## _cr1505

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---

### Executive Summary
- Mission: Financial Sector Assessment Program (FSAP) joint team from the World Bank and International Monetary Fund; mission visited Seoul from April 3–19, 2013.
- Korea’s crisis management background:
  - Experienced significant financial distress in the late 1990s and managed fallout from the 2007–08 global financial crisis.
  - Established a broad crisis management framework informed by past crises.
- Key findings and areas for improvement:
  - Consider formally setting up an apex forum for inter-agency cooperation and coordination on crisis preparedness and crisis management; consider upgrading the Macroeconomic Financial Meeting (MEFM) with participation by heads of MOSF, FSC, FSS, BOK, and KDIC and by including crisis preparedness and crisis management as an explicit mandate.
  - Emergency Liquidity Assistance (ELA) framework: review and revise legal and procedural aspects to remove scope for delays in disbursement.
  - Deposit insurance system: bring deposit insurance fund out of deficit and assure back-up funding.
  - Corrective action framework: review triggers and improve objectivity to enable timely intervention (including before banks breach regulatory thresholds); put in place norms and guidance determining use of powers to postpone or suspend corrective actions.
  - KDIC improvements to enable effective intervention and avoid avoidable losses:
    - Do not allow insolvent banks to continue to accept fresh deposits and repay existing deposits.
    - Establish a back-up funding arrangement to improve prompt depositor payouts and meet liquidity needs in crisis (options include funding arrangement with the Central Bank or a line of credit from the Government).
    - Review processes to reduce allowed timelines for decisions on depositor payouts, providing financial assistance to troubled banks, and resolution.
  - Formalization and strengthening of crisis management practices recommended:
    - Formally designate crisis management team(s) in each supervisory authority.
    - Develop crisis management handbook/manual.
    - Establish multi-agency institution-specific crisis management groups.
    - Require group-wide contingency plans by Financial Holding Companies (FHCs).
    - Periodically conduct crisis simulation exercises.
  - Strengthen inter-agency information sharing with domestic and foreign authorities from crisis preparedness and crisis management perspectives.
  - Resolution framework is comprehensive but can be improved per FSB and BCBS recommendations:
    - Clarify definition of “systemic stability.”
    - Improve resolvability through living wills and bail-ins.
    - Establish criteria for identification of systemically important financial institutions (SIFI).
    - Introduce schemes to improve resolvability, efficiency, and reduce costs.

### Executive Summary — Selected Recommendations (from Table 1)
- No. 18 (Government): Formalize an apex crisis monitoring and crisis coordination committee. Priority: H
- No. 34 (Government): Assure back-up liquidity and funding support to the KDIC. Priority: H
- No. 19 (FSC, FSS, KDIC, and Government): Strengthen inter-agency information sharing and coordination arrangements with domestic and foreign authorities from crisis preparedness and crisis management perspectives. Priority: M
- No. 31 (FSC, FSS, KDIC, and Government): Prevent banks determined as insolvent from taking fresh deposits and allowing deposit withdrawals. Priority: H
- No. 32 (FSC, FSS, KDIC, and Government): Arrange to replenish the deficit in the Deposit Insurance Fund. Priority: H
- No. 33 (FSC, FSS, KDIC, and Government): Review the funding and accounting of the Depositor Insurance Fund (DIF) (especially the Special Account) to eliminate direct cross subsidization by other segments of financial sector. Priority: M
- No. 35 (FSC, FSS, KDIC, and Government): KDIC adopt a more pro-active approach for timely depositor payouts. Priority: M
- No. 60 (FSC, FSS, KDIC, and Government): KDIC and FSC should review the processes involved to reduce the timelines allowed for making decisions on the making depositor payouts, providing financial assistance to, and resolving troubled banks.
- No. 46 (FSC, FSS, KDIC, and Government): Make improvements to the corrective action framework by reviewing the triggers and improving their objectivity to enable early intervention; put in place norms and guidance determining the postponement or suspension of corrective actions. Priority: M
- No. 51 (FSC, FSS, KDIC, and Government): Consider requiring FHCs to prepare and submit group-wide contingency plans and recovery plans. Priority: M
- No. 52 (FSC, FSS, KDIC, and Government): Formalize or improve some elements of crisis management framework (Crisis management teams; crisis management handbooks; and crisis management groups). Priority: M
- No. 53 (FSC, FSS, KDIC, and Government): Undertake periodic crisis simulation exercises to test the adequacy and effectiveness of the crisis preparedness and crisis management arrangements. Priority: H
- No. 64 (FSC, FSS, KDIC, and Government): Ensure use of public funds does not provide wrong incentives and only after first imposing losses on existing shareholders and creditors. Priority: H
- No. 84–86 (FSC, FSS, KDIC, and Government): Review and improve resolution framework for financial institutions in the light of FSB and BCBS recommendations. Priority: M
- No. 41 (BOK and Government): Review and revise the Bank of Korea Act and Enforcement Decree (BOKA) to avoid scope for potential delays in providing ELA in a timely manner. Priority: M

### Financial system structure and concentration
- Twelve FHCs constitute about 50 percent of financial sector assets.
- The FHCs increased their market share from about 39 percent at end-2010.
- The FHCs have 87 percent of their consolidated assets in banking (accounting for about 70 percent of the banking sector assets).
- Of the 18 commercial and specialized banks in Korea, 14 are operating under 10 bank holding companies, which have a total of 275 subsidiaries.
- Note: Ten Bank Holding Companies and 1 Securities Holding Company and 1 Insurance Holding Company – Bank holding companies make up 98 percent of the assets under FHC structure.
- Foreign presence:
  - Foreign financial institutions in Korea constitute roughly 11 percent of the financial sector assets.
  - Banking and insurance sectors have the highest presence of foreign companies with 15 and 12 percent market shares, respectively.
  - In the banking sector: 41 foreign-owned banks (two subsidiaries, 39 branches) from 16 countries making up about 14 percent of the banking sector.
  - In the insurance sector: 12 insurance companies’ subsidiaries from five countries make up 10 percent of the domestic insurance sector.
  - Securities sector: about six percent of the securities sector assets are held by 20 foreign companies from eight countries.
  - Korean financial institutions abroad make up roughly 2 percent of the financial sector in terms of assets; banking sector abroad operates through 100 entities in 28 countries; twenty securities companies operate in 15 countries; 15 collective investment (asset management) companies operate in 11 countries.

### Legal and institutional framework for crisis management
- Five authorities with clearly allocated mandates and powers: the FSC, the FSS, the BOK, the KDIC, and the MOSF.
- Mandates (verbatim):
  - FSC and FSS: “to promote the advancement of the financial industry and the stability of financial markets, establish sound credit order and fair financial transaction practices, and protect depositors, investors, and other financial consumers.” (Article 1 of the Act on the Establishment, etc. of the Financial Services Commission.)
  - KDIC: “to contribute to the protection of depositors and the maintenance of the stability of the financial system.” (Article 1 of the Depositor Protection Act.)
  - BOK: to “pay attention to financial stability in carrying out its monetary and credit policies.” (Article 1 of the Bank of Korea Act.)
- Special resolution regime:
  - ASIFI identifies FSC and KDIC as resolution authorities, with FSC acting as lead resolution authority.
  - BOK is not a resolution authority but can provide financial assistance indirectly through KDIC or public funds.
  - Special resolution regime under ASIFI and the Deposit Protection Act (DPA) extends to banks, the Industrial Bank of Korea, investment traders, brokers, collective investment business entities, investment advisory business entities, discretionary investment business entities, insurance companies, mutual savings banks, trust business entities, merchant banks, and financial holding companies.
  - Specialized banks are outside the purview of the special resolution regime and are governed by their own special statutes.
  - Resolution tools include merger and acquisition, purchase and assumption, bridge bank, funding by government and other relevant authorities (including the KDIC), and liquidation.
  - DPA mandates the application of the least cost test in the choice of a resolution method by the KDIC. (Article 38–4 of the DPA.)
  - KDIC can establish a financial institution for resolution (like a bridge bank) as a separate entity for taking over business or contracts of insolvent financial institutions or conducting the resolution process. (Article 36–3 of the DPA.)
- Interagency cooperation:
  - MEFM (vice-ministerial level forum) includes deputy level representation from MOSF (Chair), FSC, FSS, BOK, and KDIC (by invitation when relevant); formalized in September 2012; designed to meet on a quarterly basis at minimum; Presidential Decree requires two-thirds attendance and votes of at least two-thirds in the affirmative for deliberation.
  - Domestic MOUs: joint MOU for sharing “periodic” and “non-scheduled” financial information; MOU gives 10 days (three days if urgent) for complying with information requests and provides for confidentiality and dispute referral to the MEFM.
  - Cross-border MOUs: FSC/FSS have MOUs with 33 foreign authorities in 18 countries; KDIC has MOUs with deposit insurers or resolution authorities of ten countries.

