[Song Seungseop's Financial Light] How Does the Government Stabilize Financial Markets?

Struggling to Resolve Legoland and Call Option Non-Exercise Crisis
'50 Trillion Won Plus Alpha' Support Plan Released After One Month
6 Trillion Won Indirect Support from Bank of Korea in 4 Days
Additional 2.8 Trillion Won Measures Amid Continued Short-Term Money Market Instability

Editor's NoteFinance is difficult. Confusing terms and complex backstories are intertwined. Sometimes, you need to learn dozens of concepts just to understand a single word. Yet, finance is important. To understand the philosophy of fund management and consistently follow the flow of money, a foundation of financial knowledge is essential. Therefore, Asia Economy selects one financial issue each week and explains it in very simple terms. Even if you know nothing about finance, you can immediately understand these 'light' stories that turn on the bright 'light' of finance for you.

On the 23rd of last month, Lee Bok-hyun, Governor of the Financial Supervisory Service, Lee Chang-yong, Governor of the Bank of Korea, Deputy Prime Minister for Economy Choo Kyung-ho, Financial Services Commission Chairman Kim Joo-hyun, and Chief Presidential Secretary for Economic Affairs Choi Sang-mok posed before the start of the 'Emergency Macroeconomic and Financial Meeting' held at the Banking Hall in Jung-gu, Seoul. Photo by Yoon Dong-joo doso7@

[Asia Economy Reporter Song Seung-seop] The domestic financial market is shaken by the ‘Gangwon-do Legoland’ incident and the ‘insurance industry’s non-exercise of call options.’ [Related articles: How Kim Jin-tae and Legoland shook the financial market, Insurance industry's new capital securities 'call option' non-exercise... unstable financial market] The government and financial authorities are issuing successive measures to stabilize the market. However, due to difficult terminology, it is hard to easily understand what these measures are. What are the market stabilization measures the government is planning?

The first major measure was announced on the 23rd of last month. It came about a month after Kim Jin-tae, Governor of Gangwon-do, announced his intention to file for rehabilitation with the court against Jungdo Development Corporation (GJC), which is in charge of the Legoland project. Meanwhile, investors who could not properly recover promissory notes guaranteed by the state closed their wallets. If investments do not proceed properly, companies find it difficult to secure funds. Therefore, the government and financial authorities devised measures to secure liquidity.

At that time, Deputy Prime Minister and Minister of Economy and Finance Choo Kyung-ho, Bank of Korea Governor Lee Chang-yong, Financial Services Commission Chairman Kim Joo-hyun, Financial Supervisory Service Director Lee Bok-hyun, and Presidential Office Economic Secretary Choi Sang-mok?all heads of economic and financial authorities?gathered in one place. At the ‘Emergency Macroeconomic Financial Meeting’ held, a plan was announced to expand the liquidity supply program by 50 trillion won plus alpha (+α).

First, 20 trillion won will be injected into the ‘Bond Market Stabilization Fund (BMSF).’ The BMSF was first established in November 2008 during the Lehman Brothers crisis. When companies faced financial difficulties, 91 financial institutions pooled funds to create 10 trillion won. At that time, the fund purchased corporate bonds or promissory notes that were not selling in the market to supply funds. When the financial market fluctuated due to COVID-19 in 2020, 20 trillion won was re-established for the BMSF, and 1.6 trillion won remained unused. Given the urgent situation, the government started purchasing bonds and promissory notes using this 1.6 trillion won.

Capital Call has also been actively executed since early this month, with plans to raise additional funds if necessary. Capital Call is an investment method where money is drawn as needed. Instead of collecting all the targeted investment funds and then executing investments, only part of the investment funds are collected and invested, and additional investment demands are met immediately when they arise. The BMSF operates using the Capital Call method.

The ‘Corporate Bond and Commercial Paper (CP) Purchase Program’ will also be expanded from 8 trillion won to 16 trillion won. This decision came 11 days after increasing from 6 trillion won to 8 trillion won on the 12th of last month. The corporate bond and CP purchase program was created in March 2020 when COVID-19 began. While the BMSF was funded by contributions from private financial companies, the corporate bond and CP purchase program is led by policy financial institutions. The Korea Development Bank, Korea Credit Guarantee Fund, and IBK Industrial Bank participate.

