Bank LCR Relaxation Faces Extension Crossroads... Interest Rate Hike as a Variable (Comprehensive)

"With the First Step Taken in Base Rate Hike, LCR Normalization Phase May Follow"

[Asia Economy Reporter Park Sun-mi] The liquidity coverage ratio (LCR) relaxation measures in the banking sector, scheduled to end late next month, are at a crossroads for potential extension. Market observers believe that if the maturity extension and interest repayment deferral measures for small business owners are further extended due to the resurgence of COVID-19, the LCR relaxation measures for banks are also likely to be extended. However, since the base interest rate hike has taken its first step to withdraw the excessive liquidity released into the market, there is cautious speculation that the normalization phase may begin immediately.

According to the financial industry on the 31st, as of the end of the second quarter, the LCR of the four major commercial banks is hovering around 90%. Shinhan is the lowest at 88.97%, followed by Woori (90.05%), KB Kookmin (90.95%), and Hana (91.27%). In 2019, the LCRs of the four major banks were all above 100%: Shinhan (106.1%), Woori (107.2%), KB Kookmin (105.8%), and Hana (107.1%).

However, in April last year, financial authorities relaxed the LCR regulatory level from the existing 100% to 85% through the ‘Financial Regulation Flexibility Measures in Response to COVID-19,’ and after two extensions of the relaxation measures, it currently remains around 90%. The LCR is an indicator that measures whether a bank holds sufficient liquid assets to withstand a crisis for one month. The higher the ratio above the 100% benchmark, the more sound the bank is considered; the lower it is, the more vulnerable it is to crises. A low LCR also implies a reduced lending capacity.

If the LCR does not meet the benchmark, banks must secure additional high-quality liquid assets by issuing bank bonds, certificates of deposit (CDs), or expanding time deposit receipts.

The financial market leans toward an extension of the LCR regulatory relaxation for banks. This is because the maturity extension and interest repayment deferral measures for small business owners, which are set to expire next month, are highly likely to be extended for the third time. The temporary relaxation of the LCR in the banking sector was part of the financial regulation flexibility measures in response to COVID-19, with both measures starting simultaneously last year. Furthermore, the LCR relaxation allows banks to actively utilize their high-quality liquid assets to expand financial support for the real economy, including small and medium-sized enterprises and small business owners, during the COVID-19 crisis response.

The variable is the Bank of Korea’s base interest rate hike. Last week, the Bank of Korea raised the base rate by 0.25 percentage points, revealing a significantly changed perspective of financial authorities on the economy.

When LCR Normalizes to 100%, Required High-Quality Liquid Assets in Banking Sector Estimated at Around 24 Trillion KRW

Yoon Won-tae, a bond researcher at SK Securities, explained, "The LCR relaxation policy was a liquidity expansion policy with the same purpose as the Bank of Korea’s base rate cut," adding, "It was a monetary easing policy in the same context, saying, ‘Since the Bank of Korea lowered the base rate to expand market liquidity, commercial banks should also release their high-quality liquid assets into the market.’" This means that the Bank of Korea’s monetary policy normalization was interpreted as having the same policy direction as LCR normalization.

If the LCR relaxation measures completely end next month, banks will need to secure high-quality liquid assets, so the financial market is closely watching the speed of LCR normalization. This is because if bank bonds to secure high-quality liquid assets are issued massively all at once, it could burden the financial market.

Researcher Yoon said, "If the bank LCR normalizes to 100% all at once, the high-quality liquid assets required by commercial banks are estimated to be around 24 trillion KRW," adding, "However, if the LCR is raised by 5 percentage points every six months, banks would need to increase high-quality liquid assets by about 10 to 13 trillion KRW (about 2 to 4 trillion KRW per individual bank), so it would not cause a major shock."

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