Market Eagerly Awaiting Monetary Committee Meeting

The Bank of Korea’s Monetary Policy Committee will hold its monthly meeting today, and is expected to announce measures to soothe financial jitters.

The government as well as commercial banks and companies are urging the central bank to come to the rescue of the ailing financial sector.

The committee is expected to lift the loan ceiling to two trillion won (1.46 billion U.S. dollars) to help small and medium-size enterprises, which have suffered big losses due to the “knock-in, knock-out (KIKO)” currency option.

To rein in interest rates despite its cut on Oct. 9, the central bank will consider purchasing bank bonds and making an additional rate cut. The decision to purchase the bonds as requested by the government and the business circle, however, is unlikely due to increasing fears over moral hazard in the banking sector.

○ Buying monetary stabilization bonds

To help small and mid-size companies, the committee will reportedly raise the limit on loans extended to companies to 8.5 trillion won (6.2 billion dollars) from 6.6 trillion won (4.8 billion dollars). The expansion of bank loans, the first such move since October 2001, is intended to alleviate KIKO-inflicted damage.

The central bank earlier announced won liquidity relief by buying up repurchase agreements (RPs) and government bonds and redeeming monetary stabilization bonds. For the first time since March 2003, it will buy back 700 billion won (514 million dollars) worth of monetary stabilization bonds this morning.

Money has yet to flow into banks despite the Oct. 9 rate cut and the provision of much-needed liquidity. The central bank lowered its key interest rate a quarter percentage point, but the benchmark 91-day certificate of deposit rate has continued to rise to 6.16 percent, the highest since January 2001.

○ Rising mortgage interest rates

The government has pressured the central bank to buy up bonds issued by commercial banks. Strategy and Finance Minister Kang Man-soo told the parliamentary audit of the government yesterday, “The government is in talks with the Financial Services Commission and the Bank of Korea to purchase bank bonds and reduce mortgage rates. Detailed action plans will come out soon.”

His comments were in line with the government announcement Tuesday to lower certificate of deposit rates, which are tied to floating mortgage rates, in an effort to alleviate the burden of low-income households.

The problem is how to lower the rates. The high rates of certificates of deposit and bank bonds, which account for 30 percent of a bank’s capital, make it difficult for banks to supply liquidity. This has prompted commercial banks to urge the central bank to include bank bonds on the list of bonds subject to repurchase agreements.

Commercial banks say this will help lower interest rates and renew 25 trillion won (18.3 billion dollars) worth of bank bonds due to mature at the end of this year.

Financial Services Commission Vice Chairman Lee Chang-yong said, “The central bank should include bank bonds in repurchase agreements. If so, financial authorities will strive to prevent banks from expanding their assets through excessive issuance of bank bonds.”

Lee meant the government will take responsibility for negative side effects from the decision.

○ Moral hazard fear

The Bank of Korea, however, is apparently at a loss. The consensus within the bank is that now is not the time to buy up bank bonds, though it is part of a contingency plan to counter the financial crisis.

A bank official said, “The U.S. decision to purchase bank bonds is intended to prevent a bank run. The problem with domestic banks is not lack of ability to supply liquidity, but rather high borrowing costs. If the central bank takes the extreme step of purchasing bank bonds though the financial sector is not in a grave situation, foreign trust in the Korean financial market will deteriorate and lead to moral hazard.”

“It is feared, however, that higher borrowing costs will be passed on to low-income earners and companies through high interest on loans, resulting in a decline in property values and the collapse of financial institutions.”

The official alluded to the possibility of the measure, adding, “It is difficult to make a conclusion now, but we are watching the market situation.”

parky@donga.com