[Song Seungseop's Financial Light] Banks in Need of Funds... Will the Bank of Korea Accept Private Bonds?

Banks Facing Difficulty Issuing Public Bonds Due to Government Requests
Request to Bank of Korea to Expand Types of 'Eligible Collateral Securities'
Concerns Over Fund Concentration Decrease if Private Placements Replace Public Offerings
Issues Remain Regarding Collusion, Accounting, and Bank of Korea Act

Editor's NoteFinance is difficult. Confusing terms and complex backstories are all tangled together. 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 light up your understanding of finance.

[Image source=Yonhap News]

[Asia Economy Reporter Song Seung-seop] Financial authorities and the Bank of Korea are considering including privately placed bank bonds in the list of eligible collateral securities. If this measure is implemented, it is said that banks' funding conditions will ease. What policies are the government and the Bank of Korea planning?

Why Banks Can No Longer Issue Public Bonds

Banking is about lending money (credit) to other economic agents. However, since there are so many places to lend to, it is difficult to cover this solely with your deposits and savings. Therefore, banks also raise funds through various methods. They receive investments and sometimes borrow money. A representative method is bond issuance. Banks issue bonds to secure money from many people, then lend this money to others and generate profits to repay it.

However, bond issuance is currently difficult. The government has asked financial holding companies and banks to restrain from issuing bonds. Since the Legoland incident, small companies have faced difficulties issuing bonds.[Reference article: How Kim Jin-tae and Legoland Shook the Financial Market] As the financial market became unstable, investors started buying only high-quality bank bonds. Seeing signs of severe fund concentration, the government sent this message to banks.

The problem is that banks have lost their channels to raise funds. Banks need to invest and conduct loan operations. Moreover, the bonds banks have already issued are also problematic. When bonds mature, banks used to issue new bonds to raise funds and repay the maturing ones. But now, they are practically unable to issue new bonds. They are only repaying maturing bonds with the money they have.

Trading Bonds Among Banks... Entrust to the Bank of Korea and Bring in Funds

Banks cannot just remain idle without issuing bonds. So they requested a new path from financial authorities and the Bank of Korea. Banks can borrow money from the Bank of Korea, but they want this process to be easier. When banks borrow from the Bank of Korea, they provide collateral. This collateral is called 'eligible collateral securities.' The Bank of Korea has pre-designated financial products recognized as eligible collateral securities, such as government bonds, monetary stabilization bonds, government-guaranteed bonds, and credit securities. Banks are requesting to expand the types of collateral.

Specifically, they want 'privately placed bank bonds' to be included as eligible collateral securities. As mentioned earlier, banks raise money from many people in the market. This is called 'public bonds.' On the other hand, privately placed bonds are issued to specific entities. These bonds are not publicly traded in the market. Therefore, issuing privately placed bonds hardly reduces market liquidity or causes fund concentration issues.

The method is that one bank buys the privately placed bonds issued by another bank. Suppose Bank A issues privately placed bonds. Bank B buys them. If privately placed bonds are recognized as 'eligible collateral securities,' Bank B can pledge Bank A's privately placed bonds as eligible collateral to the Bank of Korea and secure funds. Since the Bank of Korea's funds have much higher liquidity, banks can use them to comply with regulatory ratios. Bank A succeeds in raising funds through bond issuance, so it's a win-win situation.

Issues to Address: Collusion Concerns and Accounting Treatment

However, some issues remain. First is the concern about 'collusion.' Under current law, there is no problem with banks buying privately placed bonds from other banks. However, it may appear as collusion. There is a perception that banks might issue and buy bonds in a mutually beneficial way. It's like a rigged game of Go-Stop. This falls under 'anti-competitive conduct,' which the Fair Trade Commission strictly restricts. In response to these concerns, financial authorities explained, "As long as banks do not meet in advance to coordinate conditions, there is no problem."

The second issue is accounting treatment. Although public and private bonds seem similar except for slight differences in method, they are treated differently in accounting books. Public bonds issued by banks are publicly offered to investors. Public bonds can be freely traded by various entities. Therefore, under bank supervision regulations, public bonds are classified as 'securities.' However, privately placed bonds are issued to specific parties, so they are interpreted as 'borrowed money.' This is why privately placed bonds are classified as 'loan claims.' If classified as loans, banks subject to regulations may find it difficult to actively issue privately placed bonds.

Ideal Type: Deputy Governor of the Bank of Korea
Photo by Yonhap News

The Bank of Korea Act is also an obstacle. According to the Bank of Korea Act, the currently recognized collateral assets are 'securities.' The Bank of Korea has never accepted privately placed bonds as collateral due to legal reasons. Although there are exceptions, further review is needed. Lee Sang-hyung, Deputy Governor of the Bank of Korea, stated at the Monetary and Credit Policy Report briefing on the 8th, "We are examining whether privately placed bank bonds comply with the Bank of Korea Act's loan and collateral operation regulations," and added, "We aim to make a decision within this year if possible."

Financial Supervisory Service Governor Lee Bok-hyun also said at a meeting with research institute heads on the 7th, "The issuance of privately placed bonds was reviewed under the consensus that banks should somewhat restrain bond issuance and how to handle rollovers of maturing bonds," and added, "The market situation related to high-quality bonds has changed within days, and there are aspects of urgency and exceptionality that may require different judgments at different times."

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