Bank of Korea

The Bank of Korea (BOK, 한국은행/韓國銀行) is the nation’s central bank, established on June 12, 1950 with paid-in capital of 1.5 billion won subscribed to by the government. Afterwards the Bank of Korea Act was revised in 1962 to convert the BOK into a special juridical person without capital (무자본 특수법인/無資本特殊法人).

Key words
Bank of Korea, central bank, independence, price stability, financial stability

History
Upon its foundation in 1950, the Bank, as prescribed by the Bank of Korea Act, was vested with a reasonable degree of exclusive authority over the formulation and implementation of monetary and credit policy.

However, after the Act was amended in 1962 to lend effective support to the government-led growth policy by expanding the role of the government in formulating and implementing monetary and credit policies, the Bank experienced a marked decline in its neutrality and functions. The Monetary Policy Committee, the Bank’s supreme policy-making body, was renamed the Monetary Board of Korea.

Pursuit of Independence of the Central Bank
Designed to concentrate limited resources on strategic industries deemed highly effective for the promotion of economic growth, the amendment of the Bank of Korea Act contributed somewhat to the economy’s explosive growth in the 1960s and 1970s.

This so-called “condensed economic growth” (압축성장/壓縮成長) driven under financial controls produced a number of adverse side effects, however, such as relative backwardness of the financial industry. For this reason, the need for strengthening the Bank’s independence has been an ongoing issue since the late 1980s, together with the drive for financial liberalization.

This eventually led to dual revisions to the Act, in 1997 and 2003, intended to reinforce the independence of the Bank and the impartiality of its monetary and credit policies.

As awareness of the importance of macro-prudential policy grew in the aftermath of the 2008 global financial crisis, the Bank of Korea Act was revised once again on August 31, 2011 in an effort to heighten the Bank’s role in financial stability.

Details of this revision include:
 * 1) the Bank’s responsibility for financial stability in formulating and implementing monetary and credit policy is specified in the object clause to focus on financial stability;
 * 2) the Bank was tasked with producing a Macro-financial Stability Report at least two times per year for submission to the National Assembly;
 * 3) the Bank’s access to information was improved by it being granted the right to order non-bank financial institutions to submit needed materials and by stipulating a mandatory period for joint BOK-FSS examinations of financial institutions by Presidential Decree; and
 * 4) the Bank was better empowered to take vigorous action against factors causing financial instability by providing effective emergency liquidity assistance and expanding the debts subject to reserve requirements beyond deposits.

Policy Objective
The Bank of Korea Act stipulates that the Bank pursue price stability through the effective formulation and implementation of monetary and credit policies and the exercise of due care for financial stability in its policy implementation.

Price stability is without doubt the basic objective of the Bank, which is responsible for issuance of the currency and matters concerning monetary and credit policy. Financial stability is however also indispensable to smooth implementation of its monetary and credit policies.

Price Stability
The central bank of Korea formulates and implements monetary and credit policies as a means of pursuing price stability, the Bank’s core policy function. In order to achieve this goal, a policy target (for price stability), policy instruments to reach that target, and the Bank’s organization are needed for executing the policy means. In aggregate, these three needs can be designated the monetary policy and credit policy operation system.

The system can be divided mainly into three categories, in accordance with the policy target: This new operational framework has been generally introduced by central banks since the 1990s.
 * 1) the monetary targeting system aimed at currency indexes,
 * 2) the exchange rate targeting system focused on exchange rates, and
 * 3) the inflation targeting system managing the inflation rate.

Prior to outbreak of the 1997 Asian currency crisis, Korea’s policy objective concerning monetary and credit policy focused on monetary supply measures such as M2.

Since 1998, however, the inflation targeting system, under which price stability is pursued as the ultimate goal of monetary policy, has been employed as the monetary policy operation system.

