The Key Improvements of the Short-term Benchmark Rate System

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Hi all!
If you are investing in Korea, or taking a loan/having a deposit here, then this article would directly concern you. The short-term benchmark rate system will go through reform in Korea, starting from the introduction of the short-term COFIX (The Cost of Funds Index) this November. Why? Because of the recent CD (Certificate of Deposit) rate setting scandal, the reliability of CD was called into question and it was deemed necessary that improvement measures in the short-term index rate system be taken. What this reform means is that the existing CD rate system will be complemented by the short-term COFIX, while the calculation method for CD will also be modified.

Press Briefing by the Director-General of Financial Policy Bureau

What I am telling you was announced by the joint task force for short-term benchmark rate system on August 22. For those who are not well aware of this task force, it was established on July 19 this year, in order to improve short-term rate systems including CD. This task force consists of the Financial Services Commission and affiliated agencies including the Ministry of Strategy, the Financial Supervisory Service, and the Bank of Korea.

Now, let’s examine the three major proposals the joint task force announced.

First, the short-term COFIX will be introduced to complement the pre-existing COFIX and the CD rates. The short-term COFIX would reflect the banks’ average funding costs for short-term lending with a three-month maturity. It is going to be weekly announced by the Korea Federation of Banks, starting from the first Wednesday of upcoming November.

Second, the banks will increase their brokered CD issuance to keep its monthly average balance at a level of 2 trillion won, and the 50% of them will be CDs with a three-month maturity. Why? The aim is to enhance the effectiveness of CD rates, because the recent decline in CD issuance is deemed to be a threat to its representativeness as a short-term benchmark rate.

Third, the Korea Financial Investment Association will modify and improve the calculation method of CD. It will require the securities companies to submit quotes for CDs and to this end, will prepare relevant principles. The Association will also enhance the transparency of CD, by requiring public announcement of information related to CD issuance and transaction.

In relation to this, I would like to share the ideas discussed at the conference that I attended. The conference, “Conference for improving the short-term benchmark rate”, was held by the Korea Institute of Finance (KIF) in Seoul, on 20th of August. It was two days before the joint task force’s announcement about “Key Improvements to the Short-term Benchmark Rate System.”

Conference for improving the short-term benchmark rate

The presenter, Dr Kim Young-Do from KIF, proposed the “two-track approach”, i.e. adoption of both CD and COFIX. The impression I had from the seminar was that this is an eclectic solution which takes account both the short-term and long-term necessities of financial markets: that is, the short-term necessity of CD rates and long-term necessity of COFIX. Considering the wide usage of CD in financial markets, it is impossible to abolish it in the near future. Hence, the two-track approach suggests improving the calculation method of CD along with facilitating the issuance of CD. However, the policy makers’ vision is more focused on creating a new short-term benchmark rate that will substitute CD, if possible. And the short-term COFIX is currently deemed most appropriate and viable substitute by the government and KIF.

Dr Kim’s presentation was followed by a panel discussion, with participation from academia, financial industry, and the Financial Services Commission. The professors Kang and Ahn, respectively from Dong-guk University and Seoul National University, pointed out possible pitfalls of COFIX, whereas UBS, Hanhwa Securities and Kookmin Bank advocated maintenance of CD rates. The Korea Capital Market Institute and Financial Services Commission supported two-track approach by Dr Kim.

In my personal view, for the proposals by the joint task force to be implemented, the two-track method by Dr Kim is the most viable option, at least for a while. Considering the practical necessity of CD and aspiration of reform in short-term benchmark rate, both CD and short-term COFIX would have to go together, complementing each other. Of course, none of benchmark rates are without faults. Not to mention CD, COFIX needs to be designed carefully to guard the market against systematic risks, to minimize initial trials and errors, and to properly represent the short-term financial market. With about two months to go before the first announcement about the short-term COFIX, it remains to be seen how Korea’s short-term financial market will react to a new reform.

 

 

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