### Crisis preparedness, prevention, and systemic liquidity tools
- Monitoring:
  - FSC’s early warning system grades threats on a five point scale: sound, precautionary, cautionary, grave, and critical.
  - BOK’s Financial Stability Report (FSR): published twice a year (April, October); uses the Systemic Risk Assessment Model for Macroprudential Policy (SAMP); October 2012 FSR noted household debt accumulation could reduce macro-financial resilience.
- Financial safety net elements:
  - Comprehensive BOK liquidity facilities including emergency liquidity assistance (ELA).
  - A deposit insurance scheme for deposits in financial institutions.
  - An efficient framework of financial sector supervision.
- BOK systemic liquidity tools:
  - Open market operations (OMO), standing facilities, varying reserve requirements (0 to 7 percent depending on liability type).
  - Expanded list of eligible collateral for standing credit facility includes promissory notes and bills of exchange.
  - Planned securities lending facility under the OMO window and intraday funds to participants of payment systems.

### Deposit insurance system — coverage, funding, and operations
- Coverage:
  - Protection up to KRW 50 million per depositor per covered financial institution.
  - Covered financial institutions: banks, life insurers, non-life insurers, financial investment companies (e.g., securities firms and asset management companies), merchant banks, and mutual savings banks.
  - Eligible deposits: "all money due to customers of financial institutions" including deposits in banks in Korea (including foreign bank branches in Korea), foreign currency deposits in Korea, and deposits held in foreign branches of Korean banks when not protected by the host jurisdiction.
  - Participation: mandatory for all licensed financial institutions.
  - Exclusions: deposits made by government, local government, BOK, KDIC, FSS, or a “covered financial institution,” certificates of deposits, MMFs, commercial papers and insurance policies held and paid by corporate policy holders are not eligible for KDIC’s protection.
  - The size of insurance cover per depositor is approximately twice the per capita GDP.
- Coverage extent (at end-2012):
  - KDIC’s deposit protection cover is available to about 97 percent of bank depositors and 32 percent of deposits.
  - Selected table entries (preserved as in source):
    - Banks: Share of Fully-Insured Depositors (%) 97.37; Share of Deposits Eligible for Insurance (%) 9.63; Share of Insured Deposits (%) 32.1; Ex-ante Coverage Ratio (%) 1.58
    - Life Insurer: Share of Fully-Insured Depositors (%) 94.49; Share of Deposits Eligible for Insurance (%) 5.27; Share of Insured Deposits (%) 8.9; Ex-ante Coverage Ratio (%) 1.10
    - Non-life Insurer: Share of Fully-Insured Depositors (%) 96.88; Share of Deposits Eligible for Insurance (%) 6.17; Share of Insured Deposits (%) 7.8; Ex-ante Coverage Ratio (%) 0.98
    - Financial Investment Companies: Share of Fully-Insured Depositors (%) 98.89; Share of Deposits Eligible for Insurance (%) 0.25; Share of Insured Deposits (%) 9.3; Ex-ante Coverage Ratio (%) 2.30
    - Merchant Banks: Share of Fully-Insured Depositors (%) 96.08; Share of Deposits Eligible for Insurance (%) 0.26; Share of Insured Deposits (%) 0.3; Ex-ante Coverage Ratio (%) 3.66
    - Mutual Savings Bank: Share of Fully-Insured Depositors (%) 99.39; Share of Deposits Eligible for Insurance (%) 9.94; Share of Insured Deposits (%) 2.4; Ex-ante Coverage Ratio (%) -4.39
- DIF status and structure:
  - DIF fund balance: KDIC managing a fund of KRW 8.354 trillion (as of end-2012).
  - Special account for MSB failure resolutions: created in 2011; funded ex-post and by appropriating 45 percent of the annual premium received from all insured entities; special account deficit of KRW 15.887 trillion (as of end-2012).
  - Aggregated DIF position: in deficit (negative balance) of approximately KRW 7.5 trillion.
  - DIF divided into six accounts: commercial banks, merchant banks, life insurance, non-life insurance, finance investment companies, and mutual savings banks.
- Deposit Insurance Premium Rates (preserved exactly):
  - Insurance Premium Rate: Banks 8/10,000; Financial Investment Companies 15/10,000; Insurance Companies 15/10,000; Merchant Banks 15/10,000; MSBs 40/10,000
  - Legal Maximum Limit: Banks 50/10,000; Financial Investment Companies 50/10,000; Insurance Companies 50/10,000; Merchant Banks 50/10,000; MSBs 50/10,000
- Payout procedures and timelines:
  - KDIC has an IT system (Integrated Resolution Information System (IRIS)) since 2008; capacity to handle 100,000 claims per hour.
  - No statutory time limits for deposit pay-outs generally.
  - For a ‘category one’ insurance contingency, KDIC has two months to decide whether to payout depositors (Articles 31 and 34 of the Depositor Protection Act).
  - For a ‘category two’ insurance contingency, time period for payment is not stipulated in law or regulations; KDIC shall pay insurance money upon the request of depositors.
  - Standard time for provisional pay-outs reduced to 2 weeks in 2011.
  - KDIC can make provisional pay-outs (partial payments within the insured limit) while pending full pay-outs.
- Operational and moral hazard concerns:
  - Banks declared insolvent and under resolution by KDIC are allowed to operate and accept new deposits as well as repay existing deposits; this can:
    - Expose DIF to higher losses.
    - Expose new depositors in excess of insured amounts to risk of loss.
    - Allow insolvent banks to make preferential payments or resort to asset stripping, potentially increasing burden on DIF.
- Liquidity backing and legal funding powers:
  - KDIC legal basis to garner additional funds: Article 26 DPA allows KDIC to borrow from the Government, BOK, insured financial institution, or other institutions identified by the Presidential Decree, and issuance of DIF bonds.
  - KDIC lacks access to an explicit and assured funding mechanism for emergency liquidity needs.
  - Government loans can take from 2 weeks to 3 months to arrange.
  - International best practice recommendation: assured liquidity support that can be drawn down immediately in an emergency.
- Recommendations on deposit insurance operations and funding:
  - Do not permit banks determined as insolvent to accept fresh deposits or allow withdrawal of existing deposits.
  - Arrange to replenish the deficit in the deposit insurance fund to preserve credibility and align with core principles for effective deposit insurance systems.
  - Review and modify the DPA to:
    - Preserve principle of separation of different DIF accounts.
    - Avoid cross-sector subsidization by entities in other financial sector segments.
    - Review funding options for the special account for MSB to avoid co-mingling of funds.
    - Align premiums in each account with reference to that sector’s performance without cross-subsidization.
  - Establish an explicitly assured line of credit from the Government to provide back-up funding to KDIC and clear processes for timely access.
  - KDIC should adopt a more pro-active approach for depositor payouts by putting in place a procedure for timely payouts to eligible depositors (for example within two weeks from occurrence of insurance contingencies) and without requiring depositors to lodge claims.
  - Review and revise the DPA to give priority to depositors’ claims up to the insured amount over other general classes of unsecured creditors within constitutional limits and within the broader resolution framework.
  - Authorities should review and revise the BOKA and related processes to avoid scope for potential delays in timely provision of ELA.

