Foreign Banks Booming on Currency Intervention
By Kim Jae-kyoung
Staff Reporter
Foreign banks operating here showed a robust improvement in performance last year on the back of strong profits from currency and derivatives trading.
In particular, they reaped windfall gains, capitalizing on growing arbitrage profit opportunities created by the government's intervention in the market to curb soaring short-term debt.
According to sources, the combined net profit of the 31 foreign bank branches here topped 337.7 billion won last year, up from 236.1 billion won in 2006 and 90.2 billion won in 2005.
They include HSBC, Deutsche Bank, JP Morgan Chase Manhattan, Barclays Capital, Bank of America and Bank of Nova Scotia.
They made big gains in transactions related to currency products and derivatives. Profits from such transactions reached 1.5 trillion won in 2007, compared with 319.4 billion won in 2006 and 965.2 billion won in 2005.
Another profit generator was the interest rate arbitrage transactions of which gains soared to 2.67 trillion won last year alone.
This is in stark contrast to the deficit of 200 billion won they sustained in the so-called basic profit areas made up of interest income plus commission income less operating costs. This basic business saw losses of 120 billion won in 2006 and profits of 167 billion won in 2005.
The government played a big role in increasing earnings growth ― unnecessary regulatory measures provided huge investment opportunities for them.
``In a move to discourage foreign banks from increasing offshore borrowing, the onshore-offshore basis swap rate differential has widened, creating arbitrage opportunities,'' a local bank currency dealer told The Korea Times, asking not to be named.
``The moves encouraged offshore investors to purchase more short-term Korean bonds, which translated into an increase in the short-term external debt position of Korea, the very outcome that the government has been trying to avoid,'' he added.
He pointed out the regulatory steps only helped foreign banks make windfall gains without achieving its intended goal.
Under interest rate arbitrage transactions, a foreign bank branch borrows dollars from its headquarters, and then hedges the currency risk by selling a forward contract in the same foreign currency.
Foreign bank branches borrow dollars from their headquarters at cheaper rates and invest the money in Korea's treasury and foreign exchange stabilization bonds generating higher returns.
Since they hedge the currency risk by selling a forward contract, they are immune to exposure risk. In other words, they can enjoy ``risk-less profit'' guaranteed by the onshore-offshore basis swap rate differential.
Experts express concerns that the intervention may have distorted the markets and undermined the credibility of the government's foreign exchange policy.
``The government's measures undermined the credibility of the earlier policy of liberalizing foreign exchange controls on capital account transactions,'' Seoul Financial Forum Chairman Kim Ki-hwan said in a recent interview with The Korea Times.
``The measure for all practical purposes failed to achieve what the government intended,'' he added.
Korea experienced a sharp rise in its short-term external debt position over the past two years, and short-term offshore borrowing by foreign bank branches was cited as one of the major contributors to this rise.
As short-term external debt continued to rise, Korean financial authorities were concerned with financial instability that might result, and this concern led them to take a number of direct measures to curb offshore borrowing in 2007.
``Considering that there is a continuing shortage of dollars here, it is not desirable to control short-term debts through regulatory measures,'' Korea Institute of Finance economist Shin Yong-sang said in his latest report.
``The government should try to find long-term solutions instead of short-term measures,'' he added.
Total assets at the 31 banks jumped by 36.5 percent to 138.2 trillion won last December from the previous year. Their combined non-performing loan ratio worsened to 0.23 percent from 0.12 percent during the same period.