer trust. In particular, since the government can protect customers in the event of insolvency of financial companies, the scope of stakeholders expands to include customers, the government, and taxpayers. In Korea, the Act on the Governance of Financial Companies was enacted in July 2015.

Disclosure regulation requires financial companies to transparently disclose all matters related to soundness, including financial soundness and governance. This induces sound management of financial companies through market functions.

The problem with financial supervision is that the regulatory system applied to a single financial company cannot be directly applied to financial groups. In the case of financial groups, even if each subsidiary holds sufficient capital to absorb losses, it may not be sufficient for the group's overall required capital. This is because the capital of individual subsidiaries invested in other subsidiaries is counted twice (double gearing) within the group.

Also, even if other subsidiaries are not obligated to compensate for the debts of an insolvent subsidiary, reputational risk increases, which can expand losses for the entire group.

This Financial Group Supervision Act includes necessary regulations for financial group supervision such as financial soundness regulation, governance regulation, and disclosure regulation. Accordingly, when calculating the capital size required to absorb losses to secure financial soundness, financial groups must exclude investment capital between subsidiaries and reflect various risks within the group.

Additionally, the calculation methods for required capital ratios, which differ by sector such as banks, insurance companies, and financial investment firms within the group, must be unified. Furthermore, a governance system to prevent risk occurrence within the group in advance must be established. Some financial groups have even more complex structures including non-financial companies.

The National Assembly is expected to focus on discussing the purpose of introducing this law. Some view it as a chaebol reform law because some conglomerates are included in the scope of application and it is promoted within the framework of the three fair economy laws. However, I want to emphasize that this bill is being introduced to align with international financial group supervision directions, to apply financial group supervision currently only applied to financial holding companies to other types of financial groups, thereby eliminating regulatory arbitrage and enhancing supervisory effectiveness. I sincerely hope the bill will be passed quickly so that discussions on improvement measures can be actively conducted starting next year.

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