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Prudential Standards

Banks

Prudential Guidance Standards

Banking institutions must comply with certain safety and soundness standards in respect of their capital, assets, liquidity, and other critical aspect of their banking operations. Banks that fail to meet the expected safety and soundness standards are subject to supervisory actions that can range from recapitalization and dividend payout restrictions to prompt corrective action (PCA).

Liquidity Coverage Ratio

Liquidity is a measure of how well a bank is prepared to convert assets into cash with little or no loss of value in order to meet its liquidity in various liquidity risk scenarios. To help ensure effective bank liquidity supervision, the FSC/FSS has put into effect at the beginning of 2015 the Basel III liquidity coverage ratio (LCR) framework, which replaced the previous won-denominated liquidity ratio requirements that applied to banks.

As set by the Basel Committee on Banking Supervision, the LCR is intended to improve the resilience of a bank's liquidity capacity by requiring high-quality liquid assets sufficient to enable the bank to cope with a "significant stress scenario" lasting up to 30 days. The LCR is defined as a simple ratio of stock of high quality liquid assets to the total net cash outflows over the next 30 calendar days. Commercial banks and specialized banks must maintain a minimum LCR of 100 percent. For foreign bank branches, the minimum LCR is 60 percent. In addition, banks are subject to the net stable funding ratio (NSFR) requirement that supplements the LCR with a time horizon of one year.

Foreign Exchange Management and Requirements

Banks and other financial institutions that are authorized to engage in foreign exchange-related business activities pursuant to the Foreign Exchange Transactions Act ("foreign exchange-authorized institutions") are required to operate with safe and sound management of foreign exchange liquidity and foreign exchange risk.

  • Open Foreign Exchange Position: Foreign exchange position refers to the difference between foreign currency-denominated assets and liabilities. For foreign-exchange authorized banks, the limit for aggregate foreign exchange positions (spot and forward positions) is set at 50 percent of the capital. The limit for the net forward position is 40 percent of the capital for foreign exchange-authorized banks and 200 percent for foreign bank branches.
  • Foreign Exchange Liquidity Ratio: Banks are subject to three-month foreign exchange liquidity ratio requirement, which is defined as a ratio of foreign currency-denominated assets to foreign currency-denominated liabilities maturing within three months. They must also comply with one-month maturity mismatch ratio (gap ratio) requirements. For foreign-exchange authorized banks, the minimum three-month foreign exchange liquidity ratio is 85 percent. The minimum one-month mismatch ratioㅡdefined as a ratio of net foreign currency-denominated assets (net of foreign currency-denominated liabilities) to aggregate foreign currency-denominated assetsㅡis 10 percent.
  • Stable Foreign Exchange Funding Ratio: Domestic banks are subject to foreign currency funding ratios relative to the outstanding foreign currency lending that are designed to prevent maturity mismatch between foreign currency borrowing and lending. The stable foreign exchange funding ratioㅡdefined as a ratio of foreign currency funding with maturity longer than a year to foreign currency lending with maturity longer than a yearㅡmust exceed 100 percent. Financial institutions with the outstanding amount of foreign currency lending less than USD50 million are exempt from the stable foreign exchange funding ratio requirement.
  • Loan-to-Deposit Ratio: Financial institutions are required to maintain their won-denominated loan-to-deposit ratio on a monthly average basis at or below 100 percent. For computation purposes, the amount of policy-directed loans is deducted from the numerator (loans), while the amount of covered bonds is added to the denominator (deposits).

Asset Classification

Bank assets are classified into five different classes: (1) normal; (2) precautionary; (3) substandard; (4) doubtful; and (5) resumed loss. Asset classification is made primarily on the basis of the borrower’s debt-servicing ability. It is therefore not only backward-looking (e.g., duration of any nonpayment and the occurrence of any default in the past), but also forward-looking because the borrower’s future debt-servicing ability is assessed and reflected in the classification. Loans classified as substandard, doubtful, or resumed loss are collectively referred to as “substandard or below loans” or SBLs for short.

Standard Asset Classification Criteria

The standard asset classification criteria give the due weight to the borrower's debt-servicing ability, the duration of any nonpayment from the borrower, and the occurrence of any default.