### Supervisory framework, corrective actions, and contingency planning
- Supervisory practices:
  - FSS on-site examinations in major banks once in two years; surveillance intensity depends on bank situation, size, risk profile, and macroeconomic conditions.
  - Banks assigned supervisory safety and soundness ratings on a scale of 1 to 5 using CAMEL-R.
- Corrective action framework findings:
  - Corrective measures triggered at three stages with management improvement recommendation, management improvement requirement, and management improvement order.
  - Triggers with reference to CAR are set to be activated only after a bank breaches the minimum capital ratio, allowing capital ratio to go down to 2 percent before intrusive measures.
  - In practice, for MSBs authorities adopted more stringent measures only when CAR was close to or lower than 2 percent, leading to many MSBs put into resolution after becoming insolvent.
  - Asset quality trigger in stage 2 is unclear; asset quality trigger in stage 3 is absent.
  - FSC has broad discretion on remedial and emergency measures, including restriction on taking deposits and granting credits, suspension of payment of all or parts of deposits, prohibition of debt repayment, disposal of assets, retirements of issued stocks, suspension of officers, appointment of administrators, transfer of business or contracts, suspension of business, and mergers and acquisitions.
- Postponement/suspension powers and concerns:
  - FSC can postpone or suspend corrective actions, including revocation of license, for specified periods; suspension period for corrective action limited to no more than 3 months for financial institutions with small asset volume; FSC can choose not to revoke authorization for up to one year in certain cases.
  - Lack of written criteria for exercising discretion creates uncertainty and possibility of forbearance; postponement cited as a reason for failure of MSBs and higher losses to KDIC.
- Contingency planning:
  - Financial institutions generally have contingency plans and undertake periodic stress tests; group-level preparedness less comprehensive.
  - Gap: contingency plans and crisis preparedness arrangements have not been tested through crisis simulation exercises (CSEs).
- Recommendations:
  - Review triggers for corrective actions, introduce greater clarity and objectivity, and re-set triggers to earlier stages.
  - Develop strict internal guidelines and criteria for postponement/suspension only in extremely rare systemic cases.
  - Require FHCs to prepare group-wide contingency plans and submit recovery plans.
  - Create crisis management teams (CMTs), crisis management handbooks, and institution-specific crisis management groups (CMGs).
  - Fully test crisis preparedness via periodic crisis simulation exercises at regulator and national inter-agency levels.

### Use of public funds, least cost principle, and moral hazard
- Findings on public funds:
  - Funds established post-global financial crisis (e.g., Bank Recapitalization Fund, Restructuring Fund) provide liquidity and capital support but may distort incentives if deployed without imposing losses on shareholders and creditors or holding management accountable.
  - ASIFI empowers FSC to impose corrective and resolution measures but does not explicitly require mandatory imposition of losses on shareholders and other creditors before deploying public funds.
- Least cost principle:
  - KDIC is subject to the “least cost principle” in all its operations (DPA Article 38–4).
  - Exceptions: KDIC Committee can provide financial assistance or pay insured depositors without regard to least cost principle if liquidation or bankruptcy “might seriously undermine the stability of the financial system” (DPA, Article 38–4 (3)).
  - Concerns: Exceptions are general and discretionary and may introduce significant moral hazard.
- Recommendations:
  - Authorities should review direct and indirect use of public funds (including Depositor Protection Fund) to ensure incentive frameworks are not distorted and moral hazard issues are fully addressed.
  - When public funds are used, shareholders and other creditors of insolvent financial institutions should always bear the losses caused to that institution before infusion of public funds.
  - Include key principles for application of KDIC’s Least Cost Principle in higher level norms to improve transparency and legal certainty.
  - Link exemptions to the least cost principle clearly to parameters used to define “systemic Implications.”

### Lack of precision in legal definitions and D-SIFI identification
- Identified problem: "The lack of precision in all the above cases but specially in the granting of exceptions to the least cost principle seriously reduces accountability and legal certainty."
- Consequences:
  - May allow financial authorities to take case by case decisions.
  - Undermines the basis for accountability.
  - Affects the certainty of the legal rules and the credibility of the resolution scheme.
- Recommendations on D-SIFIs and legal definitions:
  - Step-up efforts to establish criteria for identification of systemically important financial institutions and reflect those in norms integrated into the resolution regime.
  - Apply the Assessment Methodology Principles reflected in the BCBS D-SIB framework, with special regard to Principle 5 on bank-specific factors.
  - Modify existing legal definitions of systemic implications, systemic stability, and similar expressions to align with BCBS D-SIB application domestically.
  - Once definitions are reflected in laws and regulations, apply KAs directed at G-SIFIs including KA 8 (CMGs), KA 9 (COAGs), KA 11 (RRPs), and KA 10 (Resolvability Assessments).

### Key statistics and banking sector snapshot (as presented)
- Financial sector growth: average rate of 7.9 percent (past two years referenced); assets at 3.2 times GDP in end-2012.
- Financial sector composition (market share):
  - Banks: 54 percent market share.
  - Non-bank depository institutions: 13 percent.
  - Insurance companies: 18 percent.
  - Securities companies: 6 percent.
  - Collective investment companies: 8 percent.
- Banking sector counts and shares (end-2012 format preserved):
  - Banks 57 2,235,402 100.0% 3.4% 6.2%
  - commercial banks 52 1,578,043 70.6% 2.0% 5.0%
  - national banks 7 1,226,827 54.9% 0.6% 5.4%
  - local banks 6 147,082 6.6% 8.6% 9.5%
  - foreign bank branches 39 204,134 9.1% 5.7% -0.9%
  - specialized banks 5 657,359 29.4% 7.0% 9.6%
- Top 10 banks (2012) — Total assets (KRW billion), share, and % growth 2011-2012:
  - Kookmin Bank (KB) 280,310 13% 1.2%
  - Woori Bank(Woori) 265,614 12% 2.9%
  - Shinhan Bank(Shinhan) 253,955 11% 1.2%
  - NH Bank* (NH) 206,466 9% 3.9%
  - Industrial Bank of Korea* 205,668 9% 8.5%
  - Hana Bank(Hana) 168,124 8% 0.8%
  - Korea Development Bank* (KDB) 167,132 7% 12.2%
  - Korea Exchange Bank( Hana, since Feb2012) 123,058 6% 2.0%
  - SC First Bank(Standard Chartered Korea) 69,354 3% -3.0%
  - Citibank Korea (Citigroup Korea) 66,402 3% -10.5%
  - Top 5 total 1,212,013 54% 3.2%
  - Top 10 total 1,806,083 81% 2.8%
  - National totals 2,235,402 3.4%
- Aggregate figures (end-2012 and related, table values preserved):
  - Total 3,466,613 100.0 4,034,399 100
  - GDP (nominal) 1,235,161 1,272,460
  - Financial Sector as % of GDP 280.73 317.1

*Source: _cr1505 - 84.      The lack of precision in all the above cases but specially in the granting of exceptions (PDF chapter/section).*

### Preface ____________________________________________________________________________________________ 6

### Preface

### Executive Summary
- Mission: Financial Sector Assessment Program (FSAP) joint team from the World Bank and International Monetary Fund; mission visited Seoul from April 3–19, 2013.
- Korea’s crisis management background:
  - Experienced significant financial distress in the late 1990s and managed fallout from the 2007–08 global financial crisis.
  - Established a broad crisis management framework informed by past crises.
- Key areas for improvement and findings:
  - Consider formally setting up an apex forum for inter-agency cooperation and coordination on crisis preparedness and crisis management; consider upgrading the Macroeconomic Financial Meeting (MEFM) with participation by heads of MOSF, FSC, FSS, BOK, and KDIC and by including crisis preparedness and crisis management as an explicit mandate.
  - Emergency Liquidity Assistance (ELA) framework: review and revise legal and procedural aspects to remove scope for delays in disbursement.
  - Deposit insurance system: bring deposit insurance fund out of deficit and assure back-up funding.
  - Corrective action framework: review triggers and improve objectivity to enable timely intervention (including before banks breach regulatory thresholds); put in place norms and guidance determining use of powers to postpone or suspend corrective actions.
  - KDIC improvements needed to enable effective intervention and avoid avoidable losses:
    - Do not allow insolvent banks to continue to accept fresh deposits and repay existing deposits.
    - Establish a back-up funding arrangement to improve prompt depositor payouts and meet liquidity needs in crisis (options include funding arrangement with the Central Bank or a line of credit from the Government).
    - Review processes to reduce allowed timelines for decisions on depositor payouts, providing financial assistance to troubled banks, and resolution.
  - Authorities have tools to influence systemic liquidity, increase deposit insurance/investor protection (including full guarantee), mobilize public funds, and intervene and resolve troubled financial institutions.
  - Funds established post-2008 provide liquidity and capital support but may distort incentives if deployed without imposing losses on shareholders and creditors or holding management accountable.
  - Formalization and strengthening of crisis management practices recommended:
    - Formally designate crisis management team(s) in each supervisory authority.
    - Develop crisis management handbook/manual.
    - Establish multi-agency institution-specific crisis management groups.
    - Require group-wide contingency plans by Financial Holding Companies (FHCs).
    - Periodically conduct crisis simulation exercises.
  - Strengthen inter-agency information sharing with domestic and foreign authorities from crisis preparedness and crisis management perspectives.
  - Resolution framework is comprehensive but can be improved per FSB and BCBS recommendations:
    - Clarify definition of “systemic stability.”
    - Improve resolvability through living wills and bail-ins.
    - Establish criteria for identification of systemically important financial institutions (SIFI).
    - Introduce schemes to improve resolvability, efficiency, and reduce costs.

