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South Korea's Central Bank Fights Call To Print Cash For Too-Big-To-Fail State Lenders

Discussions on bailing out too-big-to-fail banks are unfolding on a whole new level in South Korea.

The country's central bank is squaring off against its government over how to rescue state-owned lenders under threat from ballooning loan losses. The idea at the center of the unusual public dispute: Have the monetary authority print new cash and give it away to the banks.

The tensions stem from rapidly deteriorating financials at major shipbuilders and shipping companies, which are forcing Korea Development Bank and Export-Import Bank of Korea to boost provisions against problem loans, potentially totaling billions of dollars.

The sectors, which once underpinned growth in South Korea's economy, have been struggling in the past few years, hit by a global economic slowdown and a commodities slump. As the industries' fortunes dwindle, commercial banks have been shunning them, leaving the two policy lenders with the unpleasant task of financing increasingly unhealthy companies.

Now, trouble is brewing for the state banks. The nonperforming loan ratio at Korea Development Bank jumped to 4.55% from 2.49% as of Dec. 31, 2015, from a year earlier, while the metric at Export-Import Bank of Korea spiked to 3.29% from 2.02% during the period. The worst, however, is probably far from over.

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As of April 19, five companies that are being restructured or have business improvement plans owed a combined 26.4 trillion won to banks, predominantly Export-Import Bank of Korea and Korea Development Bank, according to Korea Ratings. Considering that 96.8% of those loans are currently categorized as normal, provisions could increase substantially, said Kim Jung-hyun, a ratings officer at Korea Ratings.

Loans at risk

The two policy lenders, in particular, each will need at least 1 trillion won of new allowances against bad debt just from those five companies, Kim said. Among them, Daewoo Shipbuilding and Marine Engineering, the second-largest shipbuilder globally, alone holds 23 trillion won of loans, mostly from Export-Import Bank of Korea and Korea Development Bank, according to Lee Cheol-ho, an analyst at Korea Investment & Securities.

The problem does not end there. Two other South Korean companies, Hyundai Heavy Industries and Samsung Heavy Industries, which too are among the biggest shipbuilders in the world, are also in crisis, with creditors asking them to come up with restructuring plans. Combined losses at the trio doubled to 5.882 trillion won in 2015 from the previous year, according to their annual reports.

As their troubles grow, the Ministry of Finance and Strategy and the Financial Services Commission are pushing the Bank of Korea to protect Export-Import Bank of Korea and Korea Development Bank. The government is asking the central bank to inject capital into the lenders after issuing new banknotes, while the central bank, not ready to expose itself to all-too-clear risks, is not giving in.

The government is going to such great lengths to rescue the banks, as the National Assembly, now led by opposition parties after recent elections, will not easily endorse a direct state bailout funded by taxpayers.

Speaking to journalists in early May, Lee Joo-yeol, governor of the Bank of Korea, pointed out that the authority is not even allowed to invest in risky businesses without collateral, to begin with.

"We cannot use our currency-issuing function when there can be losses," Lee said.

The top monetary policymaker answered questions about the controversy again on May 13, after the central bank's monthly rate decision meeting. He said talks with the government were still underway, and no specific decisions had been made.

Many legal issues

The government is not letting the central bank off the hook easily, saying that the security requirement does not apply to Export-Import Bank of Korea. Under a special law, the central bank in fact injected capital into the policy lender without collateral in 1999, following the Asian financial crisis. As a result, the Bank of Korea to this day is the second-largest shareholder in Export-Import Bank of Korea.

Doing the same with Korea Development Bank will require the introduction of a bill, which should be passed by the National Assembly. So, the government has proposed a workaround to have the central bank print money and lend it to commercial banks, which would then pass the funds to Korea Development Bank.

Although there is no legal hurdle to that option, it would be ultimately equivalent to making banks lend to Korea Development Bank without a payment guarantee. To cover the risk, banks would be forced to build buffers, using their own capital.

"This is legally fine, but it will be a burden on the banks' capital soundness, and they will have to set aside more equity as allowances," You Jong-il, a professor at the Korea Development Institute School of Public Policy and Management, said in an interview.

Turning the Bank of Korea into a creditor of Export-Import Bank of Korea and Korea Development Bank through bond investments is not viable either, because apart from sovereign notes, the central bank can only purchase corporate debt secured by the state, something the government does not do for bonds issued by the two state institutions.

"There are many legal issues involved in injecting money into them. I don't think something like that is likely," said an official in the currency policy department at the central bank.