KDI - Korea Development Institute - RESEARCH - Research Areas

Summary

Research Monograph KOR Housing Market Regulations and Housing Supply: Focusing on LTV, DSR, Property Tax, and the Improvement of Pre-Sale Housing

The Korean government often implements financial regulations, such as the Loan-to-Value (LTV) and Debt-Service-Ratio (DSR), ratios, to stabilize the housing market. This study investigates the effectiveness of these policies in the housing market and, if effective, determines whether they enhance the utility for housing consumers.

Additionally, the government employs housing supply policies, which greatly impact the housing market. Housing provision is a lengthy and capital-intensive process. Korea supplies most of the new housing through a system known as the pre-sale policy. In fact, this system has consistently faced the challenge of overheating subscriptions for over 40 years. In light of the current housing market dynamics, Chapter 3 explores possible improvements to the existing housing supply policy.

As for the effect of financial regulation, the policy that lowers the upper limit of the LTV ratio from 70% to 40% reduces household loans by more than 31% while increasing the relative price of housing by 0.005%. If the upper limit on LTV ratios is lowered, households experience a low productivity shock, making it difficult to maintain consumption levels by increasing mortgage lending when incomes fall. As a result, they are motivated to increase savings. When the capital stock in the model economy increases due to the increase in household savings, the real interest rate falls. Wealthy households with relatively large amounts of assets reduce the share of financial assets in their asset portfolios and increase the share of housing because the real interest rate, which is the rate of return on investment in financial assets, has fallen.

The analysis in this study reveals that policies tightening household lending regulations do not effectively curtail housing prices in the long run. If the goal is long-term price stabilization, the study suggests that increasing the supply of new housing is more effective than suppressing housing demand through stricter lending regulations.

Lastly, the study proposes a new policy model for improving housing supply, especially for the younger demographic. This model seeks to address both the housing service and investment needs of younger people. Regarding public offerings and transactions of fractional ownership, housing demand is categorized into the demand for residential services and the demand for investment in housing assets. In the current pre-sale subscription method, the share of the house is divided, and public offering subscriptions are received. This method distributes shares to each subscriber in proportion to the competition rate for subscriptions. In this scenario, new housing is provided to young adults as rental properties in line with the existing subscription method to meet the need for residential demand.

Summary

Research Monograph KOR Financial Innovation and Reform in the Era of Digital Transformation

Since the financial sector restructuring after the 1997 crisis and the international financial reform after the 2008 global financial crisis completed with a well stabilized system, the main policy attention has shifted towards financial innovation. In general, financial innovation refers to a series of deregulation or redesigning to enhance the convenience of financial services, strengthening the competitiveness of the financial industry. In contrast, financial innovation in the era of digital transformation is characterized by more specific and practical attempts to drive profound changes in financial services than the general financial innovation. With the convergence of ICT and finance, transaction costs are drastically reduced, and the processes constituting financial services are subdivided into detailed tasks which are combined and synthesized to new services, Such a new type of services are sometimes not subject to or even contradicting to the existing financial regulatory system.

The so called unbundling and rebundling of financial services in the process of financial innovation have brought about a large legal gray zone in financial activities, That is, newly attempted activities are not clearly judged as lawful because of its absence of the stipulated financial codes so as to be often unduly checked. Also, financial innovation where platform and data-based technology companies enter the financial markets makes the boundaries of the financial industry blurred (Big Blur) and shifts customer contact points with non-financial firms, weakening an intermediary function of traditional financial ones. Ultimately, innovation to converge ICT and finance requires changes in the financial markets, industry, and system itself so that financial authorities confronts with a situation in which they must decide switching to a new system. In this sense financial innovation in the era of digital transformation is not just deregulation in the existing sphere, but means a reform and redesign of regulations at the micro and macro level.

