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FX reserve could lead to less corporate lending

June 01,2018
Accumulation of foreign exchange reserves by the central bank may lead to a cut in local lenders’ corporate loans and cool down a credit bubble, a central bank report said Thursday.

According to the report published by the Bank of Korea (BOK), the central bank buys foreign currency to raise the FX reserve, and the supply of local currency increases in the market.

So the central bank collects the excessive local currency through issuing monetary stabilization bonds, known as one of the safest assets.

“Banks reduce loans to firms and hold more risk-free central bank debts, and firms end up borrowing less from the banks,” the report said.

It said a rise in FX reserves worth $2.5 billion will lead to a 0.4 percentage point drop in corporate loan growth of lenders who scoop up the monetary stabilization bond.

At the same time, the central bank’s FX reserve increase also contributes to easing the expansionary effect of sudden massive capital inflows.

“Excessive capital inflows cause a hike in asset prices and a credit bubble,” said Yun Young-jin, the author of the report. “When the central bank expands its FX reserves, banks will tighten corporate loans and cool down such expansionary effects to some extent as a result. This is why many countries move this way as an effective tool to deal with massive capital inflows.”