Hello! I’m back, this is Sobin 🙂
Today I’d like to tell you about ‘covered bonds’.
The Korea Institute of Finance in cooperation with Financial Services Commission held a workshop on ‘Guidelines to Legislate Covered Bonds Issuance’. Before letting you know the details of the guidelines, I would like to explain what covered bonds are first. By definition, covered bonds are a type of bonds backed by a cover pool of assets that the issuer provides as collateral. In the event of default, investors are guaranteed dual recourse to both the pool and the issuer’s other assets.
For those of you looking for some more information about the basic ideas of covered bonds, you may refer to our previous blog post written by other FSC blogger;
‘About the Covered Bonds and the Establishment of a New Law’ https://financialservicescommission.wordpress.com/2012/08/14/492/
Then, why the issuance of covered bonds gains lots of attention these days, not only in Korea but across the world? This is because financial authorities consider that the issuance of covered bonds will produce some effective outcomes as follows;
1) A useful way to finance long term funds
-In times of crises, covered bond is an effective way of financing, since it keeps the spread in a relatively stable way compared to other bonds.
2) Structural improvement of household debt
-Issuance of covered bonds makes the expiration of domestic banks’ financing longer, which results in alleviation of interest rates and liquidity.
3) Domestic debt market will be enhanced
-It is expected to meet the demand of domestic long-term debt market which is rapidly growing.
Now, let’s look at some main features of covered bonds.
Although European countries are still suffering from the financial crisis, their balance of issuance is continuously increasing as you can see it from the above.
So, what are the requirements for the issuance of cover bonds?
Eligible Issuers of Covered Bonds
In order for a financial institution to issue covered bonds, it should satisfy both institutional and eligibility requirements.
– (institutional requirements) banks, Korea Housing Finance Corporation, Korea Finance Corporation, and other equivalent institutions designated by Presidential Decree.
– (eligibility requirement) a financial institution with more than KRW 100 billion and a BIS ratio of more than 10%, capable of ensuring proper funding, operation and risk.
A cover pool is composed of cover assets, liquid assets and other assets with a minimum coverage ratio of collateral more than 105%.
– (cover assets) mortgage loans, debts issued by governments and public institutions, government bonds
– (liquid assets) cash, certificates of deposit issued by other banks with a maturity of less than 100 days
– (other assets) recovery from cover assets, property earned through management, operation, and sale of assets, derivative contracts for hedging against currency and interest rate risks
Now you may acknowledge that covered bonds can be a stable way of financing when facing financial problems! However, some experts suggest that we need to carefully enact new regulations related to this issue. Proper implementation must be carried out for covered bonds issuance to follow the positive path taken by Europe.