### Executive Summary — Selected Recommendations (from Table 1)
- No. 18 (Government): Formalize an apex crisis monitoring and crisis coordination committee. Priority: H
- No. 34 (Government): Assure back-up liquidity and funding support to the KDIC. Priority: H
- No. 19 (FSC, FSS, KDIC, and Government): Strengthen inter-agency information sharing and coordination arrangements with domestic and foreign authorities from crisis preparedness and crisis management perspectives. Priority: M
- No. 31 (FSC, FSS, KDIC, and Government): Prevent banks determined as insolvent from taking fresh deposits and allowing deposit withdrawals. Priority: H
- No. 32 (FSC, FSS, KDIC, and Government): Arrange to replenish the deficit in the Deposit Insurance Fund. Priority: H
- No. 33 (FSC, FSS, KDIC, and Government): Review the funding and accounting of the Depositor Insurance Fund (DIF) (especially the Special Account) to eliminate direct cross subsidization by other segments of financial sector. Priority: M
- No. 35 (FSC, FSS, KDIC, and Government): KDIC adopt a more pro-active approach for timely depositor payouts. Priority: M
- No. 60 (FSC, FSS, KDIC, and Government): KDIC and FSC should review the processes involved to reduce the timelines allowed for making decisions on the making depositor payouts, providing financial assistance to, and resolving troubled banks.
- No. 46 (FSC, FSS, KDIC, and Government): Make improvements to the corrective action framework by reviewing the triggers and improving their objectivity to enable early intervention; put in place norms and guidance determining the postponement or suspension of corrective actions. Priority: M
- No. 51 (FSC, FSS, KDIC, and Government): Consider requiring FHCs to prepare and submit group-wide contingency plans and recovery plans. Priority: M
- No. 52 (FSC, FSS, KDIC, and Government): Formalize or improve some elements of crisis management framework (Crisis management teams; crisis management handbooks; and crisis management groups). Priority: M
- No. 53 (FSC, FSS, KDIC, and Government): Undertake periodic crisis simulation exercises to test the adequacy and effectiveness of the crisis preparedness and crisis management arrangements. Priority: H
- No. 64 (FSC, FSS, KDIC, and Government): Ensure use of public funds does not provide wrong incentives and only after first imposing losses on existing shareholders and creditors. Priority: H
- No. 84–86 (FSC, FSS, KDIC, and Government): Review and improve resolution framework for financial institutions in the light of FSB and BCBS recommendations. Priority: M
- No. 41 (BOK and Government): Review and revise the Bank of Korea Act and Enforcement Decree (BOKA) to avoid scope for potential delays in providing ELA in a timely manner. Priority: M

### Introduction — Past Experience in Crisis Management
- Key lessons from the 1997 crisis management approach:
  - Bold and decisive measures required to regain market confidence rather than incremental ones.
  - Government leads crisis management initiatives but private capital should be encouraged to fully participate.
  - Bank recapitalization and creation of a bad bank are not mutually exclusive; crisis measures should be politically acceptable with built-in exit strategies and clear time-frames.
  - Minimize moral hazard.
  - Reject all forms of financial protectionism.
- Korea’s response to the 2008 global financial crisis included policy and financial support stabilizing money, securities, and bond markets; extending financial support to corporate and financial entities; and supporting SME and microfinance sectors.

### Introduction — Korean Financial System (selected statistics)
- Financial sector growth: average rate of 7.9 percent (past two years referenced); assets at 3.2 times GDP in end-2012.
- Financial sector composition (market share):
  - Banks: 54 percent market share.
  - Non-bank depository institutions: 13 percent.
  - Insurance companies: 18 percent.
  - Securities companies: 6 percent.
  - Collective investment companies: 8 percent.
- Banking sector structure:
  - 13 commercial banks (7 national and 6 local).
  - 39 foreign bank branches.
  - 5 specialized banks.
  - Top 5 banks make up 54 percent of market share.

### Box 1 — Policy Measures Initiated in the Wake of the 2008 Global Financial Crisis (selected measures)
- Signed currency swap agreement with the U.S. in October 2008.
- BOK injected liquidity via repos to securities companies and asset management companies in November 2008.
- Established Bond Market Stabilization Fund in November 2008.
- Expanded SME support through Korea Development Bank & Industrial Bank of Korea.
- Created Corporate Credit Support Task Force in November 2008; restructuring began in February 2009.
- Established Bank Recapitalization Fund in February 2009.
- Established Corporate Restructuring Fund within KAMCO in March 2009.
- Created Stock Market Stabilization Fund (1Q09).
- Government and BOK provided US$16 billion of support to import-export financing.
- Eased regulation on banks’ foreign currency liquidity ratio (seven-day gap ratio) in 1Q09.
- Initiatives to support micro finance (1Q09): residential finance support through lease-deposit repayment guarantees; interest rate cuts for residential mortgage loans; reduced credit card transaction fees to street-market merchants (2.0–2.2 percent→2.0–2.2 percent); Debt restructuring (Pre-workout) plans initiated in March 2009.
- Introduction of new bond products to facilitate short-term funding of companies; support issuance of structured covered bonds and assist banks’ funding of foreign currency capital.

_This Technical Note has been prepared by Ernesto Aguirre (Consultant), IMF and Yejin Carol Lee, World Bank._

### 5.      The Korean financial system is dominated by twelve FHCs that constitute about

### _cr1505 - 5.      The Korean financial system is dominated by twelve FHCs that constitute about

### Financial system structure and concentration
- Twelve FHCs constitute about 50 percent of financial sector assets.
- The FHCs increased their market share from about 39 percent at end-2010.
- The FHCs have 87 percent of their consolidated assets in banking (accounting for about 70 percent of the banking sector assets).
- Of the 18 commercial and specialized banks in Korea, 14 are operating under 10 bank holding companies, which have a total of 275 subsidiaries.
- Financial companies under the bank holding companies operate in almost all segments of the financial sector.
- Note (from source): Ten Bank Holding Companies and 1 Securities Holding Company and 1 Insurance Holding Company – Bank holding companies make up 98 percent of the assets under FHC structure.

### Foreign presence
- Foreign financial institutions in Korea constitute roughly 11 percent of the financial sector assets.
- Banking and insurance sectors have the highest presence of foreign companies with 15 and 12 percent market shares, respectively.
- In the banking sector:
  - There are 41 foreign-owned banks (two subsidiaries, 39 branches) from 16 countries making up about 14 percent of the banking sector.
- In the insurance sector:
  - 12 insurance companies’ subsidiaries from five countries make up 10 percent of the domestic insurance sector.
- Securities sector:
  - About six percent of the securities sector assets are held by 20 foreign companies from eight countries.
- Korean financial institutions abroad:
  - Make up roughly 2 percent of the financial sector in terms of assets.
  - Banking sector abroad operates through 100 entities in 28 countries.
  - Twenty securities companies operate in 15 countries.
  - 15 collective investment (asset management) companies operate in 11 countries.

### Legal and institutional framework for crisis management — mandates and powers
- Five authorities with clearly allocated mandates and powers: the FSC, the FSS, the BOK, the KDIC, and the MOSF.
- FSC and FSS responsibility (verbatim): “to promote the advancement of the financial industry and the stability of financial markets, establish sound credit order and fair financial transaction practices, and protect depositors, investors, and other financial consumers.” (Article 1 of the Act on the Establishment, etc. of the Financial Services Commission.)
- KDIC responsibility (verbatim): “to contribute to the protection of depositors and the maintenance of the stability of the financial system.” (Article 1 of the Depositor Protection Act.)
- BOK responsibility (verbatim): to “pay attention to financial stability in carrying out its monetary and credit policies.” (Article 1 of the Bank of Korea Act.)
- MOSF develops and coordinates economic and fiscal policies and serves on various decision-making bodies of the financial regulators.
- FSC powers include early intervention and resolution measures: suspension of executives, appointment of management supervisors, suspension of all or part of the business, and writing down of shareholder equity.
- FSS is an integrated supervisor operating under the guidance of FSC and its Securities and Futures Commission (SFC).
- KDIC operates an integrated deposit insurance system and resolves troubled financial institutions, largely under FSC oversight.
- BOK is mainly responsible for monetary and credit policies, payment systems operations, and is the lender of last resort.