When digital finance becomes commonplace, the financial regulatory system will also face serious challenges. For example, virtual assets are not underpinned with a clear legal foundation but are traded like securities and geared with leverage, mimicking conventional banking and brokerage in the name of innovation. The ICT companies, which are ambiguous to be classified as financial firms under the current system, function as service providers in the financial markets, or even pursue a decentralized finance platform where financial service intermediary firms do not necessarily exist. Thus, it is not so early that policymakers set the agenda for financial innovation which is fulfilling and harmonizing with policy objectives such as consumer welfare and protection, financial industry competitiveness as well as systemic stability.

This study examines the development of financial innovations related to recent digital transformation and resulting emergence of new tasks and services, and proposes the direction of financial policies focusing on regulatory and supervisory challenges and reforms. It proposes detailed policy suggestions on how to regulate electronic payment industry and security token markets. It then deals with regulatory and supervisory issues on systemic stability and consumer protection in the prevalence of digital platform. It also argues the divergence of production and sales of financial services in the digital transformation and consequently long-time controversial debates over banking and commerce separation. Finally, it discusses a legal framework and financial policy approaches consistent with regulatory paradigm shift in the digital transformation.

Summary

Research Monograph KOR Digital Payment Innovation and Financial Consumer Protection

○ Even with weak legislative support, the digital economy is gaining momentum, propelled by the recent progress in contactless financial services and digital finance’s growing convergence with other sectors.
- As the primary legal framework for digital finance, the Electronic Financial Transactions Act (EFTA) had an amendment proposal in November 2020, but the bill is still pending at the National Assembly.
- Despite its vital importance in the Korean economy as a legal foundation for financial innovation, the EFTA has remained largely intact since its enactment in 2006 and has not been sufficient institutional support for critical technological changes like the rise of fintech and big tech.

○ Key point of the amendment is opening up payment services to non-banking financial institutions, such as tech firms (big tech) and credit card firms.
- Payment services are an essential amenity in our everyday life, encompassing payment for goods and services, cash deposit and withdrawal, salary transfer, domestic and foreign remittance, and utility bill payment.
- The amendment bill introduces a license of Comprehensive Payment Service Provider (CPSP), which is allowed to provide all payment services by directly offering a checking account like banks.
- Once the bill passes, some big tech firms as well as conventional nonbank financial institutions like credit card issuers are expected to get the license of CPSP.

○ The significance of payment services lies in that this sector is the basis for nonbank entities to expand into other areas, such as banking, insurance, and financial investment in the mid-to-long term.
- Because every economic activity involves the act of paying, CPSPs can accumulate vast user data.
- Also, these operators can bring in a massive amount of funds that customers deposit for payment transfers. Such funds can be used to launch new customized investment products or expand their business to other financial markets.

○ In the longer term, opening up digital payment services may thrust the financial industry to the next level by stimulating competition from within.
- A single app or metaverse platform is all it takes for users to carry out the whole array of financial services and e-commerce, not to mention payment transfers. Also foreseeable are crumbling barriers between different subsectors within the broad financial sector and spurring competition across the entire industry.

○ Some are rather pessimistic about the open-up because they perceive it as flinging open the door of banking; however, this study does not regard it as harming financial stability.
- The required regulatory level should be on par with banking regulations when deeming CPSPs as banks, but as nonbank payment service providers the degree of restrictiveness and protection would decrease.
- This study views the core function of banks as financial intermediation, which transfers customer deposits into illiquid loans. Since payment service operators cannot provide loans, it is reasonable to regard them as nonbank payment institutions (refer to Chapter 4).

○ On the other hand, financial consumer protection remains crucial agenda.
- Since most payment service users place their funds in demand deposit accounts, protecting these funds and guaranteeing service users’ rights are critical.
- The amendment bill contains some protective measures, but in the UK, where a similar scheme has been in operation, several payment service providers went bankrupt without returning customer funds.

Summary

Research Monograph KOR A Study on Insurance Resolution

This study theoretically and empirically analyzes key issues to be considered in improving the resolution system for insolvent insurance companies and offers policy implications. The coming adoption of the new International Financial Reporting Standard (IFRS) 17 as well as enforcement of the new capital regulation named Korean-Insurance Capital Stand (K-ICS) will likely expose the latent risk factors in domestic insurance firms and harm their financial soundness. Although a sudden, large rise in bankruptcy filings is improbable, there should be a sound institutional framework that could effectively handle the insolvency resolution in case of a default or bankruptcy of insurance firms considering the importance of the insurance industry in the financial system.

