S. Korea Backs $100 Billion in Debt to Calm Markets

S. Korea Backs $100 Billion in Debt to Calm Markets

Oct. 19 (Bloomberg) -- South Korea will guarantee $100 billion in bank debts and supply lenders with $30 billion in dollars to stabilize its financial markets.

The government will provide tax benefits for long-term equity and bond investors, while the Bank of Korea will buy repurchasing agreements and government bonds to boost won liquidity, the heads of the finance ministry, central bank and financial regulator said in a statement from Seoul. Policy makers held an emergency meeting on Oct. 17 to hammer out the plan.

South Korea is struggling with Asia's worst-performing currency, a shortage of U.S. dollars and a stock market that has lost 38 percent this year. The guarantee on bank debts comes after Standard & Poor's said last week it may cut the credit ratings of the nation's largest lenders, which triggered the worst plunge in the won since the International Monetary Fund bailed the nation out in December 1997.

``They have to do that because the market was pushing them by attacking the Korean won,'' said V. Anantha-Nageswaran, chief investment officer for Asia Pacific at Bank Julius Baer (Singapore) Ltd., part of Switzerland's biggest independent money manager for the wealthy. ``They know what the stakes are. The currency could completely careen out of proportion.''

The government and state-run lenders including Korea Development Bank will guarantee as much as $100 billion of external debt taken up by Korean banks from Oct. 20 to June 30 next year, according to today's statement. The guarantee is valid for three years.

`Allay Fears'

South Korea joins countries in Europe, along with Hong Kong and Australia, in providing state backing to banks to help fund lending amid a global financial crisis.

``We will take similar measures to avoid placing domestic banks at a comparative disadvantage in terms of overseas funding and to allay fears in the financial market,'' Finance Minister Kang Man Soo told reporters in Seoul, at a press briefing with central bank Governor Lee Seong Tae and Jun Kwang Woo, head of the Financial Services Commission.

S&P, in a report released Oct. 15, said South Korea's banks face a more than 50 percent chance the credit crunch could threaten their foreign-currency funding. Domestic lenders have $235.3 billion of foreign-currency liabilities, with about $32.7 billion due to mature in the fourth quarter, according to the Financial Supervisory Service.

Funding Loans

``Korea is one of the few banking systems in Asia where domestic deposits are insufficient to fund loans,'' Moody's Investors Service said in an Oct. 16 report. That's forced them to rely on the wholesale market for about 44 percent of their total funding, with international markets accounting for as much as 12 percent, the ratings company said.

Policy makers decided that a recapitalization of the nation's financial institutions or an expansion of deposit guarantees are ``not necessary.'' Still, the government will ``take proper actions'' should the need arise, according to the statement.

To boost the supply of U.S. dollars in the domestic market, South Korea will provide the banking industry with $30 billion from its foreign-exchange reserves, according to the statement. The government had already promised to supply a total of $15 billion to small firms and the swap market, while the Bank of Korea said on Oct. 17 it will change rules in the foreign- exchange swap market to increase banks' access to funds.

`Vicious Circle'

The U.S. financial crisis is making it more difficult for companies worldwide to secure dollars as banks hoard cash to meet their future funding needs. South Korea's currency and swap markets are experiencing a dollar shortage as local businesses, which expect the U.S. currency to strengthen against the won, don't want to sell their dollars yet.

``Providing dollar liquidity will stop the vicious circle of a shortage of dollars in banks and firms leading to a weaker won,'' said Lim Jiwon, a senior economist at JPMorgan Chase & Co. in Seoul.

Authorities will continue ``smoothing'' operations in the currency market to avoid ``extreme volatilities,'' the statement said.

To encourage long-term investing, the government will give tax benefits to investors who hold equity or corporate-bond funds for more than three years, today's statement said. The breaks include an exemption from taxes on dividends.

South Korea's benchmark Kospi stock index has lost 38 percent this year, heading for its first annual decline since 2002. The measure plunged 9.4 percent on Oct. 16, the biggest one-day fall since September 2001.

South Korea will inject 1 trillion won ($767 million) in Industrial Bank of Korea, the nation's biggest lender to small- and mid-sized businesses, by transferring its equity stakes in the state companies.

``The government has done what it can do at the moment to join global efforts to help stabilize the markets,'' said Seo Chul Soo, a fixed-income analyst at Daewoo Securities Co. in Seoul. ``More steps may be needed if the global markets remain unstable.''

BLOOMBERG