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Group-wide risks refer to the risks generated
from the various financial relationships formed
between the affiliates of a business group,
which can be formed of both financial and non-financial institutions.
For example, if an affiliate, in whom the financial institution has invested,
becomes insolvent, this could rapidly spread across the entire group
to the respective financial institution due to difficulties in withdrawing said investment.
- The most crucial policy aim of the financial supervisory authorities is to
accurately assess and manage the risks to financial institutions within a conglomerate.
- Thus, group-wide risks must be reflected in capital regulations, which are key to the policy.
- Moreover, when risks are generated in large corporations,
they will most likely be massive in scale and have a significant impact on financial stability.
Consequently, a regulatory system that could appropriately deal with group-wide risks is needed.
Capital regulations set a minimum capital requirement
that acts as a buffer when financial institutions face unexpected losses.
Therefore, this obligates the companies to manage an amount of capital that exceeds the minimum.
However, a distortion in the assessment of capital may occur
if the risks associated with financial institutions’ investment in
and relationships with their affiliates are not adequately reflected.
Accordingly, this study examines the current status of Korea’s supervisory system
for group-wide risks in regards to capital regulations and recommends directions for improvement.
In Korea’s case, the capital regulations for banks and holding companies
are based on a set of international standards proposed by the Joint Forum and are implemented throughout the entire group.
But for the majority of groups with affiliates in insurance and securities,
the group-wide risks are not sufficiently reflected, despite their focus on finance.
Take insurance for example, if the insurance company is the largest controller of the group,
the capital adequacy is assessed in two ways.
The first method is to consolidate the group into a single regulated entity
and then adjust the minimum capital requirement.
And the second method is to deduct the insurance company’s total share in affiliates from its capital.
Meanwhile, if the insurance company has shares in an affiliate but is not the largest controlling entity,
adjustments are not implemented and therefore, there may be an overestimation of its capital.
In fact, if the capital adequacy ratio is adjusted by applying the international standard,
which deducts the amount invested by the insurance company in affiliates
from its capital, the ratio falls significantly.
This suggests that the capital adequacy of insurance companies could be overestimated
as the current regulations only partially reflect the group-wide risks.
In the case of securities companies, capital adjustments are made by deducting the total investment
from their capital, regardless of the control structure.
But, even if a securities company is the largest controller, the group is not evaluated as a single entity,
therefore the evaluation of equity capital may become distorted.
Such an evaluation method unnecessarily obligates securities companies
to hold a possibly excessive amount of capital.
On the other hand, as the parent company, securities companies
are not responsible for maintaining the total capital at an adequate level
even if their subsidiaries’ capital falls short of the minimum requirement.
- A revision of the sectorial capital regulations must be implemented to properly reflect t
he group-wide risks associated with financial institutions’ holdings of shares in affiliates.
- If such risks are adequately reflected, they may also be utilized to improve related regulations
on the separation of industrial and financial capital.
- For example, if the regulation prohibiting financial institutions from holding assets
in non-financial institutions is supplemented with capital regulations,
financial institutions would be obligated to maintain an amount of capital
that is in proportion to the level of group-wide risk, resolving the issue of misappropriation to some extent.