The existing approach for insolvency resolution heavily relies on government support. When an insurance company collapsed in the past, Korea usually responded with the "total portfolio transfer" (or run-off) method. In other words, a reinsurer assumed and accepted the insolvent insurer's contracts without modifications, and in the process, the government provided support like financial bailouts for the losses incurred to the reinsurer. The drawback of this government-dependent process is that it may lead to moral hazards among insurance policyholders and carriers and a fiscal burden to the government. That way, insurance consumers are not sufficiently motivated to care for the financial soundness of their insurers, and thus, the insurers have little incentive to improve their financial health. As a result, the government's fiscal burden increases as the probability and severity of insolvency grow.

The empirical analysis in this study also shows that insurance companies worldwide are highly reliant on their government. Per the analysis, should their countries' sovereign credit rating drop, so will the financial soundness of these insurers due to the accompanying reduction in the government's tacit protection for the insurance carriers. The insurance industry exhibits greater dependence on government in countries like Korea in particular, whose fiscal soundness is projected to deteriorate henceforth, or that do not issue a reserve currency, or whose insurance industry is large relative to the size of the national economy or public finance. The lesson learned is that Korea needs to improve its insolvency resolution system with stronger vigor.

Therefore, this study suggests the adoption of a new insolvency resolution regime in which policyholders are obliged to share some losses in case an insurance company collapses. As insurers' financial condition will become an important factor for consumers to consider before signing an insurance policy, the new regime can induce insurers to race for better financial health.

However, the loss-sharing regime may trigger a phenomenon called "insurance run," in which policyholders terminate their insurance contracts en masse. When a considerable number of policyholders end their contracts and exit the contractual relations altogether, it may negatively affect the business normalization of the insolvent carrier or the financial fitness of the firm acquiring the bankrupt company. The situation may exacerbate when the exit is more prevalent among relatively low-risk policyholders.

This study recommends the following policy responses in an overview of the theoretical and empirical analysis findings. First, caution should be taken not to seriously damage the continuity of original insurance contracts due to the loss-sharing requirement. In essence, insurance contracts are long-term contracts. Insurance premiums are paid at present to prepare for future insurable accidents. Especially for disease risk later in life, people purchase an insurance policy from a young age. The theoretical analysis revealed that it is desirable to set insurance premiums relative to expected risks, higher for younger and lower for older persons, for maximum social well-being. Thus, this premium structure should not be extensively altered under the loss-sharing regime. In this context, loss-sharing measures geared towards contract termination with less-profitable older policyholders in case an insurance firm goes out of business deserve reconsideration. That is to say, rather than terminating original insurance contracts with insolvent insurers, it would be advisable to keep them with minor modifications such as increasing premiums or reducing indemnity payment amounts in order to retain the contract continuity and share the losses.

Second, the loss-sharing ratio should be set at an appropriate level. The theoretical analysis shows that a higher ratio leads to contrary results: insurance firms can bring in more premium income (or pay less insurance money) from consumers retaining original contracts, but some policyholders bring them to an end. Such a trade-off should be taken into account when setting a proper ratio.

Third, a maximum of 10% requirement for loss sharing seems not to cause serious alarm for an insurance run. According to the survey analysis, it is highly probable that many insurance consumers regard the 10% requirement as lower than anticipated. Accordingly, only a few have expressed the intent to terminate their insurance contracts if so required.

Summary

Policy Study KOR Impact of Lowering the Legal Maximum Interest Rate and Policy Implications

This report estimates the effect of a cut in the legal maximum interest rate on loan application rate, loan approval rate, default probability, a ratio of borrowers whose interest rate is lowered, changes in consumer surplus, and changes in financial institution profits.

