Published : Aug. 8, 2016 - 13:40
Last Tuesday, Korea’s Financial Services Commission announced a plan to encourage the development of mega investment banks, defined as those with equity capital above KRW10 trillion, and expand the business scope of eligible securities companies.
The plan is credit negative for securities companies because it will push them to deploy more capital into new businesses in which they have little or no previous experience, thereby jeopardizing their asset quality, liquidity and capital adequacy.
The plan divides investment banks into three broad categories based on their equity capital size and sets out the allowed business scope for each category. It also introduces new funding channels, namely promissory notes for companies with capital above KRW4 trillion and investment management accounts for companies with capital above KRW8 trillion.
The outlined plan will be implemented in second-quarter 2017, after relevant laws and regulations are revised to accommodate the new guidelines.
The proposed plan will prompt securities companies to increase the risks on their balance sheets. The plan allows firms with capital of KRW3 trillion or more to extend corporate credit up to 100% of their shareholder equity. This relaxes the current regulation limiting the sum of corporate and retail credit lending to 100% of equity. Corporate credit lending is inherently riskier than the traditional brokerage business.
The plan also opens access to several new risky businesses including market-making of unlisted companies (above KRW3 trillion of shareholder equity), foreign exchange operations (above KRW4 trillion) and property-backed trust businesses (above KRW8 trillion).
Securities companies’ participation in these businesses will undermine their liquidity and capitalization, not only because of the potential increase in risky and illiquid assets on their balance sheets, but also because of the proposal’s relaxation of capital requirements.
Among the capital relaxations is a new risk-weight scheme that would replace the current non-risk weight calculation of capital adequacy. The proposal also would exclude assets acquired by the two new funding channels from the 11x leverage rules, thereby increasing the chances that reported metrics will not fully capture the risks inherent in the new businesses.
The deterioration in the industry’s liquidity will also widen these companies’ asset-liability mismatch, given that most of their funding, including newly introduced promissory notes, are short-term in nature, which contrasts with the long tenors of some of the services promoted in the plan, such as corporate lending. This is notwithstanding that the plan also introduces new regulations such as a Korea won-denominated liquidity ratio and liquidity coverage ratios to mitigate these potential problems.
Source: Moody‘s Investors Service