The FSC announced a plan to introduce an insolvency resolution mechanism for financial institutions (tentatively called “financial stability account”) to help prevent insolvency of financial institutions. The plan was discussed at the financial risk response taskforce meeting held on July 26.
With changes in financial market environment, there have been calls for introducing a mechanism that can help protect financial institutions against insolvency and prevent risks from spreading in advance. In the wake of the 2008 global financial crisis, major economies such as the U.S., EU and Japan established such preventive support systems. In this regard, the FSC is considering ways to introduce an insolvency resolution mechanism for financial institutions (tentatively called “financial stability account”) for insolvency prevention of financial institutions through liquidity provision and capital expansion. The FSC will prepare a detailed plan after coordinating with relevant ministries and institutions and gathering opinions from experts and seek revision to the Depositor Protection Act accordingly.
Background
With some of the changes taking place in the financial industry such as the growth of the nonbank sector, deepening interconnectedness between financial sectors and unpredictability in shock originating from the real economy sector, there is growing concern about risks in certain areas spreading across the entire financial system. Therefore, through provision of liquidity injection and capital expansion to the financial sector facing temporary distress amid a crisis situation, it is necessary to keep the cost of maintaining stability in the financial system to a minimum level by preventing insolvency of financial institutions as well as spread of risks.
Major economies such as the U.S., Japan and EU had already set up relevant systems to prevent systemic risks and minimize the cost of insolvency resolution in the wake of the 2008 global financial crisis. On the contrary, the crisis response mechanisms in Korea such as the depositor insurance fund support and setting up public funds focus on ex post facto stability management after insolvency takes place. Thus, the authorities will upgrade the measures that had been introduced in the past to make proactive and preventive support system available on a permanent basis and utilize them in complement with other financial stability tools available.
Details of the Plan
I. Condition and Eligibility for Implementation
Implementation of the insolvency resolution mechanism will apply to financial institutions facing temporary distress (not an insolvent or at-risk financial institution) when the FSC considers the situation to be alarming for financial markets and the system. In the process of deciding whether to implement the insolvency resolution mechanism, the FSC will consult with relevant ministries (Ministry of Economy and Finance) and institutions (Bank of Korea and Financial Supervisory Service) to gather opinions and seek coordination with other policy goals and mechanisms.
II. Types of Funding Support
Depending on how the crisis situation unfolds, the insolvency resolution mechanism will provide support in the form of either liquidity provision (debt guarantee or loan) or capital expansion (preferred stock purchase) and collect funds within the agreed upon time frame.
(Liquidity Provision) Provide guarantees (e.g. 3-year or less) for bonds issued by financial companies and collect guarantee fees from financial companies participating
- Use loan as a supplemental tool when it is difficult for financial companies to issue and distribute bonds
(Capital Expansion) Purchase preferred stocks issued by financial companies and collect funds in the form of dividend and preferred stock payments from financial companies
III. Financing Mechanisms and Operation
Within the deposit insurance fund, a separate account (tentatively called “financial stability account”) will be established for the operation of the insolvency resolution mechanism, and government investment or issuing government-sponsored bonds will be excluded from financing methods.
(Liquidity Provision) To be operated with revenue from guarantee fees (debt guarantees require no upfront financial resources)
- In the event of a guarantee accident, payments will be made from fee revenues or through borrowing from other accounts and collect funds thereafter from the financial company
(Capital Expansion) Provide funding support through Korea Deposit Insurance Corporation’s bond issuance or borrowing from other accounts and collect funds through preferred stock payments from financial companies
IV. Procedure
Program implementation decision (by FSC in coordination with MOEF, BOK and FSS) → Application and registration by financial company (KDIC) → Application review and determination of the size of funding support (Deposit Insurance Committee) → Report to FSC → Program implementation begins (provision of funding support and post-management)
Funding support will be made available for the resolution of distress in areas where a financial company is not capable of handling on its own while taking into account its potential to improve liquidity and capital adequacy on its own during the review process.
V. Post-management
When providing funding support, financial companies will need to submit a plan for improving the soundness of business management and their compliance status will be scrutinized regularly (on a semi-annual basis). If necessary, funding support will be provided with certain conditions attached such as limitations on stock repurchase, dividends and bonus payouts to board members, etc (include in terms of agreement). Certain penalties may be imposed for non-compliance with the management improvement plan such as a raise in guarantee fee, corrective order, sanctions on employees, etc.
Further Plan
Authorities will consider holding a seminar or public hearing in August with experts from the National Assembly, academia and financial sectors participating. Authorities also plan to put up for notification a revision proposal for the Depositor Protection Act in August.