To this end, I conduct the structural model estimation to establish a demand model for financial consumers' loan application and repayment and a profit maximization model for financial institutions. After that, based on the estimation results, I present the results of a counter-factual analysis for each scenario of lowering the legal maximum interest rate and each scenario of raising the funding rate.

In all scenarios where the maximum interest rate is cut by 2%p from the 24% level to the 10% level, the reduction in consumer surplus of borrowers excluded from the market exceeds the increase in consumer surplus of borrowers whose interest rates decrease. Accordingly, further lowering of the legal maximum interest rate from the 24% level causes an average decrease in consumer surplus. On the other hand, the financial institution's profit also decreases in all scenarios. In addition, even when the funding interest rate increases at the fixed legal maximum interest rate level, consumer surplus decreases as the number of borrowers excluded from the market increases.

This means that the current policy support is essential to minimize the side effects of lowering the legal maximum interest rate. Also, the fact that an additional number of borrowers is excluded from the market when the funding rate of financial institutions rises implies the need to introduce a legal maximum interest rate system linked to the market interest rate.

Summary

Policy Study KOR Lessons from Financial Regulatory Sandbox on Financial Services Industry

The Financial Regulatory Sandbox was first implemented in the UK in 2016, and is adopted by many countries today. This is because it has a great advantage in that it is a way to reconcile both the positive aspects of innovation and the negative aspects of risk.

In Korea, financial regulatory sandbox were introduced through the Special Act on Financial Innovation Support in April 2019 to promote financial innovation while minimizing risks.

Financial regulatory sandbox seems to have a positive impact on the financial industry, including attracting investment from the venture capitals, increasing employment of fintech startups and existing financial institutions, and trying new innovative financial services. Fintech startups are analyzed to have attracted more than twice the amount of investment on average since the selection of financial regulatory sandbox, and employment has also increased, especially for IT personnel. Existing financial institutions are also known to be expanding their employment around IT personnel while using financial regulatory sandbox as part of their digital transformation, although the selection of financial regulatory sandbox is not the only cause. In addition, new financial services, such as the use of new technologies, convergence with heterogeneous industries, and non-face-to-face financial transactions, have emerged since the implementation of financial regulatory sandbox.

Analysts say that financial consumers are also positively evaluating financial regulatory sandbox. Users of innovative financial services appreciate the convenience and user experience of innovative financial services, and positively evaluate financial accessibility and low service prices, such as telecommunications and e-commerce data-based small business financial services.

However, innovative financial services selected as financial regulatory sandbox have not yet grown enough to shake the landscape of financial markets. There may be an impact of Covid-19, but many fintech startups are struggling with launching and scaling up innovative financial services, and face uncertainty over whether the service will continue after the end of the regulatory grace period.

In order for the financial regulatory sandbox to continue to promote innovation in the financial industry and enhance the benefits of financial consumers, it is imperative to pay more attention to FinTech startups after government selects them as financial innovators, reduce burden and improve procedures related to additional conditions, strengthen incentives for collaborations between FinTech startups and incumbents, resolve uncertainty on selection process.

In the meantime, many institutional studies of domestic financial regulatory sandbox have been attempted in relation to the introduction, but little has been done in terms of legal aspects of financial regulatory sandbox.

The UK operates regulatory sandbox within the discretion of financial authorities, but Korea established the 「Special Act on Financial Innovation Support」 to lay the legal basis for financial regulatory sandbox. This is because most of Korea's financial regulations are based on individual laws, and a separate legal basis is needed to designate a regulatory sandbox as an exception.

Our financial regulatory sandbox is either certification waver or temporary permits, but it is close to certification waver. The constitutional basis of the regulatory sandbox is the Article 119 of the 「Constitution」. The constitutional principle is closely related to the principle of equality. When there is no innovation, grants special status violates the principle of equality in relation to existing operators. Among the fundamental rights, it has to do with freedom of occupation. Meanwhile, the 「Framework Act on Administrative Regulations」 provides the legal basis for the special regulatory system in Article 19-3 as a basic law on administrative regulations.