### Special resolution regime and resolution tools
- Legal framework establishes a special resolution regime; ASIFI identifies FSC and KDIC as resolution authorities, with FSC acting as lead resolution authority.
- BOK is not a resolution authority but can provide financial assistance indirectly through KDIC or public funds.
- Special resolution regime under ASIFI and the Deposit Protection Act (DPA) extends to banks, the Industrial Bank of Korea, investment traders, brokers, collective investment business entities, investment advisory business entities, discretionary investment business entities, insurance companies, mutual savings banks, trust business entities, merchant banks, and financial holding companies.
- Specialized banks are outside the purview of the special resolution regime and are governed by their own special statutes.
- Resolution tools include merger and acquisition, purchase and assumption, bridge bank, funding by government and other relevant authorities (including the KDIC), and liquidation.
- FSC empowered to appoint an administrator (management supervisor) and direct the administrator to undertake the necessary resolution process if the distressed bank fails to comply with prompt corrective actions. (Article 14 of ASIFI.)
- DPA mandates the application of the least cost test in the choice of a resolution method by the KDIC. (Article 38–4 of the DPA.)
- KDIC can establish a financial institution for resolution (like a bridge bank) as a separate entity for taking over business or contracts of insolvent financial institutions or conducting the resolution process. (Article 36–3 of the DPA.)

### Interagency cooperation and coordination
- Governance structure provides for information sharing, cooperation, and coordination with cross representation at key decision-making levels.
- A vice-ministerial level forum, the “Macroeconomic Financial Meeting” (MEFM), includes deputy level representation from the MOSF (Chair), FSC, FSS, BOK, and KDIC (by invitation when relevant).
  - MEFM formalized in September 2012; it combined three previously separate meetings.
  - Designed to meet on a quarterly basis at minimum; can hold ad-hoc meetings and has in practice met frequently, sometimes weekly.
  - Presidential Decree requires two-thirds attendance and votes of at least two-thirds in the affirmative for deliberation; in practice decisions are made by consensus and unresolved issues can be escalated to the “Economic and Financial Council” or the “Blue House Meeting.”
- Domestic MOUs:
  - Domestic financial sector authorities have signed a joint Memorandum of Understanding (MOU) for sharing “periodic” and “non-scheduled” financial information submitted by financial institutions to BOK, FSS, and KDIC, and for sharing each authority’s “processed information” as much as possible.
  - The MOU gives 10 days (three days if urgent) for complying with information requests and provides for confidentiality and dispute referral to the MEFM.
  - Laws allow BOK and KDIC to request FSS for undertaking joint examinations and sharing examination reports. (Article 88 of the Bank of Korea Act and Article 21 of the Depositor Protection Act, and related Enforcement Decrees.)
  - The MOUs do not explicitly provide for crisis management elements; MEFM is used for threats to financial stability.
- Cross-border arrangements:
  - FSC/FSS have entered into MOUs with 33 foreign authorities in 18 countries; MOUs broadly cover information exchange for ongoing supervisory purposes during normal times and on request but do not explicitly provide for crisis preparedness, crisis management, or resolution matters.
  - For capital markets, FSC/FSS are signatories to the IOSCO multilateral MOU (MMOU).
  - KDIC has MOUs with deposit insurers or resolution authorities of ten countries, including the U.S. Federal Deposit Insurance Corporation and the Securities Investor Protection Corporation, providing for staff secondment but not covering information sharing arrangements for crisis situations.
  - Korean financial institutions have presence and operations in about 28 countries through 68 branches and 152 subsidiaries.

### Recommendations to strengthen crisis management
- Consider formally setting up an apex forum for leading inter-agency cooperation and coordination on crisis preparedness and crisis management that includes supervisory agencies, the Central Bank, the Deposit Insurance Agency, and the Ministry of Strategy and Finance.
- Consider upgrading the MEFM with participation by the heads of agencies and include crisis preparedness and crisis management as an explicit mandate to avoid duplication.
- Strengthen inter-agency MOUs (domestic and cross-border) by:
  - Including explicit provisions for cooperation and coordination for crisis preparedness and crisis management, including ongoing information sharing with relevant foreign agencies.
  - Explicitly covering arrangements to minimize overall costs of resolution in home and host jurisdictions.
  - Emphasizing the need to duly consider the potential impact of resolution actions on financial stability in other jurisdictions.
  - Aiming to achieve cooperative solutions with foreign resolution authorities.
- Consider institution-specific cooperation and coordination arrangements for entities that can be systemic from a home or host perspective, and jurisdiction-specific arrangements where more than one Korean entity is operating.
- Improvements can follow FSB Key Attributes of Effective Resolution Regimes for Financial Institutions and BCBS/FSB cross-border cooperation recommendations.

### Crisis preparedness and prevention — monitoring and safety net
- MEFM acts as an inter-agency forum for sharing and reviewing analyses of risks to financial system stability; agencies perform independent analyses and discuss them at MEFM.
- FSC’s early warning system grades threats on a five point scale: sound, precautionary, cautionary, grave, and critical.
- BOK’s Financial Stability Report (FSR):
  - Published twice a year (April, October).
  - Comprises analyses of changes in the macroprudential environment, potential risk factors, assessment of Korean financial system stability, and review of policy responses and future challenges.
  - Uses the Systemic Risk Assessment Model for Macroprudential Policy (SAMP), strengthens research on non-bank financial institutions (NBFIs), and monitors funding and operational behaviors of financial institutions.
  - Evaluates vulnerabilities in banks and NBFIs and suggests policies to resolve them.
  - Subdivides macroprudential environment into the world economy, the domestic economy and economic agents (households and firms).
  - Analyses risk factors in four main segments: banks, NBFIs, financial markets and foreign exchange soundness.
  - BOK compiles the FSR twice a year and submits it to the National Assembly (requirement under Article 96 of the BOKA).
  - The October 2012 FSR noted that household debt accumulation could act as a factor reducing macro-financial resilience.
- Financial safety net elements available in Korea include:
  - Comprehensive BOK liquidity facilities including emergency liquidity assistance (ELA).
  - A deposit insurance scheme for deposits in financial institutions.
  - An efficient framework of financial sector supervision.

*Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2015/_cr1505.pdf*

### 23.      The deposit insurance system in Korea is an integrated insurance system that provides

### The deposit insurance system in Korea is an integrated insurance system that provides

### Coverage scope and definitions
- Protection up to KRW 50 million per depositor per covered financial institution.
- Covered financial institutions: banks, life insurers, non-life insurers, financial investment companies (e.g., securities firms and asset management companies), merchant banks, and mutual savings banks.
- Eligible deposits: "all money due to customers of financial institutions" including deposits in banks in Korea (including foreign bank branches in Korea), foreign currency deposits in Korea, and deposits held in foreign branches of Korean banks when not protected by the host jurisdiction.
- Participation: mandatory for all licensed financial institutions.
- Exclusions: deposits made by government, local government, BOK, KDIC, FSS, or a “covered financial institution,” certificates of deposits, MMFs, commercial papers and insurance policies held and paid by corporate policy holders are not eligible for KDIC’s protection.
- The size of insurance cover per depositor is approximately twice the per capita GDP.

### Coverage extent and key statistics (at end-2012)
- KDIC’s deposit protection cover is available to about 97 percent of bank depositors and 32 percent of deposits.
- Table 3 (selected entries):
  - Banks: Share of Fully-Insured Depositors (%) 97.37; Share of Deposits Eligible for Insurance (%) 9.63; Share of Insured Deposits (%) 32.1; Ex-ante Coverage Ratio (%) 1.58
  - Life Insurer: Share of Fully-Insured Depositors (%) 94.49; Share of Deposits Eligible for Insurance (%) 5.27; Share of Insured Deposits (%) 8.9; Ex-ante Coverage Ratio (%) 1.10
  - Non-life Insurer: Share of Fully-Insured Depositors (%) 96.88; Share of Deposits Eligible for Insurance (%) 6.17; Share of Insured Deposits (%) 7.8; Ex-ante Coverage Ratio (%) 0.98
  - Financial Investment Companies: Share of Fully-Insured Depositors (%) 98.89; Share of Deposits Eligible for Insurance (%) 0.25; Share of Insured Deposits (%) 9.3; Ex-ante Coverage Ratio (%) 2.30
  - Merchant Banks: Share of Fully-Insured Depositors (%) 96.08; Share of Deposits Eligible for Insurance (%) 0.26; Share of Insured Deposits (%) 0.3; Ex-ante Coverage Ratio (%) 3.66
  - Mutual Savings Bank: Share of Fully-Insured Depositors (%) 99.39; Share of Deposits Eligible for Insurance (%) 9.94; Share of Insured Deposits (%) 2.4; Ex-ante Coverage Ratio (%) -4.39
- DIF for bank deposits: about 0.64 percent of total deposits (below target ratio of 0.825 to 1.1 percent).

