New International Financial Architecture in the Context of G20 : Korea’s Role May 14, 2009 Shin, Je-Yoon Deputy Minister Ministry of Strategy and Finance 1

Context 2 Ⅰ. Development of the financial crisis Ⅱ. Causes of the financial Crisis Ⅲ. G20’s response Ⅳ. Future prospects and Korea’s role

Global InflationWorld Economy Growth 3 World Emerging and Developing Economies Advanced Economies (%) 1.Continued strong growth with low inflation Ⅰ. Development of the financial crisis

5% 0% 10 % 15 % 20 % 25 % (bps) Policy interest rate Corporate bond spread (U.S.) Ⅰ. Development of the financial crisis 2. Continued low interest rate stance and excessive risk-taking

20 % 0 % 40 % 60 % 80 % 120 % % Ⅰ. Development of the financial crisis 3. Increased leverage across the economy : changes in the household/financial institution leverage

($, trn) H2 04 ($, bn) 6 60 H1 08H2 07H1 07H2 06H1 06H2 05H1 05 ABS Ⅰ. Development of the financial crisis 4. Tool for rapid leverage increase : financing through securitization

% 0 % 200 % 300 % 400 % 500 % CorporateHouseholdFinancial Ⅰ. Development of the financial crisis 5. Increasing moral hazard and failure to diversify risk

% 0% 2 % 3 % 4 % 5 % 6 % 2% 0% 4% 6% 8% 10% 12 % Global asset prices U.S. subprime deliquencies Ⅰ. Development of the financial crisis 6. Outcome : Bubble Bust

9 100 bp 0 bp 200 bp 300 bp 400 bp 500 bp 600 bp CDS premia for banks Assets written off and capital raised Ⅰ. Development of the financial crisis 7. Outcome : Collapse of confidence in financial institutions

10 Ⅱ. Causes of the financial crisis Pro-cyclicality Financial Crisis Lack of Transparency Poor Risk Management IFIs’ Inadequate Response Lack of Consideration for Systemic Risk

Ⅱ. Causes of the financial crisis 11 * Shadow banking : ABCP + SIVs Growth in Global Shadow Banking (US$ bn) Northern Rock’s Leverage Lack of comprehensive supervision system for macroprudential regulation Maturity transformation by unregulated entities Financial institutions’ inadequate level of capital buffers * Shareholder equity : common equity + preferred stock 1. Lack of Consideration for Systemic Risk Increasing number of unregulated institutions/markets/products

Ⅱ. Causes of the financial crisis US Investment Banks’ pro-cyclicality Leverage growth (%) Excessive leveraging in boom and rapid de-leveraging in bust Rapid de-leveraging leading to falling asset prices and instability across the financial system Asset growth (%) (%) Private Sector Credit Growth (US) Economy Growth (US) 2. Pro-cyclicality

Development of pro-cyclicality 13 Boom Bust Overvalued assets Undervalued assets Fair-value accounting Asset quality increase → Capital requirement decrease Asset quality decrease → Capital requirement increase Asset quality decrease → Capital requirement increase Capital regulation Impaired assets decrease (less provisions) Impaired assets increase (more provisions) Size of provisioning Increased fluctuation Lending capacity increase Lending capacity decrease

Ⅱ. Causes of the financial crisis Increasing number of complex structured instruments, OTC products (Uncertain where risk lies) (US$, bn)(US$, trn) Global CDO Issuance CDO 3. Lack of transparency

Ⅱ. Causes of the Financial Crisis - 3. Lack of transparency Traditional Model of Credit Traditional Model of Credit Securitised Model of Credit Securitised Model of Credit 15

Ⅱ. Causes of the financial crisis Limited effectiveness of risk management models such as VaR Short-term, asymmetric compensation scheme Lack of internal control system for risk management Relevant authorities’ inadequate supervision on risk management Increased Instability and risk across the financial system Increased Instability and risk across the financial system Inadequate risk management

Ⅱ. Causes of the financial crisis “Stigma effect” on getting assistance from the IMF Lack of resources Governance structure failing to reflect the growth of emerging economies Limited effectiveness of IFIs’crisis response Limited effectiveness of IFIs’crisis response International Financial Institutions (IMF, World Bank, MDBs etc) International Financial Institutions (IMF, World Bank, MDBs etc) International Financial Institutions (IFIs)’ inadequate response

Ⅲ. G20’s response Scope of Regulation Minimum Capital Requirement High-quality Capital Reviewing whether the current minimum capital requirement is adequate once recovery is assured Developing a universal definition of “capital” focusing on high-quality capital to strengthen the function of risk absorption BCBS providing guidelines for harmonizing the international definition of capital by 2009 Hedge fund registration and information disclosure, standardization of OTC products, establishment of Central Counterparty (CCP) Adopting simple indicators to solve the problems of Basel II risk-weighted capital Systemic approach Systemically important institutions/markets/instruments should be subject to an appropriate degree of regulation and oversight

