Bank of Korea Revamps Liquidity Management Framework

The Bank of Korea (BOK) has announced a significant update to its open market operation framework, effective from July 10. This change introduces a more structured approach to managing liquidity, with scheduled buying and selling of repurchase agreements (repos) on fixed days. Under the new system, 14-day repo purchases will occur every Tuesday, replacing the previous model that primarily used 7-day repo sales on Thursdays and irregular repo buys. This shift aims to create a more stable and predictable framework for liquidity management in the domestic financial system.

The update comes in response to evolving conditions in South Korea’s financial landscape, particularly changes in external economic flows. The central bank cited declining current account surpluses and rising outbound investments as key factors influencing this decision. These changes have led to reduced inflows of foreign capital and increased uncertainty in short-term funding demands. The revised framework is designed to help the BOK address these new dynamics more efficiently and with better timing.

A central goal of the reform is to better control short-term market interest rates amid rising volatility. The updated framework allows for quicker responses to rate fluctuations, addressing the structural decline in liquidity absorption needs. The BOK hopes that more balanced repo transactions will reduce market pressures and help stabilize short-term borrowing costs. Gong Dae-heui, who heads the BOK’s open market operations team, emphasized that current volatility is a primary concern, and the new framework aims to mitigate these issues.

Open market operations remain the BOK’s main tool for managing liquidity and setting short-term rates. These operations include the sale and purchase of government and policy bank bonds with financial institutions, aiming to keep the overnight call rate close to the central bank’s target rate. Other liquidity tools include the issuance of Monetary Stabilization Bonds and commercial deposit management through the Monetary Stabilization Account. These tools ensure a consistent flow of money in the financial system.

To support the new schedule of repo purchases, the BOK will expand acceptable collateral options. Besides government and government-guaranteed bonds, it will now include securities from three major policy banks: the Korea Development Bank, Industrial Bank of Korea, and Export-Import Bank of Korea. This expansion gives financial institutions more flexibility when participating in repo operations, enhancing the overall efficiency of transactions under the revised operational structure.

The central bank will also revise eligibility requirements for institutions involved in its operations starting in August. These new rules aim to broaden participation and ensure smoother functioning of the market framework. The BOK mentioned changes will be made to its incentive system, though details are not yet available. These changes are part of a larger scheme for maintaining monetary control in an evolving financial environment, showing a shift to help more stable money market operations.