The corporate bond and CP purchase program is divided into several sub-programs depending on the supporting institutions and methods. The purchase program by KDB and IBK increased from 5.5 trillion won to 10 trillion won. Also, while previously only CPs issued by general companies were purchased, CPs issued by financial companies will now also be purchased to stabilize the market. The Korea Credit Guarantee Fund will secure an additional 5 trillion won separately from the existing 600 billion won program budget. It will focus on purchasing corporate bonds of small and medium-sized enterprises. Considering market conditions, support for construction companies and specialized credit finance companies will also be pursued.

Photo by Getty Images Bank

3 trillion won will be provided to securities companies facing liquidity shortages. Securities companies have invested heavily in project financing (PF) - asset-backed commercial paper (ABCP). Securities companies also lent money for the construction of Gangwon-do Legoland, using the PF-ABCP method. However, as they failed to recover the funds, some securities companies faced temporary liquidity shortages. For these securities companies, Korea Securities Finance provides liquidity support using its own resources.

The support methods include repurchase agreement (RP) transactions with securities companies and securities-backed loans. In other words, money is lent under specific conditions. However, providing funds to securities companies can raise moral hazard concerns. They earn good profits through high-risk methods but receive state support when a crisis occurs. Therefore, when lending money, interest rates are set higher than market rates. The support also considers the securities companies’ capacity and urgency.

Guarantee support by the Housing and Urban Guarantee Corporation (HUG) and Korea Housing Finance Corporation will be provided on a scale of 10 trillion won. As the real estate PF market freezes, lenders are reluctant to lend even to high-quality projects. Therefore, HUG and Korea Housing Finance Corporation will each provide guarantees worth 5 trillion won.

Lee Chang-yong, Governor of the Bank of Korea. / Photo by Dongju Yoon doso7@

Four days later, the Bank of Korea announced measures. It decided to supply a total of 6 trillion won in liquidity by purchasing repurchase agreements (RPs) from securities companies and others. A repurchase agreement is a financial product where the seller agrees to repurchase the security at a predetermined price after a certain period. The Bank of Korea adjusts liquidity by buying and selling RPs. When the Bank of Korea buys RPs and lends money to securities companies, liquidity naturally increases in the market.

Various indirect support measures were also introduced. Banks borrow money from the Bank of Korea by pledging collateral. Usually, only government bonds or bonds guaranteed by the government are accepted as collateral. However, the scope of bonds accepted as collateral will be expanded to include bank bonds and public institution bonds. This allows banks to pledge more bonds and borrow more money. The Bank of Korea analyzed that this measure could enable banks to secure an additional liquidity asset scale of up to 29 trillion won.

Although the bond market has somewhat stabilized due to the announcements by financial-related institutions, the short-term money market remains unfavorable. The problematic PF-ABCP has a short maturity of 1 to 3 months. Companies must continuously issue new promissory notes to repay funds, but small and medium-sized companies are struggling with refinancing. Although the PF-ABCP of small companies accounts for about 1.5 trillion won, which is not a large share, its rating is A2, lower than that of large securities companies (usually A1).

On the morning of the 11th, Kim So-young, Vice Chairperson, presiding over the "Financial Market Status Review Meeting" held at the Korea Federation of Banks in Jung-gu, Seoul. [Image source=Yonhap News]

Therefore, the financial authorities announced new measures on the 11th, focusing on resolving the PF-ABCP issue. The scale is 2.8 trillion won plus alpha (α). PF-ABCP guaranteed by construction companies will utilize the CP purchase program of KDB and Korea Credit Guarantee Fund. KDB will establish a separate organization on the 14th to purchase PF-ABCP guaranteed by construction companies. Korea Credit Guarantee Fund will guarantee 80% of the purchase amount. The purchase target is PF-ABCP rated A2. The corporate limits are set at a maximum of 105 billion won for medium-sized enterprises and 150 billion won for large enterprises.

For securities companies, the so-called ‘Second BMSF’ created by large securities companies has been supplemented with funds from KDB and Korea Securities Finance. A total of 1.8 trillion won has been raised, prioritizing the purchase of PF-ABCP rated A2.

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