Q+A-Banks can rest easy after South Korea debt levy announced - Reuters

By Yoo Choonsik

SEOUL | Mon Dec 20, 2010 12:56am EST

SEOUL Dec 20 (Reuters) - South Korea's plan to levy banks on their foreign debt will help curb short-term borrowings from abroad but is unlikely to have much impact on banks' profits because authorities have indicated the levies will be set at low levels.

The country will possibly charge from late next year a levy of between 0.05 percent and 0.2 percent on the amount of banks' foreign-currency debt that exceeds their deposits as part of capital controls to try to ease volatility in cross-border fund flows. [ID:nTOE6BI00E]

Following are some questions and answers on the plan and its implications on economic and banking industry aspects:

WHY DO AUTHORITIES WANT TO IMPOSE THE LEVY?

South Korea has often been hit hard by a squeeze in global credit because of a heavy exposure to short-term foreign debt, the result of dollar demand from shipbuilders and by banks looking to make up for falling domestic deposits.

During the global financial crisis, the won tumbled almost 25 percent between the end of September 2008 and March 2009 as investors fretted Korean banks would struggle to fund their short-term foreign debt positions.

So authorities want the levy to finance a fund that will be used in case banks suffer a shortage of foreign currency liquidity in the future.

Authorities estimate the gap between banks' foreign debt and deposits is about $274 billion. That is more than covered by foreign exchange reserves of more than $290 billion.

But some sources said the importance of the levy may be more symbolic in that authorities have introduced a tool they can use in the future to signal to banks when their foreign debt is rising to risky levels.

HOW DID MARKETS REACT?

The levies announced on Sunday were in line with market expectations, largely because policymakers had primed investors in recent weeks.

That largely explains why bank stocks outperformed the wider market on Monday. They had underperformed in recent weeks as investors braced for measures that could potentially undercut bank profitability.

The stock exchange's sub-index on banks rose 0.6 percent by 0340 GMT while the broader index fell 1.4 percent in line with declines in other regional stock markets and as a result of increased tensions between South and North Korea.

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