### Deposit Insurance Fund (DIF) status, structure, and premiums
- DIF fund balance: KDIC managing a fund of KRW 8.354 trillion (as of end-2012).
- Special account for MSB failure resolutions: created in 2011; funded ex-post and by appropriating 45 percent of the annual premium received from all insured entities; special account deficit of KRW 15.887 trillion (as of end-2012).
- Aggregated DIF position: in deficit (negative balance) of approximately KRW 7.5 trillion.
- DIF divided into six accounts: commercial banks, merchant banks, life insurance, non-life insurance, finance investment companies, and mutual savings banks.
- Deposit Insurance Premium Rates per financial sector segment (table entries preserved exactly):
  - Insurance Premium Rate: Banks 8/10,000; Financial Investment Companies 15/10,000; Insurance Companies 15/10,000; Merchant Banks 15/10,000; MSBs 40/10,000
  - Legal Maximum Limit: Banks 50/10,000; Financial Investment Companies 50/10,000; Insurance Companies 50/10,000; Merchant Banks 50/10,000; MSBs 50/10,000

### Payout procedures, timelines, and operational capacity
- KDIC has an IT system (Integrated Resolution Information System (IRIS)) since 2008; capacity to handle 100,000 claims per hour.
- No statutory time limits for deposit pay-outs generally.
- When a ‘category one’ insurance contingency occurs, KDIC has two months to decide whether to payout depositors (Articles 31 and 34 of the Depositor Protection Act).
- For a ‘category two’ insurance contingency, time period for payment is not stipulated in law or regulations; KDIC shall pay insurance money upon the request of depositors.
- Standard time for provisional pay-outs reduced to 2 weeks in 2011.
- KDIC has not had to implement payouts of commercial bank deposits in the past 10 years.
- KDIC can make provisional pay-outs (partial payments within the insured limit) while pending full pay-outs.

### Operational and moral hazard concerns
- Banks declared insolvent and under resolution by KDIC are allowed to operate and accept new deposits as well as repay existing deposits; this can:
  - Expose DIF to higher losses.
  - Expose new depositors in excess of insured amounts to risk of loss.
  - Allow insolvent banks to make preferential payments or resort to asset stripping, potentially increasing burden on DIF.

### Liquidity backing and legal funding powers
- KDIC legal basis to garner additional funds: Article 26 DPA allows KDIC to borrow from the Government, BOK, insured financial institution, or other institutions identified by the Presidential Decree, and issuance of DIF bonds.
- KDIC lacks access to an explicit and assured funding mechanism for emergency liquidity needs.
- Potential quick market sources (borrowing from member financial institutions or issuing DIF Bonds) may be infeasible during crises.
- Government loans can take from 2 weeks to 3 months to arrange.
- International best practice recommendation: assured liquidity support that can be drawn down immediately in an emergency.

### Emergency Liquidity Assistance (ELA) by BOK
- BOK empowered to provide ELA (Article 65 of the BOKA).
- ELA can be provided against a flexible list of collateral, including instruments maturing within one year and other temporarily acceptable collateral.
- BOK policy: provide ELA only to solvent entities (policy, not formally prescribed in BOK Act).
- BOK contingency plan: MPC has developed guidance for collateral decisions (no details available).
- BOK can lend to for-profit non-bank businesses including non-financial enterprises (Article 80 of the BOKA).
- Decision-process constraints:
  - Article 65 requires BOK to hear opinions of the government before deciding on ELA.
  - Article 91 grants MOSF and FSC the right for Vice Minister/Vice Chairman to attend and state opinions at MPC meetings.
  - Article 92 allows MOSF to request MPC reconsider decisions deemed in conflict with Government’s economic policy; reconsideration may be elevated to the President if five MPC members continue to disagree; requests for reconsideration must be publicly disclosed immediately.
- These processes have potential to delay ELA decisions.

### Supervisory framework and corrective action
- FSC/FSS oversight: on-site CAMEL-R assessments and off-site surveillance.
- FSS on-site examinations in major banks once in two years; surveillance intensity depends on bank situation, size, risk profile, and macroeconomic conditions.
- Banks are assigned supervisory safety and soundness ratings on a scale of 1 to 5 using CAMEL-R.
- Corrective action framework:
  - Corrective measures triggered at three stages with management improvement recommendation, management improvement requirement, and management improvement order.
  - Triggers with reference to CAR are set to be activated only after a bank breaches the minimum capital ratio, allowing capital ratio to go down to 2 percent before intrusive measures.
  - In practice, for MSBs authorities adopted more stringent measures only when CAR was close to or lower than 2 percent, leading to many MSBs put into resolution after becoming insolvent.
  - Asset quality trigger in stage 2 is unclear; asset quality trigger in stage 3 is absent.
- FSC has broad discretion on remedial and emergency measures (Articles 34 to 36 of the Regulation on supervision of banking business and Enforcement Decree), including restriction on taking deposits and granting credits, suspension of payment of all or parts of deposits, prohibition of debt repayment, disposal of assets, retirements of issued stocks, suspension of officers, appointment of administrators, transfer of business or contracts, suspension of business, and mergers and acquisitions.

### Recommendations (policy actions emphasized)
- Do not permit banks determined as insolvent to accept fresh deposits or allow withdrawal of existing deposits.
- Arrange to replenish the deficit in the deposit insurance fund to preserve credibility and align with core principles for effective deposit insurance systems.
- Review and modify the DPA to:
  - Preserve principle of separation of different DIF accounts.
  - Avoid cross-sector subsidization by entities in other financial sector segments.
  - Review funding options for the special account for MSB to avoid co-mingling of funds.
  - Align premiums in each account with reference to that sector’s performance without cross-subsidization.
- Establish an explicitly assured line of credit from the Government to provide back-up funding to KDIC and clear processes for timely access.
- KDIC should adopt a more pro-active approach for depositor payouts by putting in place a procedure for timely payouts to eligible depositors (for example within two weeks from occurrence of insurance contingencies) and without requiring depositors to lodge claims.
- Review and revise the DPA to give priority to depositors’ claims up to the insured amount over other general classes of unsecured creditors within constitutional limits and within the broader resolution framework.
- Authorities should review and revise the BOKA and related processes to avoid scope for potential delays in timely provision of ELA.

*Source: IMF staff report content (extract).*

### 45.      Pursuant to ASIFI and DPA, the FSC can postpone or suspend the corrective actions,

### _cr1505 - 45.      Pursuant to ASIFI and DPA, the FSC can postpone or suspend the corrective actions,

### Corrective actions framework and postponement powers
- The FSC can postpone or suspend corrective actions, including revocation of license, for a specified period under certain special situations (e.g., where the institution is expected to meet required standards within a short time such as capital increase or disposal of assets).
- Subordinate regulations: suspension period for corrective action is limited to no more than 3 months for financial institutions with small asset volume.
- The FSC can choose not to revoke authorization or permission for a period up to one year where a financial institution ordered to reduce capital, or amortize all or some of its stocks, or consolidate its stocks, complies with the order.
- Under Article 21(6) of the DPA, where the KDIC requests the FSC to take adequate measures because of a threat to the insurance contingency, the FSC should comply unless there exist “any special grounds” for it not to comply.
- Lack of written criteria for exercising discretion under these provisions creates uncertainty on the efficacy of the intervention framework and creates the possibility of forbearance.
- The FSC has used its power to postpone corrective actions in mutual savings banks; this postponement is cited anecdotally as a reason for their failure and results in higher losses to the KDIC.

### Recommendations on corrective actions
- Review the triggers for corrective actions, introduce greater clarity and objectivity to the triggers, and re-set triggers to earlier stages in the deterioration of an institution’s health to comply with international standards that require early supervisory intervention.
- Develop strict internal guidelines and criteria to allow postponement or suspension of serious corrective actions (including interventions) only in extremely rare cases of systemic relevance warranting support to preserve financial stability.
- Authorities should undertake revisions to the relevant laws (primary law or subsidiary legislation) rather than rely solely on internal guidelines.

