[Square] Beyond Same Function-Same Regulation to the Same Safety Net

As large information technology companies have become more active in providing financial services recently, the principle of "same function, same regulation" has come to the forefront. If big tech companies are effectively offering financial services identical to those of traditional financial institutions, then regulation and supervision should be conducted at the same level. However, the importance of financial regulation and supervision needs to be viewed from a broader perspective of the financial safety net.

The necessity of regulation and supervision of the financial industry, and furthermore the financial safety net, stems from the inherent instability embedded in financial intermediation activities. Banks, as representative financial institutions, inherently carry liquidity risk due to maturity mismatch, operating short-term liabilities such as deposits into long-term assets like loans. If, for any reason, a large-scale repayment demand arises from holders of short-term liabilities (depositors), the resulting liquidity crisis at banks can spread into systemic instability across the financial system. The central bank’s role as the lender of last resort was established to provide emergency funding support to banks in such bank run situations, and the deposit insurance system was created to suppress sudden withdrawal demands from depositors. The roles of the central bank and deposit insurance organizations are essential components of the financial safety net, alongside regulation and supervision.

The history of finance is also a history of financial crises caused by delays in the introduction of appropriate regulation and financial safety nets in response to new financial innovations. In the United States, during the free banking era in the mid-19th century, the problem of excessive issuance of banknotes by private banks was addressed by the enactment of the National Bank Act in 1863, which effectively prohibited private banknote issuance. Banks’ efforts to circumvent this regulation led to the financial innovation of demand deposits. Although demand deposits, as short-term liabilities, functioned similarly to private banknotes of the free banking era and carried the same inherent risks, insufficient regulation and safety nets caused repeated financial panics and bank runs. This was ultimately resolved with the establishment of the Federal Reserve System and the Federal Deposit Insurance Corporation in the early 20th century.

Similar cases have recurred. Decades later, with changes in the financial environment, shadow banking?non-bank financial intermediation performing bank-like intermediary functions but outside the banking regulatory framework?emerged. Although different in form from bank deposits, short-term liabilities such as RP (repurchase agreements) and ABCP (asset-backed commercial paper), which effectively perform almost identical functions, were used to raise funds and invest in long-term assets like MBS (mortgage-backed securities). When the housing market declined, short-term debt holders in the capital markets refused to roll over their maturities and demanded repayment, triggering the 2008 financial crisis.

In short, the reason the 2008 financial crisis occurred was the absence of the same regulation for the same functions, and the difficulties in crisis response were due to the lack of the same safety net for the same functions. Under the financial safety net, which was primarily organized around banks at the time, the Federal Reserve crossed the boundaries of legal and regulatory norms by establishing separate lending facilities to support the non-bank sector, and the Federal Deposit Insurance Corporation had to implement emergency measures such as debt guarantee programs to ensure the stability of non-deposit liabilities outside the deposit insurance system.

Although regulation of non-bank financial intermediation has been strengthened since the crisis, the safety net remains inadequate. Due to opposition to bailouts during financial reform, the central bank’s authority to provide funding support to the non-bank sector has actually weakened, and deposit insurance organizations can only provide limited guarantees for non-deposit short-term liabilities. In Korea, the deposit insurance organization effectively lacks any preemptive funding support function for the non-bank sector.

Moreover, recent ongoing financial innovations pose additional challenges. Big tech companies are participating in payment services through prepaid funds similar to deposits, and overseas virtual asset issuers are expanding the issuance of stablecoins, which are similar to deposits. The principle of same regulation and same safety net for the same functions remains equally important here. Recently, a U.S. presidential advisory council proposed limiting stablecoin issuers to banks (same regulation) and incorporating them into the deposit insurance system (same safety net), reflecting this very intent.

Preemptive protection for bank deposits, guarantees for non-deposit short-term liabilities in emergencies, and protection for big tech companies’ prepaid funds and stablecoins can all be understood as the same safety net for the same functions. Furthermore, all of these are tasks for deposit insurance organizations in responding to the instability of short-term liabilities inherent in financial intermediation activities.

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