The 「Special Act on Financial Innovation Support」 presents eight elements as criteria for the examination of certification waver. Service areas, innovation of services, consumer benefits, inevitability of regulatory exemptions, eligibility and capability of services, scope and business methods, consumer protection and risk management measures, stability of financial markets and financial order, and achievement of the purpose of financial laws. The most important element of this is innovation, which is also the justification of the exception.

The legal nature of the regulatory sandbox designation is a kind of special permission like charter. The existence of innovation, the increase in consumer benefits, the impact of financial market stability, and the feasibility of the business plan fall under the professional judgment of financial authorities, especially the Innovation Review Committee. Regulatory sandbox designation is invalid, if there is a merger or conversion. However, the effect of the designation may be maintained according to the business operator's application and the Financial Services Commission's permission. On the other hand, if sufficient testing is not done during the special period, the designation period of the special period may be extended.

When designating innovative financial services, the Financial Services Commission may attach conditions necessary for the protection of financial consumers and the stability of the financial market and financial market order. The type of the condition may be issued in various forms, such as conditions for deadline, burden, and reservation of the right to withdraw.

Of course, administrative procedures are also applied to the designation of innovative financial services under the 「Administrative Procedures Act」. Services that apply for innovative financial services are often fused with other industries as well as finance. Therefore, to designate an exception for the service, it must obtain consent from other jurisdictions. Designation of innovative financial services shall be subject to cancellation under certain conditions, such as failure to comply with the obligations accompanying the designation or violation of the enforcement regulations.

There is an Innovative Financial Review Committee as an examination body for the designation of innovative financial services. The Innovation Finance Review Committee reviews whether the services applied meet the permission criteria. In addition, the Financial Services Commission receives a decision as an advice by the Innovation Review Committee and makes a final designation in consideration of financial market conditions. If the Financial Services Commission designates an application that has not been reviewed by the Innovation Review Committee as an innovative financial service, it is a designation measure with significant defects, which is a reason for its invalidity.

Consumer protection is also an important factor in the designation of innovative financial services. The 「Special Act on Financial Innovation Support」 proposes consumer protection measures such as control of the amount of transactions, risk notices, dispute settlement, liability insurance, and personal information protection. The expansion of the insurance and fund system may be considered in preparation for the lack of self-sufficiency of liability for damages. On the other hand, the 「Special Act on Financial Innovation Support」 in relation to civil claims shifts the burden of proof by requiring operators to prove that they are not intentional or culpable, which is an important element of financial consumer protection.

Alternative dispute resolution(ADR) procedures are also in place to resolve disputes quickly between innovative financial services providers and consumers. On the other hand, if an application for the designation of an innovative financial business operator is rejected, it may be argued through a lawsuit for cancellation of the rejection. There is also a possibility of competitive litigation between businesses regarding exclusive operating rights.

In principle, this is subject to an information disclosure claim, but it is limited to the disclosure of information as it is likely to significantly harm the interests of corporations, etc. if disclosed in the 「Information Disclosure Act」.

Summary

Policy Study KOR Analysis of Market Discipline at the Capital Market: The Case of Korea

This paper analyzes how the size of firms, unrelated to inherent credit risks, influences firms’ access to capital markets. Specifically, we theoretically and empirically whether credit rating agencies (CRAs) unduly give favors to large-sized companies and conglomerates than small and mid-sized companies when CRAs evaluate default risks of these companies on their debts. In a simple theory model in a Bayesian persuasion framework, we find that CRAs have an incentive to generously underestimate default risks on the large-sized firms when these firms raise capital from bond markets more often than small and mid-sized firms, and thus become a very important client to CRAs. However, the bond buyers rationally infer the default risks on these large-sized companies with high credit rating, and thus charges a higher risk premium than they would to small and mid-sized companies conditional on the same financial conditions. Using a financial dataset in Korea, we document that the interest rates of bonds issued by mid-sized companies are in fact lower on average than those issued by large-sized companies. We further find that mid-sized companies are less likely to receive a high credit rating than the large-sized companies. These findings suggest that CRAs unfairly treat companies willing to issue bonds based on their sizes, thereby possibly distorting credit market structures.

