Korean banks now better positioned to manage liquidity stresses: S&P

Improved funding structures will likely mitigate the risk.

Standard & Poor's Ratings Services said that recent volatility in global financial markets will test Korean banks, which have a relatively high reliance on foreign-currency funding, although their improved funding structures will likely mitigate the risk.

Here's more from S&P:

In our opinion, Korean banks are better positioned to manage potential foreign-currency funding and liquidity stresses than they were in 2008. Korean banks have lengthened their average debt tenors and secured relatively liquid foreign-currency assets compared to 2008, and we believe these measures will likely help the banks withstand the stresses to a certain degree.

We also expect the government of Korea (local currency rating AA-/Stable/A-1+; foreign currency rating A+/Stable/A-1) to provide financial support and liquidity when needed, as it did in 2008 when Korean banks faced a foreign-currency liquidity crunch.

Korean banks have further lengthened the average tenors of their foreign-currency debt in 2013 and improved funding maturity structures. Collectively, they have materially reduced their reliance on short-term foreign-currency debt in the past several years.

The banks, including foreign bank branches in Korea, have lowered the percentage of such debt funding in their total foreign-currency debt to about 47% at the end of the first quarter of 2013, from about 52% at the end of 2011, and about 73% at the end of the third quarter of 2008.

In our view, Korean banks have also secured more liquid foreign-currency assets under tightened regulatory guidance. The average three-month regulatory foreign-currency liquidity ratio (foreign currency assets maturing in three months, with some weighting depending on the liquidity of different asset classes, divided by foreign currency liabilities due in three months) of Korean banks also steadily increased to about 108% as of June 17, 2013, compared with 99% at the end of 2008.

We regard the Korean government's role in system-wide funding as "strong," given its record of providing financial support and liquidity during the last banking crisis as highlighted in our Banking Industry Country Risk Assessment (BICRA) report published on April 19, 2012.

For example, it provided guarantees for foreign-currency debenture issues, and established a recapitalization fund to strengthen the capitalization of banks. We believe these kinds of support measures will likely continue when needed. Korea’s foreign-exchange reserves have steadily increased since 2008, amounting to about US$330 billion at the end of May 2013 compared with US$201 billion at the end of 2008.

The ratio of foreign-exchange reserves to short-term debt of Korean banks (including foreign bank branches) also increased to about 3.8x at the end of March 2013, compared with about 1.5x at the end of September 2008. Furthermore, according to the financial regulator in Korea, all 18 domestic Korean banks have sufficient foreign currency liquidity to withstand the same level of stress seen in 2008 on a stand-alone basis for three months as of the end of this April.

Nevertheless, Korean banks’ reliance on foreign-currency funding--which accounts for roughly 13% of total funding and is mostly made up of wholesale funding--remains a risk factor, in our view. We do not expect Korean banks’ liquidity to dry up sharply under our base-case scenario, although we note that U.S. monetary policy indicates a gradual exit from its latest round of quantitative easing, resulting in potential capital outflow from many Asian countries, including Korea, in the next few years.

Nevertheless, if the Korean won further depreciates sharply, coupled with significant foreign capital outflow and these adverse movements are prolonged in the absence of timely government support measures, Korean banks may face difficulties in refinancing their foreign currency debt.

That said, we believe the Korean government will likely act in a timely manner to provide financial support and liquidity in any stressed scenario, given its tight monitoring of Korean banks and increased capacity to provide support in recent years.

In our view, Korea’s relatively sound fiscal condition and high current account surplus in recent years, as well as our expectation of a gradual recovery in economic growth in both Korea and globally in the next few years could lend confidence to potential government support.

Meanwhile, along with potentially higher foreign currency funding costs and recent weak financial market performance, we believe Korean banks’ profitability will likely remain under pressure in the next few year.