### Contingency plans and preparedness
- Financial institutions, particularly banks, have prepared contingency plans addressing risk exposures (liquidity and operational risks) and undertake periodic stress tests; these are subject to periodic oversight by the FSS.
- Group-level preparedness may be less comprehensive than entity-level: financial groups oversee risk at the solo level and are at early stages of adopting a group-wide approach; contingency plans tend to be at the subsidiary level.
- The FSC, FSS, KDIC, BOK, and MOSF state they have contingency plans; the assessment team did not have access to all plans but authorities assert plans are detailed and adequate.
- Reported gap: contingency plans and crisis preparedness arrangements have not been tested through crisis simulation exercises (CSEs).
  - CSEs diagnose organizational, legal, operational, information-sharing, coordination, and communications gaps and enable “learning by doing.”
  - Industry and regulators report they have not yet undertaken CSEs to test frameworks and functionaries.

### Recommendations on contingency planning and crisis preparedness
- Require FHCs to prepare group-wide contingency plans and submit recovery plans (alignment with FSB Key Attributes).
- Review and enhance crisis preparedness elements:
  - (a) Crisis management teams (CMTs): each agency (FSC, FSS, BOK, KDIC, MOSF) identify key officials responsible for crisis preparedness and management tasks.
  - (b) Crisis management handbook or reference materials: prepare protocols/procedures, extracts of relevant laws and regulations, summaries of key policies, templates of key documents, updated stakeholder lists with contacts, and communication protocols.
  - (c) Crisis management groups (CMGs): consider establishing institution-specific CMGs for systemically relevant institutions, including domestic and key foreign authorities, supervisory authorities, central banks, resolution authorities, finance ministries, and public authorities responsible for guarantee schemes.
- Fully test crisis preparedness and crisis management capabilities through periodic crisis simulation exercises, both at individual regulator level and national inter-agency level, covering severe but plausible scenarios and repeated periodically when key changes occur.

### Crisis management framework principles
- Objective: prevent serious domestic or international financial instability that would adversely impact the real economy.
- FSB principles to guide interventions:
  - (a) Maintain incentives for financial institutions to behave prudently.
  - (b) Promote private sector solutions and use public sector interventions only when necessary to preserve financial stability.
  - (c) Maintain a level, competitive international playing field, in the spirit of the Basel Accord.

### Crisis response tools available
- Authorities have options to influence systemic liquidity, increase deposit insurance and investor protection (including full guarantee), mobilize public funds, and intervene/resolve troubled institutions.

### Systemic liquidity (BOK tools)
- The BOK influences systemic liquidity via open market operations (OMO), standing facilities, and varying reserve requirements.
- OMOs use certain specified securities (Government bonds of the Republic of Korea and securities with full government guarantee).
- The BOK’s expanded list of eligible collateral for the standing credit facility (Liquidity Adjustment Loans) includes other credit securities such as promissory notes and bills of exchange.
- Reserve requirements vary between 0 and 7 percent depending on the type of liability; banks may be required to maintain marginal reserves over and above the ratio of reserves on liabilities.
- The BOK has planned a securities lending facility under the OMO window and provides intraday funds to participant institutions of payment systems to address gridlock situations in the BOK Wire settlement system (available to participants of payment systems operated directly by the BOK).

### Deposit insurance and guarantee (KDIC)
- Raising/widening deposit insurance cover is a tested option to signal commitment to market calm in crisis.
- Historical actions: KDIC raised insurance cover from KRW 20 million to a blanket guarantee in November 1997 and dropped coverage in 2001 to KRW 50 million, where it remains unchanged.
- In 2008, deposit insurance cover was extended to cover foreign currency deposits.
- Legal and procedural processes for depositor repayment and resolution can be lengthy:
  - KDIC undertakes due diligence, performs a least cost test, and refers proposals to the FSC for approval.
  - These steps are expected to take at least about two months even for mutual savings banks.
  - If the option involves use of public funds, obtaining approvals and raising funds are expected to take about 2 more months.
  - When a financial institution is required to write down shareholder equity and creditors’ claims under the chosen option, KDIC/failed bank is required to provide due notice of at least 10 days to the creditors.

### Recommendation on deposit insurance processes
- KDIC and FSC should review processes to reduce timelines for making decisions on depositor payouts, providing financial assistance to, and resolving troubled banks.

### Public financial support and moral hazard concerns
- Korea established several funds post-global financial crisis to provide liquidity and capital assistance (examples include Bank Recapitalization Fund and Restructuring Fund); some receive support from the Government and BOK via loans or bond guarantees.
- These funds serve as additional tools for managing stress but can distort incentives and create moral hazard.
- Funding or guarantees have been largely provided by state-owned financial enterprises; establishment of such funds may weaken institutions’ incentives to manage risk.
- ASIFI empowers FSC to impose corrective and resolution measures but does not explicitly provide for mandatory imposition of losses first on shareholders and other creditors before deploying public funds—this contrasts with the FSB KAs and DICP.
- Authorities assert that in practice the FSC has imposed losses on shareholders; formalizing the requirement would help address moral hazard and align with FSB KA (6.4) and DICP requirements that shareholders take first losses.

*Source: _cr1505 - 45. Pursuant to ASIFI and DPA, the FSC can postpone or suspend the corrective actions,*

### Box 3. Use of Public Funds to Support the Financial System

### Box 3. Use of Public Funds to Support the Financial System

### Recommendations (overview)
- Authorities should review direct and indirect use of public funds (including Depositor Protection Fund) to ensure incentive frameworks are not distorted and moral hazard issues are fully addressed.
- International trend: costs of financial institution resolutions borne by the private sector first; public funds used only when private sector sources are not available or cannot achieve the objective.
- When public funds are inevitable, shareholders and other creditors of insolvent financial institutions should always bear the losses caused to that institution before infusion of public funds.
- Authorities should ensure utilization of public funds for managing stress situations, including resolution, complies with the above principles.
- Authorities should consider and incorporate clear options or principles for exit from public involvement to restore market discipline and promote efficient operation of financial markets.

### A. Financial institutions resolution — Resolution measures for insolvent banks
Findings
- The FSC has legal powers to take stronger measures for insolvent banks; a second level of legal triggers allows radical measures including suspension of business or total transfer to another institution; these actions require the institution to be “insolvent.”
- KDIC becomes a key player once insolvency is determined.
- Definition of “insolvency” under Korean financial laws (ASIFI, article 2.2, and DPA, Article 2.5) has three aspects:
  - (a) the financial institution’s liabilities exceed its assets (balance sheet insolvency);
  - (b) the financial institution has suspended its payments; and
  - (c) The financial institution, in the opinion of the FSC or the KDIC, is deemed as having difficulty in paying its claims without financial assistance.
- KDIC actions:
  - In cases (a) and (b), KDIC shall pay the insured deposits (DPA Article 31) and FSC may file a petition for bankruptcy if grounds exist.
  - If KDIC considers the institution needs help for protection of depositors or “the stability of the credit market” (DPA Article 38(1)2) it may provide financial assistance by resolution of its Committee; in practice this applies to most insolvency cases under criterion (c).
- Determination of the specific resolution operation is made by the FSC at the request of the KDIC (DPA Article 36–2); KDIC typically performs total or partial mergers, or partial/total transfer of business or contracts.
- Resolution operations are generally performed under management appointed by the FSC (Management Supervisor); when KDIC provides financial assistance the Management Supervisor shall be “an executive or employee” of the KDIC (ASIFI, Article 14–6 (1)).
- FSC may reduce and/or consolidate capital of insolvent institutions when performing resolution operations using powers from Article 10 (1) of ASIFI in concordance with Article 12 (3).
- KDIC can provide financial assistance where Government has made investments to avoid “complete destabilization” (ASIFI, Article 12 (1)).
- KDIC can provide assistance to sound institutions accepting merger/transfer from insolvent institutions; assistance is provided to the sound entity (DPA, Article 38 (1) 1).
- KDIC can create “bridge banks” / establish a Financial Resolution Institution (FRI) to take over business or conduct resolution; capital of FRI paid up in full by KDIC (DPA, 36–3).

Recommendations (legal & procedural)
- Definition of “Insolvent Financial Institutions” should be made less discretionary by law to make resolution process more precise and improve legal certainty; consider inclusion in law of key parameters to declare insolvency under ASIFI Article 2, 2.(c) and DPA Article 2.5.(c).
- Reduction or consolidation of capital in insolvent institutions under resolution should be the general rule; consider changing law to make capital reduction the general rule and allow exceptions only in extreme and very justified cases as determined by law.