Summary

Policy Study KOR Study on the Distribution of Income and Wealth and Household Debt

This study analyzes the relation between the rise in household debt and household characteristics such as income and assets using microdata on households. Based on the findings, implications are presented for the management of Korean households’ financial soundness and of the relevance of household debt to economic inequality.

The growth in household debt since the early 2000s is significantly associated with income and assets. On the one hand, in terms of income, bottom-income households have increased their debt relative to income by a big margin, possibly posing a threat to financial soundness. In addition, the rise in household debt is positively correlated with income growth, suggesting that the recent slowdown in debt growth is linked not only to the policies of tightening housing finance regulations, but also to the reduced income growth stemming from the macroeconomic slowdown. On the other hand, in terms of assets, households with larger assets exhibit a higher increase in their debt-to-income ratio compared to other households. The increase in household debt is positively correlated with the growth in real estate assets, which can be understood to mean that the increase in real estate assets is closely tied to the increase in household debt during the period in question. However, if the growth in real estate assets had been driven by temporary factors, it would be possible for the risk of debt default to increase as the real estate market would adjust.

The relevance between income growth and debt growth and between the growth in real estate assets and debt growth is stronger among households in the lower income quintile. This may be due in part to the increase in lifetime income, but considering the restrictions on their access to the financial market, the increase in income and real estate assets seems to have acted to mitigate those borrowing constraints. Meanwhile, in terms of real estate asset quintile, households in the middle and upper groups were found to take on more debt when their real estate assets grow, meaning that the interaction between asset growth and debt growth appears much stronger in the middle and upper groups.

According to the relative income hypothesis, it is expected that the larger the income inequality, the higher the increase in debt, particularly among low-income households. This study analyzes microdata on households to examine whether the increase in household debt is actually related to the economic inequality during the period since the early 2000s. When the data is compared by region, the analysis reveals no significant relevance between income inequality and the debt growth of low-income households in the same region. Also, there is no meaningful relevance between the inequality in household asset and debt growth in bottom-asset households. On the other hand, when the comparison is based on age group (nationwide), the analysis finds that low-income households of the same age group react to the income inequality within the group and respond by taking on more loans.

The recent slowdown in debt growth seems to be associated with the slowing growth in GDP as well as with the tighter mortgage regulations. But, as long as the real estate market is thriving, more debt may follow. Furthermore, the income gap within similar age groups may also likely drive up the debt in low-income households within the age groups. Accordingly, to induce a soft landing for household debt, the government should seek policy measures to stabilize the real estate market and to reduce the consumption gap stemming from income inequality in addition to tightening borrowing regulations.

Summary

Research Monograph KOR Impact of Easing Housing Finance Regulations on Borrowing Behavior

As the primary drivers of Korea’s swelling household debt and continued signs of an overheating in the housing market, many have pointed to the government’s use of the LTV and DTI ratios to ease housing finance regulations in August 2014, especially within the capital region. Indeed, although there was much interest in and debates over the impact of the easing at the time, there was little understanding of the actual effects. Accordingly, this study examines the impact of the easing of housing finance regulations on households’ decision-making, particularly in terms of borrowing behavior, home purchases and credit risk. To that end, this study uses household survey data and individual-level Credit Bureau (CB) data, and applies the difference -in-difference identification method which uses households in the capital region―who were subject to more expansive regulatory easing―as the experimental group. Subsequently, the impact of the eased regulations on the borrowing behavior of both households and individuals, demand for home purchases and debtors’ debt structure and credit risk was then analyzed.

Drawing on the Survey of Household Finances and Living Conditions, Chapter 2 examines how the regulatory easing affected households’ borrowing behavior and home purchasing decisions. In particular, the changes in borrowing behavior were connected to the changes in the number of homes owned in order to discern not only the impact on borrowing behavior but also the direct and indirect impact on the demand for home purchases. According to the results, the effects of regulatory easing were mainly centered around households with pre-existing mortgages. And in terms of the effect on housing demand, there was a considerable indirect effect of increased additional home purchases without loans as well as the direct effect of increased home purchases via mortgages. An additional analysis was also conducted on the differing impact of the eased regulations according to household characteristics such as age, net asset, income, multi-home ownership and LTV level.

