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Based on theoretical and empirical research results from uniquely designed analysis frameworks, KCMI Research Papers draw out implications as well as policy directions for Korea’s financial industry and markets.

보고서 1
Financial innovation by fintech and its implications [21-03]
Research Fellow Lee, Sungbok / Feb. 02, 2021
This report analyzes the aspects of FinTech leading the digitalization of finance by focusing on financial innovation and draw implications for the domestic financial industries and authorities by comparing the overseas and domestic aspects, in order to objectively evaluate financial innovation driven by FinTech. The results of the analysis confirms that FinTech innovation shows a very different aspects from the past financial innovation by technological progress as the literature of FinTech innovation asserts. For example, financial innovation by FinTech is appearing and spreading all over the world, showing an aspect of combination or convergence of heterogeneous industries, and appearing all-round and simultaneously in almost all financial sectors. In addition, an aspect of combination and convergence between financial services is also observed, along with the emergence of a new type of financial service that has not been present.
 
However, it can also be found that the effects of financial innovation by FinTech are somewhat overestimated. For example, the unbundling of existing financial services provided by incumbent financial companies has less impact than originally expected, disintermediation by P2P financial services is very limited, and the effect of increasing financial inclusion by FinTech also shows a gap depending on the financial service sectors. In addition, although the adoption rate of FinTech continues to increase, it is evaluated that the higher the proportion of the population aging in countries, the higher the possibility that the elderly would be excluded from financial services through FinTech.

The aspect of financial innovation by FinTech on reshaping the financial industries is also expected to unfold differently than originally expected. This is because even FinTech companies that choose to compete with incumbent financial companies show a aspect of enhancing collaboration with the incumbents financial companies and other FinTech companies to expand their customer base and generate more profits. On the contrary, the entry of big tech companies with a strong customer base and significant capital into the financial industries is expected to intensify competition between incumbent financial companies and BigTech companies, and significantly weaken the influence of incumbent financial companies as well. Meanwhile, active overseas expansion of FinTech companies is promoting competition for financial services across borders.

Looking at the aspects of financial innovation by FinTech in Korea, it can be found that there are many similarities with foreign countries but also there are significant differences. For example, though there are FinTech companies that discover new types of financial services, more FinTech companies seem to imitate financial services that have already been introduced. As a result, it is observed an aspect that FinTech companies are excessively focused on specific fields. Also, the unbundling of existing financial services, the new introduction of bank-like financial services, and the rebundling of financial service using open banking are not also observed in detail. The effect of increasing financial inclusion through simple transfer and P2P lending services is also very limited.

It is also characteristic that Korean FinTech companies expand their customer base through competition for price or benefits and generate revenue by recommending or advertising financial products of incumbent financial companies. This may be due to the fact that the domestic market size of each financial sector is not large enough for FinTech companies to generate revenue independently. This may be the reason that domestic FinTech companies are more active in overseas expansion than is known. Meanwhile, the impact of BigTech companies' entry into the financial industry on the competitive landscape in financial industries is likely to be greater than in the US or China. For example, the customer contact points of incumbent financial companies can be drastically reduced, and the survival of FinTech companies can be greatly threatened.

Financial innovation by FinTech is leading to changes in the landscape of the financial industries and financial markets in a different way than before, but like the previous financial innovation, it can cause negative effects as well as positive effects. With this in mind, it is necessary to create an environment for fair competition between incumbent financial companies, FinTech companies, and BigTech companies, and to minimize regulatory arbitrage and regulatory gray zone under the principle of the same activity, the same regulation. In addition, if Korea's FinTech has succeeded in quantitative growth over the past five years, it is now necessary to focus on promoting qualitative growth so that financial innovation by FinTech can substantially improve the efficiency of the financial industry and improve international competitiveness.
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보고서 1
Recent changes in US dollar funding market and its implications on Korea [21-02]
Senior Research Fellow LEE, Seungho and others / Jan. 22, 2021
The US dollar plays key role in the international financial market. Its functions as the foremost funding currency is reinforced by its use as a vehicle currency for foreign exchange transaction. Almost the half of all cross-border loans and international debt securities are denominated in US dollars, as well as over the three quarters of foreign exchange transactions occur over US dollars.
 
However, the experience of global dollar shortage during the global financial crisis(GFC) has led the changes in the US dollar funding market landscape after crisis. Non-US banks, which were the major suppliers of US dollar funding before GFC, has reduced its US dollar intermediation business, especially those from European region. Also US dollar funding is increasingly obtained through capital market as the banks conduct less US dollar intermediation. In the short-term dollar funding market, deviations from covered interest parity(CIP) persist since GFC and it is now characterized as low liquidity and higher cost market compare to pre GFC era.
 
In the case of Korea, abundant liquidity conditions in the spot foreign exchange market has been maintained until recently due to persistent current account surplus as well as the growth trend of incoming foreign portfolio investment. However, liquidity conditions of short-term dollar funding market, typically assessed by CIP deviations in the FX swap market, has been worsening since GFC. According to empirical results in this paper, recent structural changes in the global US dollar funding market  influence short-term dollar funding market conditions in Korea through reduced US dollar loans from foreign branches of global banks in Korea.

This report provides the following implications for the Korea’s foreign exchange policies. First, one should closely monitor various cause of foreign exchange market volatility beyond what were considered before the structural changes. This would include changes in the risk appetite of non-banking sector, international debt market conditions, changes of broad dollar index, among others. It is worth stress again that since it is non-banking sector that led the US dollar credit growth recently the focus of foreign exchange market stability policies should extended to those sectors that are not in the locus of macro-prudential policy.

