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- Introduction of E-money and Payment Institution in Korea: Issues and Challenges [23-20]
- Senior Research Fellow Lee, Sungbok / Oct. 25, 2023
- The discussion of introducing the E-money and Payment Institution (EMPI) has been revisited in Korea, sparking debates of pros and cons, while the issues raised so far have not been sufficiently resolved. Banks raise concerns that such an introduction may allow industrial conglomerates to enter the banking industry without a legal banking license, potentially weaken the principle of same conduct, same risk and same regulation, and pose threats to the stability of the payment settlement and financial system. On the other hand, fintech firms and credit card companies advocate for the positive impacts of introducing EMPI, foreseeing enhanced competition in money transfer services, greater competition in financial services, cost reduction in financial transactions, and increased benefits for financial consumers.
Interestingly, these issues are rooted in four primary factors that mostly have been overlooked. First, although an EMPI is distinct from a bank, it could be argued to be similar to a bank depending on the ways of providing financial services. Second, payment default risk arises because real-time money transfers are processed through deferred net settlement (DNS) and for this reason direct or indirect participation in the retail payment system in Korea is allowed only through collective decision-making of banks. Third, anticipated money movement can create a conflict of interests between EMPIs and banks. Lastly, it is uncertain whether the positive impacts claimed by fintech firms and credit card companies would materialize through the introduction of EMPI.
When looking at cases in the UK, EU, Singapore, and the US that have introduced schemes akin to the EMPI, the issues raised in Korea have not been reported. These jurisdictions do not classify or regard them as a bank. In addition, even non-banking financial institutions can directly participate in their own retail payment system or indirectly participate by making a private agreement or contract with a bank without concerns about payment stability. It is also hard to find any reports suggesting significant money movement and enhanced competition in financial services. However, as incidents of failure to manage customer funds or abuse of money laundering occur, there is a trend to improve and strengthen related regulations to protect customer funds and expand financial inclusion.
In conclusion, it may be a priority to resolve concerns about payment stability before introducing the EMPI whose positive effects are not certain. This involves adopting a real-time gross settlement system as soon as possible and improving unique features of the existing participation in the retail payment system. To introduce the EMPI first, it should revise relevant regulations such as limits on third-party operation of financial services so that positive effects can actually be realized, and strengthen related regulations to prevent problems such as potential digital run and reverse discrimination against depositors.
- A Decade of Comprehensive Financial Investment Business Entities in Korea: Evaluation and Development Strategies to Become "Korean IBs" [23-14]
- Senior Research Fellow Lee, Hyo Seob / Aug. 07, 2023
- A decade has passed since South Korea introduced its ‘comprehensive financial investment business entity (CFIBE, hereinafter)’ framework in May 2013. On this significant milestone, this paper evaluates how Korean CFIBEs have developed their businesses in alignment with policy objectives and proposes development strategies to gain a competitive edge over global investment banks.
Among other aspects, this study examines how Korean CFIBEs have performed in relation to the four policy objectives outlined at the outset: Expansion, profitability and business differentiation, corporate financing expansion, and risk capital provision. For the past decade, Korean CFIBEs achieved quantitative growth in expansion and profitability, with their equity capital and net revenues rising 148% and 650%, respectively. Their qualitative performance is somewhat disappointing, with 70% to 80% of their revenues still derived from brokerage and principal investment, showing no indications of business diversification. Their quantitative performance is outstanding as their credit provision increased twentyfold over the past decade. However, Korean CFIBEs are ranked between 20th and 30th, and 60th and 70th in Asian ECM/DCM and M&A, respectively, showing their weaker capacities in corporate finance compared to global peers. Furthermore, they fell short of meeting expectations as providers of risk capital since a significant portion of their corporate loans were tied to SPC and real estate assets, with only a modest amount of capital invested in equity in innovative venture firms.
The second part of this report proposes development strategies for CFIBEs based on a comparative analysis of the business strategies of Korean CFIBEs and global IBs. A SWOT analysis suggested that CFIBEs have an edge in retail and structured financing, while disproportionately concentrating on ELS, DLS, and debt guarantees to real estate PF. This shows that they lack in diversity in corporate financing services while falling short of business differentiation. Their external opportunities include accelerated digitalization, growth in new southern countries, and increased demand for wealth management. Conversely, they are confronting threats, including increased competition from players entering bigtech and fintech sectors, the blurring of boundaries in financial services, growing political and economic uncertainties, and the climate crisis.