Ⅲ. G20’s response Capital Buffer Dynamic Provisioning Fair Value Accounting Building capital buffers once recovery is assured (Build more capital in good times and use it in bad times) Strengthening accounting recognition of loan-loss provisions by incorporating a broad range of credit information Improving standards for the valuation of financial instruments to reduce pro-cyclicality and systemic risks Adopting the FSF principles to reduce pro-cyclicality of accounting standards FSB,BCBS,CGFS developing guidelines on building capital buffers by Reducing pro-cyclicality

Ⅲ. G20’s response Accounting Standard Credit Rating Agency (CRA) Accounting standards setters taking action to improve accounting standards by the end of 2009 to reduce pro-cyclicality and enhance transparency ☞ Reducing the complexity of accounting standards for financial instruments and improving accounting standards for provisioning and off-balance sheet exposures ☞ Achieving consistency in the application of valuation standards internationally and developing a single set of global accounting standards All CRAs should be subject to a regulatory oversight regime that includes registration Managing conflicts of interest and assuring the transparency and quality of the rating process The oversight framework should be consistent across jurisdictions CRAs should differentiate ratings for structured products and provide full disclosure of information Increasing transparency – accounting standards/credit rating agencies

Ⅲ. G20’s response Risk Management Compensation Complementing the existing VaR with other measures including “stressed VaR” Giving greater weight to “stress tests” in risk management Developing an internal control system for risk management and strengthening liquidity risk management Adopting the FSF principles on compensation scheme Assessing firms’ compensation policies as part of overall assessment of their soundness ☞ Strengthening regulation such as increased capital requirements when necessary ☞ Requiring compensation arrangements to properly reflect risk and requiring firms to publicly disclose comprehensive and timely information about compensation Improving risk management system – risk management, compensation scheme

Ⅲ. G20’s response Reform of the IFIs Increasing support for emerging/developing economies through IFIs ($1.1 trillion) Increasing the resources of the IMF ($250 billion → $750 billion) Enhancing global liquidity through the IMF’s new allocation of Special Drawing Rights (SDRs) worth $250 billion Reforming IFIs’ decision-making process and governance (including the IMF) Increasing the size of MDB lending ($100 billion) Providing $250 billion internationally for trade finance Establishing a new Financial Stability Board (FSB) with a strengthened mandate, as a successor to the Financial Stability Forum (FSF) Expanding the membership of int’l standard setters including the FSB and BCBS Reform of the IFIs

1. Changes in the financial industry Complementing financial Convergence..  Complementing the convergence and merging trend of financial sectors Developing a system to prevent conflicts of interest between commercial banking and investment banking limiting market discipline & enhancing supervision..  Partly restricting excessive market autonomy regarding capital buffers and internal crisis management Harmonizing financial institutions’ efficient use of capital and regulatory authorities’ prevention of excessive costs in crisis regulation according to systemic importance..  Redefining systemically important institutions Imposing proper regulation on hedge funds and IBs through reassessment on their systemic importance Ⅳ. Future prospects and Korea’s role - Future prospects 23

2. Increasing role of emerging economies Ⅳ. Future prospects and Korea’s role - Future prospects Increasing participation in IFIs  FSF and BCBS expanding its membership to emerging countries  Quota and voice reform of the IMF Quota reform deadline: January 2011 Economic potential  Sizeable foreign reserves (China, Brazil, India, Korea etc)  Relatively sound compared to other countries Emerging countries strengthening their role and voice in the global community 24

Korea’s strengths Ⅳ. Future prospects and Korea’s role - Korea’s role Korea’s Role Leading emerging country Over- coming Asian financial crisis Over- coming Asian financial crisis  FSF, BCBS membership  Large foreign reserves  Relatively sound economy  Continued financial advancement (improving regulation etc)  Once a recipient country, now a donor  Successfully overcoming the crisis in a short period of time - Successful cases in corporate restructuring (Impaired asset resolution, bank recapitalization etc) 25 G20 Troika G20 Troika  ’09-’11 : G20 Troika  ’10 : G20 Chair Develop G20 as int’l forum for macroeconomic/financial policies - Facilitate macro policy coordination to tackle the current crisis and promote “standstill” Representing the emerging countries (rule taker → rule setter) - Proposal of adequate level of regulation and emerging economies’ financial advancement plan - Proposal of improving FX translation accounting Active participation in increasing IMF resources Providing support for CMI (16%, $19.2 bn) Increasing support for the poorest nations Share Korea’s experience with other nations - Korea’s experience of dealing with impaired assets reflected in the G20 impaired assets resolution plan

26 Thank You