Also it is advised that Korea should maintain its attention on the stable overseas dollar funding sources because cross-border dollar loans through global banks are still the main source of dollar funding in the Korea’s foreign exchange market. In such a respect, one should carefully monitor and analyze impact of global regulatory reform on lending activities of non-US banks, as well as shifting business models of intermediaries. The paper also implies that it would be worthwhile to overhaul the existing macro-prudential policy framework in respond to the recent changes in the US dollar funding market landscape and the measures should be carefully adopted considering recent changes in the global US dollar funding market.
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보고서 1
Analysis on the Characteristics of Korea’s Strip Bond Market and Plans for Facilitating the Market [21-01]
Senior Research Fellow Kim, Pil-Kyu / Jan. 08, 2021
This study aims to analyze the characteristics and economic effects of Korea’s strip bond market in terms of the secondary market and the market’s issuers, investors, and yields, based on which to propose ideas for facilitating the market. A strip bond is a debt obligation which is broken into coupon and principal components and issued as several zero-coupon bonds. Investor can benefit from investing in those bonds as they offer a broader opportunity for long-term, arbitrage investment and eliminate the reinvestment risk a coupon bond usually has. In addition, more information on zero-coupon bonds with diverse maturities in the strip bond market could help complete the yield curve, making the market more comprehensive.
 
Korea’s strip bond market has been introduced in March 2006 for the purpose of improving the liquidity of benchmark Korea Treasury Bonds, revitalizing the long-term bond market, and effectively responding to market demand for long-term zero-interest bonds. It was 2010 that the issuance of strip bonds began picking up. A more significant increase has been observed around the on-exchange secondary market since 2016.

This paper analyzed the primary and secondary market data to grasp the main characteristics of Korea’s strip bond market. The results confirm the market’s wide-ranging benefits to investors. First, strip bonds have the effect of expanding the supply of long-term duration bonds in response to investors’ demand for long-term assets. With the average maturity of domestic strip bonds continuously on the rise, the proportion of stripped long-term government bonds has been also increasing. The prolonged maturity of those bonds results from two factors. First, the insurance sector increased investment in long-term bonds in response to regulatory changes. Second, institutions holding long-term debt are increasingly using strip bonds for the purpose of duration matching.

The main institutions that invest in strip bonds include insurers, pension funds, asset managers and banks. As a result of analyzing the behavior of major strip bond investors using the trading data of the over-the-counter market, insurers and pension funds tend to invest in long-term strip bonds in order to eliminate maturity mismatches between assets and liabilities. By contrast, asset managers are found to prefer high investment returns, investing in short-term principal strips and coupon strips that have relatively high spreads. Banks act as strip bond providers while investing in various types of strip bonds for higher profitability.

The most notable feature in Korea’s secondary market for strip bonds is the divergence of bond types and market participants between the on-exchange and the over-the exchange markets. The KRX—Korea’s on-exchange market—is a marketplace where principal strips that mature less than one year take up a large proportion of trading, while the OTC market sees a diversity of stripped principal and coupon components changing hands. Recently, liquidity of strip bonds in the KRX has improved significantly, mainly because of the government’s regulatory actions such as introducing a primary dealer system for strip bonds that mandates the dealers to engage in market making for strip bonds with less than one-year maturity. Such a boost in the on-exchange secondary market is certainly viewed positively as it has improved the liquidity of short-term strip bonds, and has helped complete the yield curve of short-term, risk-free bonds. However, its crowding-out effect of contracting trades of longer-term strip bonds is posing a negative aspect.

The introduction of strip bonds provides the effect of improving long-term government bonds and off-the-run bond liquidity. A comparative look at strip bonds with other risk-free bonds, strip bonds’ liquidity is lower than that of short-term KTBs and two-year Monetary Stabilization Bonds, but is higher than long-term KTBs. Stripping long-term KTBs helps boost the liquidity of those otherwise illiquid bonds. 

According to the analysis in this paper, Korea’s strip bonds showed higher excess spreads than government bonds do. The average yield on Korea’s strip bonds was found to be consistently higher than the mark-to-market yield on KTBs with the same maturity. Such a result could have been affected by strip bonds’ higher price sensitivity to interest rate changes, compared to coupon bonds with the same maturity. This paper also compared the yields on principal and coupon strips, and found coupon strips’ spread to be higher than principal strips, which is consistent with previous studies on strip bond prices in other countries. Because stripped interest payments are issued as various small-amount bonds, they are illiquid and serve for investors whose investment purpose and strategy are often different from those investing in stripped principal components. Also noteworthy was strip bonds’ spread varying widely across strip types, maturities, interest rate hikes, and trading venues, all of which suggest diverse factors behind how strip bonds are priced.

For steering Korea’s strip bond market towards sustainable development, several improvements are needed in the areas of issuers, investors, secondary market and market infrastructure. Plans are needed to help the issuers to accurately grasp the demand of strip bonds and to elastically supply them. Investors should refine their strategy, fully reflecting the market’s characteristics. Also necessary is a plan to introduce diverse packaged products based on strip bonds. The secondary market needs improvements in price efficiency, which could be achieved by improved liquidity of strip bonds. Last but not least, it is necessary to promote more information on the strip bond market and the underlying bonds to be analyzed and provided.
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