Chapter 3 explores the effects of the LTV and DTI ratio-based regulatory easing on the demand for mortgages at the individual level using the CB’s credit data on individuals. Above all, efforts were made to understand the changes in borrowing behaviour as a result of regulatory easing in relation to the demand for home purchases and housing market conditions by including information on borrowers’ residence and on the housing market conditions of the region, even at the administrative division-level (dong). The results show that the probability of taking on another mortgage was more pronounced among those with pre-existing mortgages for both the purposes of buying homes and being used for living expenses. In addition, the impact of the regulatory easing varied depending on the regional housing market conditions of borrowers as well as on individual characteristics such as income; whether the individual was self-employed and; credit ratings.

Chapter 4 analyzes the relation between the eased regulations in the capital region (August 2014) and borrowers’ credit risk, and examines which credit group was more affected by the changes in credit risk. It was found that borrowers in the capital region were less likely to make late payments than their non-capital region counterparts, and that the impact was more obvious among low-income/low-credit debtors. This is because the regulatory easing was more focused on low-rate mortgages which could help lower the credit risk of borrowers who could afford to take on another mortgage. The analysis confirms that the reduction in credit risk resulting from regulatory easing was driven by the changes in borrowers’ debt structure which comes with the decrease in the proportion of high-cost loans and repayment burden.

Overall, this study examines the impact of the eased regulations on households’ borrowing, demand for home purchases and credit risk using micro-data analysis. It also provides significant implications for not only the comprehensive understanding of the impact of the easing but also for the effects of different household and individual characteristics, relevance to the housing market and specific implementation methods. By comprehensively taking into account the heterogeneous characteristics of borrowers and housing market conditions, this study attempts to contribute to the understanding of the ripple effects of regulatory policies and to enhancing the effectiveness of future policy designs.

Summary

KDI FOCUS Effects of Revolving Doors in the Financial Sector: Evidence from Korea

□ The revolving door practice, i.e. the recruitment of ex-regulators by regulated firms, has long been subject to criticism in Korea. Despite its importance, however, there are few studies on the economic impact of the revolving door. By applying a unique dataset of financial firms in Korea, it was found that the practice does not improve the financial soundness of the recruiting firms. Additionally, it was observed that firms, shortly after hiring former regulators, are less likely to receive regulatory penalties. This result appears to be associated with Korea’s financial supervisory system, wherein the majority of supervisory tasks are concentrated within a single agency.

- Despite the public’s criticism, there have been few empirical studies on the effects of the ‘revolving door’ practice.

- This study provides analysis of the economic impact of the revolving door for financial regulators in Korea.

- The ‘expertise hypothesis’ argues that former financial officials can contribute to improving the risk management of recruiterfirms due to the officials’expertise.

- The ‘collusion hypothesis’ claims that financial firms recruit former officials to seek unduly gains, such as evading regulatory enforcement.

- The empirical analysis found no indications of improvement in financial risk management performance after the appointment of former financial officials.

- The probability of receiving regulatory action after hiring ex-FSS regulators as executives decreases 16.4% and it is statistically significant, while the probability does not change significantly after hiring ex-regulators from other institutions.

- It is possible that executives who were formly in the FSS can help manage the nonfinancial risks. But, the empirical analysis found no indications of such a contribution when the probability of regulatory action decreased.

- In the US, financial companies with former financial officials as executives exhibited noticeable improvements in their financial soundness while no meaningful changes were found in the probability of regulatory action.

- Unlike the US’ decentralized task structure run by multiple authorities, Korea’s financial supervisory tasks are concentrated in a single institution.

- According to relevant studies, such a centralized structure could incur more incentives for collusive ties between the pertinent government authority and financial firms.

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