South Korea’s top regulator said Wednesday that the watchdog plans to conduct stricter stress tests on local banks’ foreign currency liquidity conditions in a bid to shield the country from a potential financial crisis.

Financial Supervisory Service Gov. Kwon Hyouk-se said the financial watchdog plans to make stress tests based on the second-quarter FX liquidity data by taking into account various severe situations including the potential spread of the eurozone debt crisis.

Stress tests are usually conducted to measure how well lenders could withstand the worst-case market scenario. The FSS has been conducting such tests on a quarterly basis since the second half of last year.

“In the past, Korean banks were hit hard even as they seemed to have sufficient foreign currency liquidity. The tests aim to make them secure FX liquidity in advance,” Kwon said.

His remarks came as the financial watchdog has requested that 12 local banks unveil their contingency plans on how to fund foreign currency liquidity when potential financial turmoil occurs, though their FX liquidity situations remain firm for now.

South Korea learned a painful lesson about the importance of beefing up banks’ foreign currency liquidity after experiencing the 1997-98 Asia-wide financial crisis and the global financial turmoil.

In the height of the global financial storm, Korean banks, saddled with high short-term external debt, had difficulties in refinancing foreign currency loans or securing FX liquidity, as foreign capital fled the country en masse.

South Korea holds more than $300 billion in foreign reserves and banks’ overall foreign currency conditions are sound, but unexpected external shocks pose a risk of leading the country to face another liquidity squeeze.

In a related move, South Korea is making efforts to smooth excessive cross-border capital movement as the country’s financial markets and currency used to undergo high volatility whenever big external shocks occurred. The country has tightened regulations on banks’ holdings of foreign currency derivatives and plans to impose a levy on bank’s non-core borrowing starting in August. 

(Yonhap News)