On the path toward becoming Korean IBs, CFIBEs should fully leverage their technological strength in ICT for expanding their presence abroad in brokerage and principal investment. Based on Korea's business development company scheme and M&A activities, they need to strengthen their corporate financing capacity, and join hands with pension funds and sovereign wealth funds. As part of their preemptive measures to future changes in the financial services industry, it is advisable for Korean CFIBEs to recruit additional ICT staff, increase investments in infrastructure, and concentrate their resources and capabilities on digital finance and transition finance. Additionally, in the long run, further efforts are needed to enable CFIBEs to participate in payment and settlement services for corporations. Furthermore, CFIBEs should make efforts to enhance their risk management capabilities by enhancing their remuneration schemes and internal controls.
- Analysis of Risk Factors Arising from the Use of Artificial Intelligence in the Financial Services Industry [23-13]
- Research Fellow Noh, Sungho / Jul. 25, 2023
- In recent years, the escalating race to develop AI and the resulting technological advancements have sparked the interest of participants in the financial services industry. Beneath this heightened interest, however, lie concerns like technological illiteracy and the resulting increase in market risk. Acknowledging this specific issue, this paper provides an overview of how AI functions and identifies the associated risk factors through concrete examples.
Rule-based, inductive learning within the framework of machine learning is an aspect of AI that has recently gained prominence. In technical terms, the machine learning process consists of two fundamental elements: data and algorithms. The rapid growth of modern AI can be attributed in particular to the development of algorithms and the expansion of data. On another note, this also pertains to the core risk factors associated with these two elements, indicating potential challenges in interpreting results or assessing data relevance. Taking a closer look at how this impacts each financial market participant revealed several problematic areas, including prediction errors stemming from past data biases, arbitrary interpretations of generated results, underestimations, and reduced efficiency due to false positives.
This study proposes three steps of policy responses that are designed to minimize the core risk factors and the consequent damages expected as a result of AI use. Above all, it is advisable to accurately recognize and monitor the core elements of machine learning-based AI in order to effectively mitigate the potential damages arising from the complex and non-transparent nature of data collection and learning algorithms. Additionally, it is necessary to establish a clear legal framework and regulatory accountability for AI-generated content. This will undoubtedly internalize risk and thereby contribute to the responsible development and utilization of AI.
- Korean Securities Firms' Real Estate PF: Risk Factors and Future Responses [23-10]
- Senior Research Fellow JANG, GEUNHYUK and others / May. 22, 2023
- Real estate project financing in South Korea is characterized by a unique structure marked by high leverage and ongoing financing throughout a project. A slowdown in the market and other factors leading to decreased profitability in real estate development projects could expose the vulnerability of the financing structure, thereby increasing risks associated with real estate PF. An analysis was carried out on the yields on asset-backed commercial paper (ABCP) for real estate PF guaranteed by securities firms. The results revealed that in a stable market, credit ratings were the sole factor affecting yields, while during a crisis, several other factors came into play. This suggests a scenario in which the risk associated with real estate PF could be underestimated during periods of high profitability in real estate development projects. Therefore, investors involved in real estate PF should exercise caution when expanding their exposure to this market during a real estate boom.
It is also noteworthy that real estate PF is now more interconnected with financial firms and capital markets than ever before, thanks to a broader range of financial firms and a greater variety of financing options available in the market. However, the risk of real estate PF has increased as the market has deteriorated since 2022. The government and participants in this market should monitor not only the constructors, businesses, and financial firms involved in real estate PF, but also the whole macroeconomic environment including the money market and real estate market. Especially in 2023, they need to be vigilant regarding the potential for risk transfers between real estate PF, financial firms, and markets. Moreover, when extending liquidity and other policy support to real estate PF businesses, the government needs to enhance market discipline by thoroughly evaluating business feasibility and profitability, and enforcing stringent qualifications for policy support.
In the short term, securities firms that typically participate in this market through asset-backed securities (ABS) and refinancing should assess their own risks to secure additional liquidity or unwind their positions, while also preparing their responses in the event of any real estate PF business defaults. They should also adopt long-term strategies to enhance internal controls related to real estate PF. This includes establishing risk management standards for real estate PF that consider expected returns and risks, exercising caution against excessive risks or following trends with certain developers, and redesigning their staff remuneration policies and examination criteria that align with the nature of real estate PF. Additionally, it is essential to review the issuance of ABS with maturities that align with those of real estate PF loans.