Following the 13^th “Emergency Economy and Public Welfare Meeting” held by the Korean Government on February 15, 2023, the Financial Supervisory Service (the “FSS”) formed a Task Force (the “TF”) to improve the banking sector’s management, business practices and system on February 17, 2023. On July 15, 2023, the TF proposed its improvement plans, which include a stress capital buffer requirement that increases banks’ ability to absorb losses. The relevant regulations will be amended so that this new requirement can be implemented starting from the end of 2024.

The stress capital buffer is a policy under which financial regulators impose additional capital reserve requirements if a bank’s or a bank holding company’s internal stress tests show that their Common Equity Tier 1 (“CET1”) ratio falls below a certain level. The regulatory capital requirement consists of the following: (i) minimum capital requirement, (ii) capital conservation buffer, (iii) capital surcharge for Domestic Systemically Important Banks (“D-SIB”), (iv) countercyclical capital buffer, and (v) stress capital buffer. Unlike other regulatory capital requirements, the stress capital buffer level differs from bank to bank.

Specifically, the applicable level of stress capital buffer will vary depending on the FSS’s risk assessment of each bank and bank holding company. Therefore, pursuant to Article 29 of the Detailed Supervisory Regulations of the Banking Industry (the “DSRBI”) and Article 12-3 of the Detailed Supervisory Regulations on Financial Holding Companies (the “DSRFHC”), the FSS has been conducting risk assessments on banks and bank holding companies since the second quarter of 2024. Risk assessment ratings are categorized into five tiers, ranging from Level 1 (“excellent”) to Level 5 (“dangerous”). Each tier is further classified into 15 sub-levels.

The FSS’s risk assessment will include both quantitative and non-quantitative components based on the DSRBI and DSRFHC. Greater emphasis will be given to non-quantitative components (70% of the evaluation score) compared to quantitative components (30% of the evaluation score). The non-quantitative assessment will be made in five areas: (i) risk governance and management policy (“G”), (ii) capital adequacy (“C”), (iii) liquidity (“L”), (iv) risk management (“R”), and (v) stress testing (“S”). As the FSS’s risk management assessment will likely be a multi-faceted evaluation with a focus on non-quantitative components, banks and bank holding companies will need to strengthen their risk management practices by taking into account the FSS’s assessment plan.

The FSS’s initiative to strengthen the banking sector’s ability to absorb losses has led to the introduction of the countercyclical capital buffer requirement in May 2024, and the stress capital buffer requirement, which will be introduced starting from the end of this year. In light of the above mentioned circumstances, it has become important for banks and bank holding companies to manage capital adequacy ratios from higher regulatory capital requirements. Banks may even need to reduce their dividend pay-outs depending on the level of stress capital buffer they are required to maintain.

The stress capital buffer will vary from bank to bank depending on the FSS’s risk assessment results. Moreover, considering the risk assessment’s focus on non-quantitative components, banks and bank holding companies are advised to thoroughly prepare for the FSS’s risk assessment to minimize their stress capital buffer.

[Korean Version]