  • Borrower’s Debt-Servicing Ability: Asset classification on the basis of the borrower’s debt-servicing ability is made in consideration of the borrower’s debt-paying ability and credit risk factors that include risks to the borrower’s cash flows, business, industry, and financial stability.
  • Duration of Any Nonpayment: Nonpayment means interest or principal payment not made before the predetermined date with the lender. Asset classifications made on the basis of the duration of a borrower's nonpayment of interest or principle is presented as follows:

    Standard Asset Classification Criteria

      Duration of Nonpayment for Business and Household Loans Duration of Nonpayment for Individual Credit Card Receivables
    Normal

    Less than a month;

    Less than a month;

    Precautionary

    More than a month, but shorter than three months;

    More than a month, but shorter than three months;

    Substandard

    More than three months (for estimated collectible amount);

    More than three months (for estimated collectible amount);

    Doubtful

    More than three months, but shorter than 12 months (in excess of the estimated collectible amount);

    More than three months, but shorter than six months (in excess of the estimated collectible amount);

    Presumed loss

    More than 12 months (in excess of the estimated collectible amount);

    More than six months (in excess of the estimated collectible amount);

  • Default Criterion: Where the borrower's business is terminated, the borrower's default becomes final, or the borrower is in bankruptcy proceedings or in the process of business liquidation, the estimated collectible amount from the borrower collateral is classified as "substandard," and the excess amount not covered by the borrower collateral as "presumed loss."

    Table of Asset Classification Criteria

      Debt-Servicing Ability Duration of Nonpayment Default
    Criteria
    Normal

    Assets that are judged to pose little or no risk to full lender collection given the strength of the borrower’s debt-servicing ability in consideration of its overall business soundness, financial conditions, and future cash flows;

     
    -- --
    Precautionary

    Assets that are judged to pose no immediate risk to full lender collection given the borrower’s overall business soundness, financial conditions, and future cash flows, but are susceptible to potential risks that may reduce the borrower’s debt-servicing ability in the future;

     

    Assets whose interest and principal payments from the borrower have been overdue longer than a month, but shorter than three months;

    --
    Substandard
    • Assets that are judged to pose significant risks to full lender collection because of the presence of risk factors that may undermine borrower’s future debt-servicing ability;
    • Portions expected to be collected from assets that are classified as either “doubtful” or “presumed loss”;

    Portions expected to be collected from assets whose interest and principal payments from the borrower have been overdue longer than three months;

    Portions expected to be collected from assets that pose significant risks to full lender collection because of borrower default, bankruptcy, business liquidation, or business termination;

    Doubtful

    Portions of assets not expected to be collected given the borrower’s sharply deteriorating debt-servicing ability that makes full lender collection unlikely;

     

    Portions not expected to be collected from assets whose interest and principal payments from the borrower have been overdue longer than three months, but shorter than 12 months;

     
    --
    Presumed loss

    Portions of assets not expected to be collected given the borrower’s sharply deteriorating debt-servicing ability that makes recognition of loan losses unavoidable;

    Portions not expected to be collected from assets whose interest and principle payments from the borrower have been overdue longer than 12 months;

    Assets that pose significant risks to full lender collection because of borrower default, bankruptcy, business liquidation, or business termination;

Assets Subject to Classification and Allowance for Loan Losses

Asset classification and allowance for loan losses are applicable to all assets that are inherently vulnerable to credit risk and impairment. For banks, this rule applies to loans and credit guarantees under banking account. The same rule applies to assets subject to credit risk and impairment under the trust account.

Minimum Allowance for Credit Losses for Banks

The FSC/FSS requires banks to provide for estimated credit losses within their loan and other asset portfolios as allowances for loan losses, which are presented on the balance sheet as a contra-asset account. The minimum allowances for the five asset classes are presented in the table below. The FSC/FSS requires banks to adjust IFRS-based loan loss provisions (“adjustment to loan loss provisions”) to ensure consistency with the regulatory minimum for loan loss allowances.

Minimum Allowance for Credit Losses for Banks
  Normal Precautionary Substandard Doubtful Presumed Loss
Businesses 0.85/0.90* 7 20 50 100
Households 1.0 10 20 55 100
Credit cards Credit card receivables 1.1 40 60 75 100
Credit card loans 2.5 50 65 75 100

* The minimum allowance for companies in construction, real estate, wholesale and retail, lodging, and restaurant businesses is 0.90%.