### B. The Least Cost Principle
Findings
- KDIC is subject to the “least cost principle” in all its operations: insurance payments and resolution actions subject to minimizing any loss to the deposit insurance fund (DPA Article 38–4).
- Complementary elements in secondary legislation and KDIC policies: DPA Enforcement Decree Article 24–3 requires minimizing loss to the deposit insurance fund by “objectively understanding the management status and financial conditions … through a due diligence of assets and liabilities, etc.” KDIC reportedly has internal criteria for due diligence.
- Exceptions: KDIC Committee can provide financial assistance or pay insured depositors without regard to least cost principle if liquidation or bankruptcy “might seriously undermine the stability of the financial system” (DPA, Article 38–4 (3)).

Concerns
- Exceptions are general and discretionary. KDIC is authorized to receive Government contributions (DPA Act, Article 24 (2) 2), borrow from Government and the BOK (DPA Act, Article 26 (1)), and issue Deposit Insurance Fund Bonds guaranteed by the Government (DPA Act, Article 26–2 (5)). The general formulation of the least cost principle and high degree of discretion for exemptions may introduce significant moral hazard.
- Some criteria exist in policy for due diligence but would benefit from being placed in higher-level provisions to improve legal certainty.

Recommendations (least cost)
- Include key principles for application of KDIC’s Least Cost Principle in higher level norms (e.g., the DPA Enforcement Decree) to improve transparency and legal certainty.
- Link exemptions to the least cost principle clearly to parameters used to define “systemic Implications”; once parameters and key criteria for “systemic implications” are identified, exemptions should be linked to those parameters either by law or the Enforcement Decree.

### C. Systemic implications — definitions and triggers
Findings
- Korean financial laws use several expressions implying “systemic implications” that trigger special funding possibilities; these expressions are not identical and none is specifically defined by law.
- Examples of triggering provisions:
  - (a) DPA Article 38 (1) 2: KDIC may provide financial assistance where insolvent institution needs assistance for protection of depositors and “the stability of the credit market.”
  - (b) DPA Article 36: KDIC may “make arrangements” for merger/business transfer where necessary for protection of depositors and “the maintenance of financial stability”; KDIC can request FSC to take “the necessary measures” and can provide financial assistance to sound entities participating in merger/transfer (Article 38 (1) 1).
  - (c) DPA Article 36–3: KDIC may establish an FRI with FSC approval to take over business/contracts when “deemed necessary for the protection of depositors and maintenance of the stability of the financial system”; FRI fully capitalized by KDIC and can operate initially for up to five years, extendable by FSC.
  - (d) DPA Article 38–4 (3): KDIC may pay insurance money or provide assistance beyond the least cost principle when Committee deems liquidation or bankruptcy “might seriously undermine the stability of the financial system.”
- The varied and undefined formulations granting additional funding powers to the KDIC may have significant implications for financial stability and moral hazard.

Key policy implication
- Clarify and standardize legal definitions and parameters for “systemic implications” to reduce discretionality and limit moral hazard arising from broad statutory funding powers.

*Box 3. Use of Public Funds to Support the Financial System*

### 84.      The lack of precision in all the above cases but specially in the granting of exceptions

### _cr1505 - 84.      The lack of precision in all the above cases but specially in the granting of exceptions

### Lack of precision and its effects
- "The lack of precision in all the above cases but specially in the granting of exceptions to the least cost principle seriously reduces accountability and legal certainty."
- The lack of precision of the used terms, "especially in the case that allows for exceptions to the KDIC’s least cost principle," is identified as a systemic weakness.
- Consequences listed:
  - May allow the financial authorities to take case by case decisions.
  - Undermines the basis for accountability.
  - Affects the certainty of the legal rules and the credibility of the resolution scheme.
- Citation line present in source: "75 DPA Act, Article 36–2 (1)."

### Identification of Domestic Systemically Important Financial Institutions (D-SIFIs)
- Recommendation to align with BCBS D-SIB framework: "In line with the recommendations of the BCBS in its key documents on Domestic Systemically Important Financial Institutions (DSIFIS), the financial sector authorities shall continue its efforts to develop parameters to objectively identify systemically important FI and then to reflect them in norms."
- Rationale: "Sustained progress should be made in the current efforts of the financial authorities to identify parameters that can objectively help to identify the degree of systemic importance that a financial institution or financial holding company may have, and then to reflect those parameters in appropriate norms, in order to reduce the high degree of discretionality implied in the current system and to improve accountability and legal certainty."
- Footnote commentary in source:
  - "76 The BOK, in coordination with industry members is currently developing studies in order to establish appropriate criteria and parameters to identify domestic Systemically Important Financial Institutions. The plan of the financial authorities is to develop those parameters and to reflect them in regulations by 2016."
  - "77 The KDIC has since engaged in consultation with the FSC for identifying the domestic SIFIs and applying the relevant FSB KAs."

### Recommendations (numbered in source)
- "86. The financial authorities shall step-up its current efforts to establish criteria for the identification of systemically important financial institutions and to reflect those in norms to be integrated into the resolution regime."
  - "In order to be able to apply the KA directed at G-SIFIS in an appropriate manner, the financial authorities should continue their efforts to develop objective parameters and criteria to identify systemically important financial institutions and groups, and the FSC shall reflect those criteria in norms integrating the resolution regime."
  - Authorities should follow "the Assessment Methodology Principles reflected in the BCBS D-SIB framework, with special regard to Principle 5 in relation to the bank-specific factors that should be taken into account in order to determine those which should be considered as D-SIFIs in the Korean context."
  - "The financial authorities should be empowered to take all necessary measures since an early stage, to reduce the potential cost of resolving systemically important FI, and to facilitate the progressive implementation of resolution operations as needed."
- "87. As part of the process mentioned in the above paragraph, the authorities should modify the existing legal definitions of systemic implications, systemic stability, and similar expressions used in the different laws, to be in alignment with the domestic application of the principles reflected in the BCBS D-SIB framework."
  - "Those definitions should be replaced by new ones resulting from the application of the BCBS D-SIB framework in Korea, and, once the definitions are reflected in the domestic laws and regulations, KA directed at G-SIFIs shall be applied, including KA 8 on CMGs, KA 9 on institution specific cooperation agreements (COAGs), KA 11 on Resolution and Recovery Plans (RRPs), and KA 10 on Resolvability Assessments."

### Appendix I — Financial System: key statistics and structure (as presented)
- Source: BOK.
- Notes from table: 
  - "(1) Includes consolidated financial accounts of banks and securities companies."
  - "(2) As of end-2011."
  - "(3) Excludes foreign branches."
  - "(4) Based on investment trust accounts."
- Aggregate figures (end-2012 and related):
  - "Total 3,466,613 100.0 4,034,399 100" (presented as total institutions and total assets in source table columns)
  - "GDP (nominal) 1,235,161 1,272,460"
  - "Financial Sector as % of GDP 280.73 317.1"
  - "end-2010 end-2012 Total As s ets" (table headers retained as in source)
- Banking sector snapshot (end-2012) — totals and percent changes (preserve formatting and values as in source):
  - "Banks 57 2,235,402 100.0% 3.4% 6.2%"
  - Breakdown:
    - "commercial banks 52 1,578,043 70.6% 2.0% 5.0%"
    - "national banks 7 1,226,827 54.9% 0.6% 5.4%"
    - "local banks 6 147,082 6.6% 8.6% 9.5%"
    - "foreign bank branches 39 204,134 9.1% 5.7% -0.9%"
    - "specialized banks 5 657,359 29.4% 7.0% 9.6%"
- Top 10 banks (2012) — Total assets (KRW billion), share, and % growth 2011-2012 (values preserved exactly as in source):
  - "Kookmin Bank (KB) 280,310 13% 1.2%"
  - "Woori Bank(Woori) 265,614 12% 2.9%"
  - "Shinhan Bank(Shinhan) 253,955 11% 1.2%"
  - "NH Bank* (NH) 206,466 9% 3.9%"
  - "Industrial Bank of Korea* 205,668 9% 8.5%"
  - "Hana Bank(Hana) 168,124 8% 0.8%"
  - "Korea Development Bank* (KDB) 167,132 7% 12.2%"
  - "Korea Exchange Bank( Hana, since Feb2012) 123,058 6% 2.0%"
  - "SC First Bank(Standard Chartered Korea) 69,354 3% -3.0%"
  - "Citibank Korea (Citigroup Korea) 66,402 3% -10.5%"
  - "Top 5 total 1,212,013 54% 3.2%"
  - "Top 10 total 1,806,083 81% 2.8%"
  - "National totals 2,235,402 3.4%"

*Italicized source attribution as in the overlay pipeline:*
*Source: _cr1505 - 84.      The lack of precision in all the above cases but specially in the granting of exceptions (PDF chapter/section).*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2015/_cr1505.pdf_