Financial Stability Control
Since the 1990s, financial stability has emerged as a further key policy objective for the Bank, alongside price stability. While continuous efforts to control aggregate demand through monetary and credit polices had succeeded in stabilizing prices, there were frequently recurring financial crises, great and small, resulting primarily from financial liberalization, trade liberalization and financial innovation. All of this raised public expectations for financial stability.

Financial stability can be split between two branches that cover the entire financial system: institutional stability and market stability. The former refers to the conditions under which financial institutions are capable of fulfilling their contractual obligations without hindrance, and market participants retain confidence in their capabilities.

This is also known as micro-level financial stability, in that it aims to prevent individual financial institutions from becoming insolvent. The latter category, on the other hand, refers to a settled economic environment in which financial institutions serve as reliable financial intermediaries, market participants maintain their trust in the market, and the values of financial assets do not stray far from fundamentals. This is similarly known as macro-level financial stability, in that its goal is to ensure stability of the overall financial system.

These micro- and macro-level financial stabilities are closely interconnected. A failure to stabilize macro-finance commonly results in asset-price bubbles. In the process of easing such bubbles, asset values at financial institutions can plummet and institutions may suffer insolvency. On the other hand, the fear that the consequences of poor management at a financial institution could have knock-on effects on other institutions causes stagnation in the flow of funds and drives volatility in the financial markets, amid for example fluctuations in the prices of financial assets such as interest rates and stock prices and stocks.

Moreover, when the central bank implements monetary and credit policies, the close correlation between the two factors also plays a key role. This is because unstable market conditions are bound to reduce investor confidence and interrupt smooth functioning of the of monetary and credit policy distribution channels, making it difficult to stabilize prices through these policies.

For this purpose, the Bank of Korea should conduct ex-ante year-round supervision by regularly collecting and analyzing materials related to the management statuses of financial institutions and inspecting these institutions as necessary.

Overcoming Financial Crises
During the 2008 global financial crisis, the Bank of Korea played a pivotal role in addressing the crisis by means such as providing ample liquidity, as is usually done by central banks in other countries. In consideration of the global legislative trend of heightening the financial stability functions of central banks, the Bank of Korea Act was then revised in 2011.

The Act’s object clause stipulates that the Bank shall exercise due regard for financial stability, which means that the responsibility of the Bank for promoting financial stability is manifest in the Bank of Korea Act.

Since the 1990s, the world has suffered from repeated financial crises and their ripple effects. Under these conditions, central banks in leading countries have begun to recognize the need for preparing assessment reports on overall stability of their financial systems. In Keeping with this trend, the Bank of Korea has published, twice a year since 2003, a Financial Stability Report that mainly focuses on monitoring the potential risks capable of affecting the Korean financial system, along with providing a general assessment of its stability.

Beyond the main aim of quickly identifying potential risk factors in the financial system, the report was also designed to spark discussion of financial stability among market participants and raise awareness of its importance. Through the eighth revision of the Bank of Korea Act in 2011, it is now required that the Financial Stability Reports be submitted to the National Assembly in the form of statutory reports on the status assessment of macro-financial stability.

General Control and Oversight of Payment and Settlement Systems
Transactions invariably entail payments made by opposite parties, and so any failure to provide safe and effective payment and settlement processes is guaranteed to reduce economic activity. In this respect, most countries assign to their central banks as a key task maintenance of the efficiency and safety of their payment and settlement systems. This is also a result of central banks exerting the exclusive authority to issue currency, a key means of payment, and because credits and debits between financial institutions arising from their customer-targeted payment services can be eventually settled through transfers between their current accounts with the central bank.

As prescribed by the Bank of Korea Act, the Bank of Korea is tasked with directing and monitoring the payment and settlement systems, including seeking ways to oversee and improve these systems. The Bank in addition operates the Bank of Korea Financial Wire Network (BOK-Wire+), the heart of the Korean payment and settlement systems, and also, to prevent fund shortages at certain institutions from triggering chains of defaults that would jeopardize the financial system overall, makes loans to banks and non-bank financial institutions suffering temporary shortages of settlement funds.